I recently wrote an update on the Royce Value Trust (RVT) and a reader asked if I have any thoughts on the Royce Micro-Cap Trust (NYSE:RMT), RVT’s smaller sibling fund.
Unsurprisingly, the RMT fund shares many of the same qualities as the RVT fund, as they are both managed by Chuck Royce and his team. The RMT fund has outperformed the Russell 2000 index on most time frames. I also like RMT’s managed distribution policy that ensures the fund’s attractive distribution is sustainable. Overall, I rate the RMT fund a buy.
Fund Overview
The Royce Micro-Cap Trust is a closed-end fund (“CEF”) providing exposure to micro-cap stocks, i.e. those that typically have less than $500 million in market cap. Micro-cap stocks tend to have greater volatility and are thus inherently riskier. Furthermore, there is usually limited information available on micro-cap companies, as they are not large enough for investment banks to launch research coverage. So it is usually up to the investor to do their own due diligence to avoid fraudulent stocks and other potential pitfalls. At the same time, micro-caps can offer huge rewards, as there is a larger potential for security mispricings given the limited research coverage.
The RMT fund has $465 million in net assets and has been in operation since 1993.
Strategy
Chuck Royce, the renowned small- and micro-cap investing expert managing the RMT fund describes the fund’s strategy as:
“Our task is to scour the large and diverse universe of micro-cap companies for businesses that look mispriced and underappreciated, with the caveat being that they must also have a discernible margin of safety. We are looking for stocks trading at a discount to our estimate of their worth as businesses.”
Basically, the Royce Micro-Cap Trust takes a value oriented approach to look for underappreciated companies trading at a discount to intrinsic value.
Portfolio Holdings
RMT’s portfolio has 276 holdings with an average market cap of $676 million. Figure 1 shows RMT’s sector allocation, with Information Technology being the largest sector weight at 22.1%, followed by Industrials at 19.0% and Financials at 14.5%. Health Care at 12.1% and Energy at 8.2% round out the five largest sectors.
Returns
The RMT fund has a strong return history, outperforming the Russell 2000 Index and Russell Microcap Index on most time frames (Figure 2). On an absolute basis, the RMT fund has returned 11.6%/4.6%/8.2% on a 3/5/10Yr timeframe to September 30, 2023.
Similar to the RVT fund, the RMT fund outperforms in the long-run by being incrementally better than the market, year-in and year-out. While the year-to-year difference can be small, compounded over a long horizon, investors in the RMT fund would have beaten the Russell 2000 Index by a cumulative 74% since inception (Figure 3).
In fact, comparing between the RMT fund and the RVT fund, the RMT fund has actually performed better than the Royce Value Trust, which has only returned 8.5%/5.4%/7.6% on a 3/5/10yr time horizon (Figure 4).
Another interesting fact with the RMT fund is that it has roughly the same volatility as the Russell 2000 Index, but has significantly higher returns (Figure 5).
In contrast, the RVT fund has lower volatility, and higher returns, but less than that of the RMT fund (Figure 6).
Distribution & Yield
Similar to the RVT fund, the Royce Micro-Cap Trust follows a managed distribution policy (“MDP”), paying a quarterly distribution at an annual rate of 7% of the average of the prior four quarter-end net asset values (“NAV”).
In the trailing 12 months, this has worked out to a $0.80 / share distribution or a 9.7% yield (Figure 7).
What I like most about Royce’s managed distribution policy is that it is both attractive and sustainable. In periods when the fund has strong investment performance, the MDP ensures that unit holders are rewarded with rising distributions. When markets are down and investment performance is poor, the MDP naturally reduces the distribution rate, ensuring the RMT fund does not continue to pay out unsustainable distributions that deplete the fund’s NAV.
Furthermore, for investors who do not need their cash distributions, Royce offers a distribution re-investment plan (“DRIP”) that allows investors to reinvest their distributions into shares at the lower of market price or NAV. For the most recent quarter, this reinvestment was at $8.50 versus the $9.81 NAV on the ex-date, September 8, 2023 (Figure 8).
RMT vs. RVT
Comparing between the Royce Micro-Cap Trust and the Royce Value Trust, in terms of structure, the RMT is a smaller fund, with only $465 million in assets versus $1.66 billion for RVT. This leads to the RMT fund having a higher expense ratio of 1.35% (Figure 9). Both funds are more expensive than a passive ETF like the iShares Russell 2000 ETF (IWM).
In terms of returns, the RMT fund has outperformed the RVT fund, with a 3 year total return of 24.4% vs. RVT at 17.1% and IWM at 8.9% (Figure 10).
The difference in returns is not as pronounced on longer-term horizons, with RMT returning 103.2% in the past 10 years vs. 92.2% for RVT and 77.5% for IWM (Figure 11).
However, as discussed in Figure 5 and 6 above, the RVT fund has a lower volatility than the RMT fund.
I believe both the RMT and RVT are solid long-term investment funds focusing on small-cap equities. For more aggressive investors, the RMT is recommended as it delivers superior returns with similar volatilities to the benchmark index. For more conservative investors, the RVT is recommended, as it has lower volatility and higher returns than the Russell 2000 Index.
Conclusion
The Royce Micro-Cap Trust is a CEF focused on investments in the micro-cap space. The RMT fund shares many of the same qualities that I fund appealing with the Royce Value Trust. Both funds are well managed and provide an attractive distribution yield that are sustainable.
The RMT fund is recommended for investors who have a higher risk tolerance, as it delivers superior returns with similar risk to the Russell 2000 Index. The RVT fund delivers lower volatilities and better returns than the Russell 2000 Index, but lower than the RMT fund. I believe the RVT fund is more suitable for conservative investors. I rate the RMT fund a buy.
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