Royce European Smaller Companies Fund Managers Scoop Up Bargain Stocks
Royce European Smaller Companies (symbol RISCX) has deftly tiptoed around the European debt crisis. For instance, because so many European banks are in bad shape, the fund's managers, Chuck Royce and David Nadel, avoid most financial companies and hold 9.5% of the fund’s assets in precious-metals stocks. Says Nadel: "Everything those companies make is in finite supply, whereas Europe's approach to its paper currency implies that there is an infinite supply [of euros]."
Nadel and Royce, who have been investing in small-company value stocks for decades, also favor exporters that sell to consumers in emerging markets. Growing wealth in developing nations enables their citizens to spend more. By contrast, European consumers are buried in debt.
The Royce fund is the top fund in its category over the past year. It returned 43.2% over the past year through April 27, beating its peer group by an average of 20.2 percentage points. Over the past three years the fund gained 8.2% annualized, trumping other European stock funds by an average of 10.9 percentage points per year.
While many investors chase after the next hot thing to make a quick buck, Nadel and Royce search for companies they can invest in for three to five years. They hunt for firms with market values of $250 million to $5 billion whose stock prices have been beaten down. And while news about the debt crisis in places such as Ireland and Portugal has caused selloffs in some European stocks from time to time, the dips create bargains for Royce and Nadel to scoop up. “The headlines on Europe are so negative that it’s inevitable that the stocks get hit,” says Nadel. Those declines, he adds, are often temporary.
Nadel and Royce prefer companies with dominant market shares and strong balance sheets that generate returns on capital (profits relative to how much is invested in the business) of 15% or more. The managers also look for companies that have survived multiple recessions and are expanding through existing operations rather than by acquiring other firms. They especially favor industrial and manufacturing companies because it’s easier for these types of firms to maintain prices for their products. “We’re not looking for earnings surprises,” says Nadel. “We’re looking for consistent cash flow.”
While many investors remain concerned about excessive debt loads in some European countries, Nadel is also starting to worry about an uptick in inflation, a byproduct of the European Central Bank’s easy-money policies. To cushion their portfolio against rising prices, Nadel and Royce are investing in agriculture-related companies, energy-services providers and companies tied to hard assets, such as gold and silver miners.
Other areas the managers favor include industrials and technology and health care companies. The fund has virtually no exposure to telecommunications companies, utilities or banks. Although the fiscal situation of individual countries isn’t much more precarious than that of the U.S., Nadel says, European banks are in far worse shape than U.S. banks because they were never forced to recapitalize the way American banks were during the global financial crisis.
Among the fund’s top holdings are German industrial company Pfeiffer Vacuum and Semperit, an Austrian firm that is the world’s leading maker of escalator handrails. The fund recently had 82% of its assets in Western Europe, with the bulk of it in the United Kingdom, France, Germany and Switzerland. It had 11% in Africa and other non-European countries. And the managers had 7% in cash, which can be used to scoop up bargains.
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