Fund Performance

Royce International Premier Fund declined -4.7% for the year-to-date period ended 6/30/24, lagging its benchmark, the MSCI ACWI ex USA Small Cap Index, which was up 2.8% for the same period. And while the Fund was behind the benchmark for the 1-, 5-, and 10-year periods ended 6/30/24, it beat the benchmark for the since inception (12/31/10) period ended 6/30/24.

What Worked... and What Didn’t

Five of the portfolio’s eight equity sectors made a negative impact on 2024’s first-half performance, with the largest detractions coming from Information Technology, Health Care, and Materials while the only positive impacts came from Real Estate, Communication Services, and Financials. At the industry level, software (Information Technology), health care providers & services (Health Care), and chemicals (Materials) detracted most, while commercial services & supplies (Industrials), electronic equipment, instruments & components (Information Technology), and professional services (Industrials) were the largest contributors. At the country level, Japan, Canada, and Australia detracted most for the year-to-date period, while Sweden, South Korea, and Poland were the largest contributors.

The portfolio’s top detractor at the position level in the first half of 2024 was CVS Group, a U.K. listed company that is one of the leading providers of veterinary healthcare in the U.K. The company also operates an online retail store, diagnostic laboratories, and crematoria, offering a ‘cradle to grave’ value proposition to its customers. One of the key attractions of CVS is its diversified customer base that has proven to be both very loyal and price inelastic. The company serves more than a million pets annually, while its services cost pet owners a few hundred pounds a year, a price they consider well worth the health of their companion animals which are increasingly viewed as a part of the family. We believe CVS will continue to benefit from an aging cohort of young pets acquired during the pandemic that will require more expensive care. More important, CVS has long been a consolidator of its industry. With corporate ownership of the U.K. vet industry having increased from under 20% in 2009 to 60% today, CVS has now set its sights on the rest of the world, recently expanding into Australia, another sizeable market where corporate ownership is still just 15%.

In March 2024, the U.K.’s Competition Markets Authority (CMA) announced that it was extending its industry-wide review due to the industry’s persistent price hikes through the COVID pandemic and the CMA’s view that competition is inadequate in certain regions. This extension may last another 18 months during which the CMA will conduct further diligence to ensure consumers have access to adequate information and competitive alternatives when making decisions about their pets. Additional uncertainty around the outcome of the investigation has caused CVS’s stock price to fall more than 50% since the CMA initially announced its review in September of 2023. While the range of potential outcomes is wide, due diligence with industry experts suggests that industry participants have not engaged in egregious business practices, excess profit taking, or anti-competitive behavior, and that remedies will primarily entail added transparency, a view reinforced by the former Legal Director and Director of Mergers at the CMA. We continue to believe that the current share price significantly understates the value of the enterprise and have thus added to our position to reduce our cost basis in the stock.

Listed in Italy, Carel Industries is a family owned, global leader in the manufacture of niche electronic components such as controllers, sensors, and software for original equipment manufacturers in the HVAC and refrigeration sectors. Its products help air conditioners, humidifiers, and heat exchangers work more intelligently and effectively, resulting in improved energy efficiency and lower total cost of ownership. Further, Carel’s solutions are designed into customers’ end products over multi-year development cycles, resulting in high switching costs and enduring customer relationships. Tough comparables and a slowdown in the European heat pump market put pressure on its stock price in the first half. Despite these near-term macroeconomic headwinds, Carel has stayed true to its long-term focus by continuing to invest in R&D to strengthen its competitive positioning while maintaining a conversative balance sheet. We believe the long-term demand outlook for Carel’s solutions remains strong, supported by growing energy efficiency measures and increasingly stringent regulations, while recent industry data points reassuringly indicate green shoots of a macroeconomic recovery in its end markets.

Listed in Belgium, Azelis Group is a global leader in specialty chemicals distribution and sits between 2,700 suppliers selling more than 110,000 unique products to 59,000 customers ranging from industrial to life sciences and consumer goods companies. Azelis enjoys longstanding and often exclusive relationships with suppliers who view the company as an extension of their own salesforces, serving the tens of thousands of customers to whom they would otherwise find it uneconomical to sell directly while Azelis’s customers view it as a one-stop-shop for their chemical needs, as well as value-added services such as product formulation support. Because specialty chemicals account for a low percentage of the cost of the end product but determine its key characteristics, they are very rarely switched out once designed into a formulation, resulting in enduring customer relationships. Its shares were weak in the first half due to an industry-wide growth slowdown. As a business operating a volume-based revenue model, periods of choppy growth are not uncommon for Azelis, particularly after almost two years of disruption from destocking effects, inflation, and supply chain bottlenecks. Its business fundamentals remain intact, however, with supplier and customer retention rates high and unchanged, and cash conversion healthy at more than 90% with free cash flow margins exceeding 45%. Meanwhile, the specialty chemical distribution market remains highly fragmented and therefore ripe for consolidation, with the top four players, including Azelis, holding just 10% market share; the rest of the market is occupied by more than 20,000 local mom-and-pop operators. We see Azelis as a leading consolidator and an attractive home for sellers given its successful M&A track record, having acquired more than 100 companies in the past 20 years.

The top contributing position was the U.K.’s Marlowe, a B2B company that offers a wide range of services and related software such as the testing and certification of fire safety systems, HR compliance and e-learning software, and audits to ensure compliance with environmental regulations. We like the way in which its essential and mandated services are sold into the operating budgets of a highly fragmented customer base of more than 40,000 companies, which in turn creates longstanding customer relationships that average 12 years. This structure gives its businesses recurring or highly predictable revenues amounting to approximately 85% of the group total. Marlowe is also a leading consolidator of its large and fragmented addressable markets and typically re-deploys its ample cash flows into attractively priced, bolt-on acquisitions that in turn leads to logical cross-selling opportunities and scale advantages. Marlowe’s share price rallied in the first half of the year thanks to the conclusion of its strategic review that was announced late last year. In February, Marlowe reported that a private equity buyer had agreed to acquire its Governance, Risk & Compliance (GRC) segment, which accounted for approximately 40% of Group earnings before interest, taxes, depreciation & amortization (“EBITDA”), for roughly ?4,300 million, the equivalent of more than 16x this segment’s EBITDA and more than 120% of Marlowe’s market capitalization. The proceeds have been used to pay off all debt, return a special dividend of ?150 million to shareholders, and commence a ?75 million share buyback program. We believe that, while this transaction has crystallized substantial near-term value for shareholders, the valuation of the remaining Testing, Inspection and Certification (“TIC”) business still provides significant future upside. At roughly 6x enterprise value to EBITDA, the business trades at a substantial discount to its peers, which trade at closer to 11x. In the meantime, we continue to be attracted to the key business attributes of the TIC business while Marlowe’s now debt-free position will enable it to continue to act as a long-term consolidator of its end markets.

Listed in Sweden, Karnov Group is known as the “Bloomberg of legal information services,” providing legal, tax, and accounting data to law firms, tax and accounting firms, corporations, and the public sector. The company generates 85% recurring revenue from ongoing subscription fees, and Karnov enjoys very low customer churn of just 3% annually due to the low-cost but mission-critical nature of its data. In May, shares in Karnov rose more than 30% in local currency terms as the company was subject to a take-over bid by a consortium of investors at a 28% premium to the prevailing price. The stock then gave up some of these gains in mid-June when the deal fell through. Notably, the offer had been accepted by only 26% of Karnov shareholders, far from the 90% needed to complete the transaction and indicative of the significant value that existing Karnov shareholders associate with this high-quality asset. While we had decided to trim our shareholding in May when the shares were trading above the offer price and were thus able to lock in profits significantly above current levels, we continue to have conviction in the long-term prospects for Karnov and thus remain happy shareholders in the business.

Another holding based in Sweden, Alimak Group is the global leader in providing hoists, work platforms, and elevators used by construction companies to transport people and materials, by building owners to access building facades for cleaning and repairs, and by industrial companies for safety and operational inspections. Alimak’s products are mission-critical to customers’ workflows but account for a low cost of their budgets, while a significant proportion of its products are customized for each end-application, which disincentivizes customers from switching. Finally, Alimak generates approximately 70% of profits from aftermarket services such as spare part replacements and repairs, which ensures a relatively predictable and stable profit base. Its shares appreciated strongly in the first half despite weak underlying demand in its end markets. The company has been able to maintain mid-teens profit margins, generate strong cash flows, and de-lever its balance sheet, highlighting the resilience of the business in times of macroeconomic weakness. We also believe Alimak benefited from increased institutional discovery as a reputable pan-European broker in February initiated coverage with a Buy rating with 38% upside.

The portfolio’s disadvantage versus the MSCI ACWI ex USA Small Cap was attributable to stock selection in the year-to-date period ended 6/30/24—sector allocation decisions were additive. At the sector level, stock selection hurt most in Information Technology, Industrials, and Health Care. Conversely, our substantially lower weighting in Real Estate, lower exposure to Consumer Staples, and stock selection in Communication Services all boosted relative performance in the first half of 2024.

Current Positioning and Outlook

The Fund’s recent performance has been disappointing, though we are confident that such underperformance relates overwhelmingly to factor headwinds associated with the high-quality companies in which we invest. We also understand the desire for clarity around when these headwinds may turn into tailwinds. Though we cannot predict the timing of shifts in market behavior, we firmly believe that the performance mean reversion, when it comes, will be significant: high return on invested capital companies in aggregate are still far from generating the levels of outperformance seen in the past, bond yields remain elevated, and the ongoing strength in the U.S. dollar means foreign currencies like the Japanese Yen now trade at discounts of more than 40% to their purchasing power parity-implied exchange rates. Meanwhile, the Fund’s holdings were trading at significant valuation discounts to the benchmark at the end of June despite their superior returns—a fact that remained appreciated and exploited by private market investors. The second quarter thus marked the seventh consecutive quarter of take-private activity for portfolio holdings, with two take-private bids received. What made this quarter different, however, is that neither deal was consummated because in both cases shareholders aggressively and publicly rejected the take-private approaches, even when in one case the premium offered was nearly 70%. Such results indicate that the dislocation between the underlying value of our holdings and their current valuations has become so pronounced that patient shareholders are no longer willing to forgo the long-term potential gains even for substantial short-term profits. Meanwhile, we continue to focus on identifying opportunities to upgrade the portfolio’s holdings, including via the addition of three high-quality companies during the second quarter. Despite the Fund’s performance challenges, we have never been more optimistic about the future.

Average Annual Total Returns Through 06/30/24 (%)

Annual Operating Expenses: Gross 1.61 Net 1.44

¹ Not annualized.

Important Performance, Expense and Disclosure Information