Royce Micro-Cap Trust (NYSE:RMT) is a closed-end fund with a history going back 27 years to 1993. Management notes that fund is one of the oldest and largest focused on the micro-cap segment. The fund takes an active fundamentals-based approach to investing in stocks with a market cap generally below $1 billion in capitalization. The focus is identifying companies that are intrinsically undervalued with strong fundamentals or have strong growth potential. The current composition includes 140 equity holdings with the underlying stocks presenting an average market cap of $446.5 million. Current total assets under management for the fund are at $375 million with an expense ratio at 1.35%.
Royce Micro-Cap Fund Holdings Exposure. Source: Royce Funds
The table below highlights the top 10 winners and losers year to date 2019 based on the holdings as of the end of Q1 with market data current from July 11 2019. Westport Fuel Systems (WPRT) with a market cap of $400 million and 0.34% weighting in the fund is the best performer in 2019, up an impressive 125.6%. Nautilus (NLS) with a 0.42% weighting is the biggest loser, down 83.9%. 80 of the 140 equity holdings or 57% have a positive return year to date, with the average winner up 28% compared to the average loser down 20%.
Year to date, RMT is up 15.3% on a total return basis, lagging broader market indexes like the S&P 500, which has returned 21%. Much of this return is based on the strong rebound compared to depressed levels of the stock market at the close of 2018. Volatility has been high among small- and micro-cap stocks over the past year. The total return for the fund is actually still down 13.3% over a one-year period highlighting the extreme volatility particularly in Q4 of 2018. It’s been a challenging environment for micro caps with over 50% of the current holdings in RMT down more than 20% from their respective 52-week highs.
A dynamic in the market has been to favor more defensive-type large-cap stocks with the perception of safe payout yields given emerging concerns over the growth outlook. We expect the environment for small caps to remain difficult as valuations are typically more sensitive to economic growth sentiment. Our view to favor quality, large-cap stocks.
RMT’s Mixed Relative Performance in Recent Years
We view the Russell Micro-Cap index as an appropriate benchmark for RMT. However, on the fund’s website, it also includes the larger Russell 2000 index in comparison, which helps for marketing purposes by highlighting certain metrics where RMT is stronger in one or the other. In reality, going back nearly 15 years since all three funds existed, with the inception of Russell Micro-Cap in the year 2000, the data shows mixed performance among the benchmarks over different periods. Royce includes the following comments:
Outperformed Russell 2000 for the 20-Year and since inception (12/14/93) periods as of 06/30/19. Outpaced Russell Microcap for the Quarter, 1-Year, 10-Year and 15-Year periods as of 06/30/19.
Average Annual Returns. Source: Royce Funds
The table above shows that over the past five years, the fund has significantly underperformed the Russell 2000 and Russell Micro-Cap Index. Separately, Russell 2000 in particular has materially diverged higher from micro-caps over the past one year. The cumulative impact of lower average annual total returns in RMT over the past five years has become significant. Based on the chart below, the total return performance of RMT along with the corresponding Russell ETFs – iShares Russell 2000 ETF (NYSE:IWM) and iShares Micro-Cap ETF (NYSE:IWC) – show RMT has returned 26.27% while IWM is up nearly 45% followed by IWC at 35%.
Going back to the near the highs of the previous bull market in 2007, RMT has also underperformed cumulatively in the 12 years since. RMT did in fact outperform the Russell Micro-Cap over the past 10 years. The overall relative returns will depend on the exact holding period. Our take is that Royce may have had some consistent alpha back in the 1990s and early 2000s, but more recently including the past five years has been unable to generate excess returns in the current market environment.
RMT Risk Metrics
The other consideration here is the relative risk measures to the comparable ETFs. RMT suffered a larger max drawdown during the last financial crisis, declining by 73.93% compared to 64.67% for IWC and 59.03% in IWM. RMT’s Sharpe ratio at 0.7878, a measure of risk-adjusted returns, is slightly higher than IWC’s 0.742, but lower than IWM’s 0.843. Daily and monthly value at risk “VaR” in RMT is also higher.
The market is in a constant state of rotation among different sectors, and equity styles like large-cap relative to small-cap and value versus growth factor stocks in relative terms. It’s possible RMT outperforms its benchmarks more significantly going forward, but our view is that there isn’t enough of a compelling reason to favor this closed-end-fund over comparable ETFs. Founder of the Royce Funds, Mr. Chuck Royce, is a pioneer in small-cap investing, while the current fund managers of the Micro-Cap Trust Fund still need to prove they can continue that legacy. Take a look at the fund prospectus for a full list of risks and disclosures.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.