Fund name: Royce Dividend Value Fund (RYDVX)

Objective: The fund is after long-term growth plus current income. It invests in dividend-paying stocks in the micro- to mid-cap range, which translates to stocks with a capitalization under $5 billion. It can, in theory, also hold fixed income securities, such as convertible bonds.

Adviser: Royce & Associates, LLC which is owned by Legg Mason, though Royce retains autonomy over its investment process and day-to-day operations. Royce is a smaller-company value specialist with 30 funds (including closed-end and variable annuity accounts). It was founded by Mr. Royce in 1972 and now employs more than 100 people, including 29 investment professionals. As of 9/30/2009, Royce had $27 billion in assets under management.

Manager(s): Charles Royce and Jay Kaplan. Mr. Royce is firm’s founder, President and Chief Investment Officer. He also serves as Portfolio Manager or Co-Manager for Royce Pennsylvania Mutual, Premier, Total Return, Heritage, 100, Financial Services, Dividend Value, European Smaller-Companies, SMid-Cap Value, International Smaller-Companies and Partners funds. In total, he manages over $11 billion between 16 mutual funds, two "private pooled investment vehicles" (generally a synonym for hedge funds) and 11 other accounts. Mr. Kaplan joined Royce in 2000 as a Portfolio Manager; for the five years before that he managed Prudential Small Company Value with mixed results. Mr. Kaplan oversees about $4 billion including a five-star fund (Royce Capital Small-Cap) available only through insurance company annuities.

Management’s Stake in the Fund: Mr. Royce has over $100,000 in each of 16 Royce funds and somewhere over $500,000 in this fund. The Royce Family Trust owns nearly a third of the fund’s investment class (i.e., institutional) shares. Royce employees and board members own 14% of the service class (i.e., retail) shares. Mr. Kaplan has, as of July 2009, not invested a dime in the fund though he has more than a half million in each of the three other funds he manages.

Opening date: May 3, 2004.

Minimum investment: $2000 for regular accounts, $1000 for IRAs or accounts with AIPs.

Expense ratio: 1.49% after waivers, on $25 million in assets. Those waivers will expire on April 30, 2010 and expenses might rise by about 20 basis points thereafter. There is a 1% redemption fee for shares held for less than 180 days.

Comments: Clyde McGregor likes to describe his splendid Oakmark Equity & Income (OAKBX) fund as "the Oakmark fund with an airbag." This may not earn quite the same distinction but it is, at the very least "Royce with really good seatbelts and anti-lock brakes."

The fund comes with three important safety features: (1) Royce is uniformly committed to buying good companies for cheap. They note, "our portfolio managers share a common investment approach—one that emphasizes paying attention to risk and buying what each thinks are strong companies at attractively discounted prices." That discipline helped across the board during the cycle that began at the small-cap peak in 2007. Royce reports that, "Led by our more risk-averse funds, 11 of 13 Royce Funds outperformed the Russell 2000 during the decline." (2) Royce Dividend Value has a somewhat larger investable universe than many of the Royce funds, since it can hold mid-cap as well as small- and micro-cap stocks. About 15% of the portfolio is invested overseas, and that number can rise to 25%. The fund also holds a large number of stocks – about 160 in November 2009 – which minimizes the prospect of being hurt by any single position. The fund’s ten largest positions each accounts for a bit more than 1% of the portfolio. Finally (3) the focus on dividends provides down-market protection. Dividends help in three ways:

• They’ve always been an important contributor to a fund’s total returns (Eaton Vance and Standard & Poor’s separately calculated dividend’s long-term contribution at 33-50% of total returns);



• The dividends provide an ongoing source of cash for reinvestment, especially during downturns when investors might otherwise be reluctant to add to their positions; and,



• Dividends are often a useful signal of the underlying health of the company, and that helps investors decrease the prospect of having a position blow up.

The fund’s dividend yield of 3.8 – 4.3%, depending on how you calculate it, is higher than 10-year Treasuries are paying (as of 11/25/09) and more than twice the category average.

The result has been a remarkably robust portfolio:

• Royce Dividend Value Fund is consistently in the top 20% of small-blend funds: as of this writing, it holds that position for the trailing day, week, month, quarter, year, three years and five years. It’s a testament to the Royce culture that RYDVX has one of the family’s worst five-year records against its competition: it beat only 6 out of 7 peers while most Royce funds beat 9 out of 10.



• The fund finished in the top 20% of small-core funds during 2008’s meltdown.



• It also trounced its benchmark during 2009’s bloody first quarter, losing 9% to the index’s 14%.



• And it has outperformed its peer group every year since inception.
The fund has also outperformed its benchmark in every major decline since its inception. No surprise since it’s designed to hold up.



• It’s more striking that the fund has prospered during 2009’s melt-up. The fund returned 34% through Thanksgiving, placing it in the top 20% of small-core funds YTD. It also outgained both the Russell 2000 benchmark and its small-core peers between the March low on March 9 2009 and Thanksgiving.



• The fund dramatically outperformed its peers and benchmark for the cycle that began with the small-cap market peak (7/3/07) through Thanksgiving, 2009: RYDVX lost 9.5% while the Russell is down 23.7% and the small-core cohort is down 22.5%.

There are a couple concerns worth considering. One concern is Mr. Royce’s longevity. He’s 69 and manages more funds (16) than anyone I know of. While Mr. Royce has never publicly discussed retirement and there doubtless are a few older managers (Marty Whitman continues piloting Third Avenue at age 84), there are, at most, a few. Mr. Kaplan has done well managing Royce Capital Small-Cap on his own. From 2002-09, he turned a $10,000 investment into $20,500, beating his small blend peers by better than $4,000 without taking on any added risk. Presumably he’ll succeed Mr. Royce. That said, Mr. Royce has been uniquely successful in this field. A second concern relates to Legg Mason’s ownership of Royce. Legg bought Royce in October 2001. At the time of the acquisition, key personnel signed "long term agreements" to remain with Royce. It will be interesting to see whether the ten-year anniversary of Royce’s sale brings changes – in personnel or fees (Legg Mason is famous for usorious fees) – to Royce. Finally, the cap on fund expenses expires in the spring of 2010. At the moment, it looks like the expense ratio would go from "a bit steep" to "oh, geez" unless assets grow enough to spread the fixed costs about.

Bottom Line: RYDVX is an exceedingly strong option for investors looking for two things: (1) exposure to a broad range of smaller cap stocks – though not exclusively to small cap ones, and (2) strong downside protection. While all of Royce’s small cap funds are splendid, disciplined performers, this is only one of two funds (Total Return is the other) to earn Morningstar’s "low risk" designation. By Royce’s calculation, it’s one of its four least volatile funds. Lipper designates it a "Lipper Leader" both for Total Return and Capital Preservation. While the fund will probably lag during an extended small-cap bull market (and will be left in the dust during the market’s "froth and bother" phase), there are few more attractive choices for folks whose holding period is five or more years rather than just a year or so.