The Scott Letter: Closed-End Fund Report©
Published by Closed-End Fund Advisors, Inc.

November 2001, Volume I, Issue 7
George Cole Scott, Editor

Interview with The Royce Funds

Net Average Total Returns for The Royce Closed-End Funds,
through September 30, 2001

Focus Trust
Value Trust
3rd Quarter 200120.29%    21.64%   18.15%    14.38%   
Year-to-Date11.23%    21.40%   15.48%    6.94%   
1-Year Average33.39%    21.10%   24.93%    0.66%   
3-Year Average8.59%    10.33%   12.69%    5.32%   
5-Year AverageN/A       14.21%   16.47%    9.62%   
Since Inception12.29%    14.69%   13.75%    13.50%   

Royce & Associates manages three closed-end funds: Royce Value Trust, the first small-cap value closed-end fund offering (1986); Royce Micro-Cap Trust, the only micro-cap closed-end fund (1993); and Royce Focus Trust, a closed-end fund that invests in a limited number of domestic and foreign companies (1996).

"For more than 25 years, our approach has focused on evaluating a company's current worth — our assessment of what we believe a knowledgeable buyer might pay to acquire the entire company or what we think the value of the company should be in the stock market. This analysis takes into consideration a number of relevant factors, including the company's future prospects. We select these securities using a risk-averse value approach, with the expectation that their market prices should increase toward our estimate of their current worth, resulting in capital appreciation for the fund."

CEFA interviewed Charles Royce on October 23, 2001.

Scott: It is good to talk to you after so long. We disbanded the old paid subscription Scott Letter in 1996. This new online letter gives you an idea of what we do. Investors call and e-mail us from all over the world. They look us up under closed-end funds and reach our web site, Closed-End Fund Advisors. We recently received e-mails from Egypt and London. We are also linked to the Closed-End Fund Association, our trade organization of which your own John Diederich is the current President. We send the newsletter to anyone who is interested at no charge. Late in 1996, I purchased the investment advisory from Frank Cappiello and moved it to Richmond in 1997.

Royce: Do you still run money?

Scott: Yes, as I have done so for over 30 years now. You and your staff do an excellent job of educating investors with your reports, which are very well done. You also have clear explanations of closed-end funds. You do a good job of telling your shareholders about the advantages of closed-end funds. In spite of all that, do you think people really understand what they are all about?

Royce: I would say that you are right on the money. People tend to ignore closed-end funds because, as you know, they are marketed and are sold not bought. After the transaction, brokers generally don't sell closed-end funds at the time of an initial public offering. Investment in closed-end funds requires a level of sophistication and understanding. They also are not evenly distributed in the investment world. You therefore get a more sophisticated investor in closed-end funds because they have to find you.

Scott: We agree. We get a lot of professional people like doctors and engineers contacting us. Do you think it is a kind of an elite thing?

Royce: It is a more sophisticated product, and it doesn't get the attention of the man on the street. We have to seek out our investors, and it requires someone who does his own thinking. This is because few brokers are recommending closed-end funds, as there is little commission in them.

Scott: For years I attended the Smith Barney closed-end country fund conference in New York. This radically changed last March when half of the conference was devoted to the new "exchange-traded funds" or "ETFs", which are a cross between a closed-end and mutual fund and are based on various indices.

Royce: We are interested in ETFs. They  are another layer of conversation but make sense too. They exist side by side with closed-end funds. There are four or five ETFs in the small-cap world. There is nothing wrong with ETFs for people who want them. We are an active manager, however, and want to have better returns than the indices on which the ETFs are based.

Scott: I attended the recent Investment Company Institute Fund Directors conference in Washington and found that a big part of it was the corporate governance issues relevant to the responsibilities of outside directors. This is the legacy of Arthur Levitt, the retired SEC Chairman. As you know, the prime responsibility of outside directors is to look out for the outside shareholders. At this conference, the pricing of securities was an important issue. Have you had any difficulty pricing your securities?

Royce: We use all the normal rules. If a security stopped trading, we go to what is called fair value pricing set by our pricing committee, composed of outside directors. We have found that we don't have many problems with pricing, and we don't have many international securities which have caused the majority of the problems in this area. We don't calculate the fund net asset values ourselves as we use State Street. Almost all of our stocks are tradable domestic stocks, so I don' t know where the error would be. It could be an error in the pricing system, but that is not a normal problem.

Scott: How do the objectives of your three funds differ?

Royce: The objectives are very clearly stated for each of the funds. Royce Value Trust, our largest fund, takes a broad brush and buys both small-cap and micro-cap stocks in a very diversified way. It is a good small-cap fund and has excellent returns versus the Russell 2000 index. Our Micro-Cap fund buys the smallest companies primarily under $400 million in market cap. The Royce Focus Trust uses a concentrated approach to invest in small and micro-cap securities.

Scott: What are your thoughts on the small-cap universe and the value stocks versus the growth guys at this point?

Royce: I think this will be the decade of the small-cap the same way the last decade was one of large-cap. It has started that way, and there is plenty of evidence that it can go on for some time. Small-caps were dramatically under-appreciated in the last go-around, and I think they will have a better time of it in this market cycle. In the 1990s, the mega and large-cap companies did the best and now the opposite is true. That is part of the normal cyclical processes that take place over time. History shows that some asset categories do well for periods, and then they fall out of favor as other categories take the lead. We have just concluded a speculative boom in mega-caps especially in the technology area.

Scott: Is this why some of the large-cap funds had a difficult time in the last two years?

Royce: Yes, but they were never swept away by the speculative part of it.

Scott: How many securities are in your universe?

Royce: There are about 8000 small and micro-cap securities in the U.S. which is our pricing universe.

Scott: You also have had rights offerings. Do you think your shareholders understand these offerings?

Royce: We have done small rights offerings to freshen-up the capital base to compensate for the dividends that are paid out to shareholders as not all of the dividends are reinvested. We have historically used rights offerings to provide fresh capital, and all of them were very small. We have not had any rights offerings for some time.

Scott: Tell us about the leverage you do with your preferred issues?

Royce: We continue to do this and have modest leverage. A preferred offering is a wonderful way to raise long-term capital at fixed rates where you do not have to worry about what the banks are doing and rates shifting around. The funds have had up to 10 or 15% of effective leverage, and I am very satisfied with preferred as part of the capital structure. It adds to the equation.

Scott: You also are one of the few closed-end funds that uses incentive fees. Would you tell me how yours work?

Royce: Sure. They are clearly spelled-out in our reports.  Royce Value Trust and Royce Micro-Cap Trust have a fulcrum fee, driven-off very long-term performance, three or five year returns. The structure is designed to compensate us well if we do well. There is a base fee of 1%, and we go up to 1½% or drop to one-half of a percent, depending to the fund's performance relative to its benchmark — the S&P 600 for Royce Value Trust. For the Micro-Cap Trust, we use the Russell 2000 index. Relative performance is measured over the trailing five years for Royce Value Trust and trailing three years for the Micro-Cap Trust

Scott: So, if you underperform there is no fee?

Royce: Yes, for Royce Value Trust. If we have at month-end an absolute return for the trailing 3-year period that is below zero, there is no fee. I think this is unique for the fund industry, and I believe in these kinds of social contracts with shareholders.

Scott: This is important to me as I do some consulting with some of the newer funds who need to know the best way to structure performance fees and other issues.

We also interviewed John Diederich, the chief administrator for these funds and the current President of the Closed-End Fund Association.

Scott: John, I have known your funds for over ten years now, but we know very little about your background. Would you tell us about it?

Diederich: I am a Vice President for each of the closed-end funds and Chief Operating Officer for Royce Associates. I began my career as a CPA and worked for Price Waterhouse for 12 years. Then I joined Fund Plan Services outside Philadelphia where I was President and Chief Operating Officer. In 1993, I joined Royce.

Scott: What do you think is the most important issue facing the closed-end fund industry?

Diederich: I think trying to get the word out that closed-end funds can be an integral part of anyone's long-term investment plans. Unfortunately closed-end funds are often sold and then tucked away as brokers have little incentive to sell or recommend them. Closed-end funds historically haven't had the ability to keep themselves on the front page like mutual funds do.

Scott: What do you think we can do about this?

Diederich: The key objective of the Closed-End Fund Association is to try to promote a better understanding of closed-end funds and how they can fit into someone's portfolio. I regularly talk to Brian Smith, the Executive Director of CEFA. He is an integral part of the Association and has done a wonderful job of building and promoting it. He has also been the impetus behind the web site which is our best public vehicle for explaining closed-end funds.

Scott: Now, would you tell me what you do at the Royce Funds?

Diederich: The Royce Funds are a relatively small shop and here people wear lots of hats. I am actively involved with many aspects including administration, operations and shareholder reporting.

Scott: How do the assets of the Royce Group break down between closed-ends and mutual funds?

Diederich: We have approximately 5 billion dollars under management. About 20% of that are in our closed-end funds and 70% in our mutual funds.

Scott: We recently learned that your firm has been sold to the brokerage firm, Legg Mason. How will that change your business?

Diederich: We expect that, particularly on the closed-end fund side, nothing will change. The deal closed on October 1st. We have full investment autonomy over our funds and the existing Directors will continue to serve on the Boards. Charles Royce loves this business and would like to continue to manage money for a long time.

Scott: What is the distribution policy of your closed-end funds, and how did you decide on the formula for payout?

Diederich: RVT is the oldest and largest small-cap closed-end fund. Because of its longevity and its successful investing, it has built up a considerable amount of unrealized appreciation that is paid out to shareholders over time as gains are realized. We currently make quarterly distributions at an annualized rate of 9% of the prior four quarter NAVs of Royce Value Trust. The 9% was the approximate level of the historical distributions on RVT.

Scott: This seems to be the current trend in the industry. Why do you feel you need to make a quarterly distribution?

Diederich: By making the distributions periodically during the year, you can eliminate the reluctance of investors to buy shares of a fund toward the end of the year because of the distributions. This is an advantage that mutual funds don't have.

Scott: We do everything we can to promote the advantages of closed-end funds. What percentage of your shareholders invests the distributions in new shares?

Diederich: It varies for the three funds but is anywhere from 50% to 70%.

Scott: I believe you told me that you issue new shares for the distributions. Is this what most other funds do?

Diederich: Some issue shares and others buy shares in the open market. What they do often depends upon where the market price is relative to the NAV. By issuing new shares, we keep shareholders' investments in place if they wish.

Scott: I bring this up as shareholders need to know that when a fund issues shares there can be a certain amount of dilution for those shareholders who take the distributions in cash This can lower the net asset value. What are your thoughts on the importance of being shareholder friendly?

Diederich: We are, of course, big proponents of being shareholder friendly and do everything we can to provide information to our shareholders in the form of semi-annual reports and monthly press releases. Our web site provides information for closed-end funds (

Scott: I want to thank you and Chuck for your time and wish you continued success.

Closed-End Fund News

Adams Express

In the quarterly letter to stockholders of Adams Express, Douglas Ober, Chairman of Adams Express wrote:

"Both the Standard & Poor's 500 Index and the Dow Jones Industrial Average are off sharply from the beginning of the year. After two years of outperforming the S&P 500 Index, Adams Express has underperformed the Index thus far in 2001. There are a number of reasons for our performance which we will review in this report. However, we want our shareholders to know that we have remained true to our investment philosophy and the policies we use in following that philosophy. We are still vitally concerned with the preservation of capital, providing a reasonable income, and an opportunity for capital gain."

Adams Express has just released the amount of its year-end distribution. It is a total of $1.41, of which $0.06 per share represents undistributed net investment income for the year 2001, $1.35 per share, represents the undistributed net capital gain, of which $1.27 is long-term and $0.08 is short term. The distribution is payable December 27th.

General American Investors

The year-end distribution for General American Investors will be a capital gain dividend of approximately $1.26 per share. This is composed of approximately $0.82 per share of undistributed income and short-term capital gain and approximately $0.45 per share from short-term capital gain. Both dividends are payable December 20, 2001 to stockholders of record November 15. Shareholders may receive the distribution in shares of the company's common stock, receive shares of common stock for the capital gain dividend or receive cash for both dividends.

Year-end distributions for other closed-end funds are listed on the Closed-End Fund Association web site under

Daily NAVs for Investors

We have calculated the number of funds that report their net asset values daily. This information is reported in The Wall Street Journal and the Closed-End Fund Association web site ( Our findings show that of 475 funds listed in 108 are equity funds with 84 reporting their NAV’s daily (77.7%) and 373 are bond funds with 283 reporting their NAV’s daily (75.8%). This is a good number, but we urge funds that do not report their net asset values daily to try to do so.

There are currently 588 closed-end funds in the following categories:

Category No. of Funds Assets* ($ million) % of Industry
Bond Funds (292)
Corporate Bond — High Yield 30       7,351.80      6.49%   
Corporate Bond — Investment Grade 4       643.78      
Government Bond 5       2,463.79      2.01%   
Municipal High Yield 4       1,218.53      
Municipal National 100       31,292.02      37.68%   
Municipal Single State 127       13,936.36       
General Bond — Investment Grade 10       1593.24      5.39%   
Multi-Sector Bond 12       5,031.71       
Foreign Investment (128)
Non-U.S. Equity 82       11,562.27       
Global Equity 7       562.75       
Global Income 28       8,803.12      18.59%   
Emerging Market Equity 4       643.78       
Emerging Market Income 7       1,355.65       
Domestic Equity (120)
Domestic Growth 82       6,779.38       
Growth & Income 29       11,549.06      15.77%   
Equity Income 9       1,085.56       
Sector Funds (25)
Energy/Natural Resources   474.82       
Financial Services 4       1,363.07       
Health/Biotechnology 7       844.27       
Precious Metals 6       376.99      4.29%   
Utilities 3       2,219.65       
Other/Miscellaneous (23)
General Mortgage 18       9,025.49      9.78%   
Loan Participation 5       3,015.69       
*Assets are Net Assets in millions and exclude leveraged capital (preferred stock, debt etc), which totals $28 billion.
Source: Closed-End Fund Association

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