Legg Mason IF Royce US Smaller Companies: April 2020 fund update

• The fund is managed by Lauren Romeo, who is supported by a highly experienced team at Royce
• Romeo is required to invest in her own fund and is rewarded based on its long term performance, aligning her interests with investors
• The fund offers a differentiated approach to a lot of other US equity funds which means it has the potential to perform quite differently

How it fits in a portfolio

The fund aims to deliver long-term growth by investing in unloved high-risk smaller companies. It could be a good addition to a portfolio with little invested in the US, or work well alongside other US funds focused on larger, more growth-style companies.

Manager

The fund is managed by Lauren Romeo, she’s been at Royce and Associates since 2004 and has been manager of the fund since 2011. We like the Royce team’s disciplined approach, and Lauren is supported by a team with bags of experience, including the firm’s founder Chuck Royce who has been investing client money since 1972.

Process

Romeo looks to invest in companies that are unpopular with investors and aims to buy shares at a price significantly lower than she feels they’re actually worth. The companies Romeo's looking for could well be facing headwinds, so it's important they don't have too much debt. Romeo and her team spend a lot of time meeting with a company's managers to make sure they've got the skill and experience to turn the business around. They also speak to customers, suppliers and competitors to make sure the managers are actually executing their plan.

This analysis leads Romeo’s team to decide what they think a company's shares should be worth. She thinks this process can provide opportunities to spot companies that are undervalued which can then give the fund some margin of safety when times are difficult.

They won't get it right every time though and even when they do, it can take some time for other investors to realise the opportunity and to see the share price rise. This means that there will be periods where the fund underperforms and seems at odds with the wider market, so this style of investing requires patience.

Culture

Smaller-company value investing is Royce's specialism – it’s what they do and is where their expertise lies. This single focus distinguishes the firm from other asset managers in the US.

Fund managers at Royce are required to invest substantial amounts in the funds they run and have variable bonuses based on the long term performance of their fund. We feel this is a positive and ensures alignment with the interests of investors. Additionally, Legg Mason’s ownership of Royce means that the fund benefits from a multi layered approach to risk management adding rigour.

Romeo also considers ESG (Environmental, Social and Governance) issues when researching individual companies. She thinks that these factors have the potential to affect the long term value of the investment and thinks sound understanding of how these factors could affect businesses is an important part of managing risk in the fund.

Cost

The fund has an ongoing annual charge of 0.98%, but we’ve secured HL clients an ongoing saving of 0.33%. This means you’ll pay a net ongoing charge of 0.65%. The fund discount is achieved through a loyalty bonus, which could be subject to tax if held outside an ISA or SIPP. The HL platform fee of up to 0.45% per year also applies.

Performance

The fund’s made attractive returns since the financial crisis but has not managed to keep up with the broader US market. Performance has been disappointing over this period and we would have expected the fund to perform better given the manager’s bias towards higher-quality smaller companies. But we think it’s important to take into account the managers strategy and focus on valuation and we continue to believe that the fund harnesses the skill of a talented team with a sensible investment approach.

It’s important to remember that the fund offers something quite different to some others with its focus on undervalued companies. The benefits of Romeo’s style were highlighted towards the end of 2018 when markets did fall. The fund lost money but not as much as its benchmark. So far this year, encompassing the recent coronavirus-related market volatility, the fund has performed similarly to its index, falling by 23.6% compared with a fall of 21.6% for the Russell 2000*. This is a very short timeframe to compare performance though, and it isn’t a guide to the future. Smaller companies are higher-risk than their larger counterparts.

*Source: Lipper IM 01/01/2020-17/04/2020

Past performance is not a guide to the future. Source: Lipper IM to 31/03/2020.

Find out more about Legg Mason IF Royce US Smaller Companies including charges

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