Small-Cap Quality’s Advantages During Market Declines—Royce
article , video 06-06-2022

Small-Cap Quality’s Advantages During Market Declines

PM Steven McBoyle details how quality has been holding up amid market volatility, how recent supply chain issues have affected his investment process, and where he’s finding quality small-cap opportunities in the semiconductor industry.


How are changes in the semiconductor industry’s ecosystem creating opportunities?

So within the semiconductor ecosystem, the Premier Fund has exposure to a fabless semiconductor manufacturer, to a leading subsystems provider, to a leading test and measurement company, and in each of these instances, what we’re looking for are differentiated, durable business models but, importantly, where we can identify what I refer to as a structural multiplier effect.

So take, for example, the ongoing challenge within the industry as it relates to the continued miniaturization of the chip. The legacy architecture of chip manufacturing was to put everything onto one chip and shrink that over time, referred to as Moore’s law, but that architecture has effectively hit its limit. So what’s referred to in the industry today as advanced packaging, whereby we’re mixing and matching all these chips onto a system-on-chip, within that approach and the architecture around that, what becomes increasingly important is the interconnect between all these chips on the system-on-chip, and that’s increasingly driving complexity and critical elements as it relates to this ecosystem.

FormFactor is a direct beneficiary of advanced packaging because, as you put more chips onto these advanced architectures, the more probe cards and testers are required. So FormFactor is a dominant scale provider. They are the largest provider in the U.S. of probe cards and testers. They have a full third share in advanced processing. They have the largest R&D budget in the industry, so fairly dominant in scale, which is important because there is an underlying secular intensity as it relates to capacity which is, again, creating barriers for others to come into the ecosystem.

How have the recent supply chain issues affected the way you invest?

Well, I think the supply chain issues are well known. They’re heighted and they’re going to continue and be protracted for a long period of time across many, many industries. So what’s very critical throughout this time period is to understand as it relates to the supply cost inflation, whether business models have the ability, either tactically or strategically, to pass on pricing. And there I think we’re very comforted as it relates to the Premier Fund because our companies have pricing power. They have the ability to tactically address price, perhaps sometimes in a situation on a lag basis but, more importantly, what we’re finding is they’re taking advantage of this period of time to price more strategically, price more to the value of the product and service that they provide, and what we’re hearing is that will remain relatively sticky and permanent over time.

What are some of the advantages of a small-cap quality approach?

In the first quarter of this year, quality outperformed, protecting on the downside as you would expect, particularly in the strategy of Premier to do so during these volatile times. I think it’s important to note even in the month of April, a month where you saw shy of a full 10% correction, Premier had a downside capture ratio of 65%.

As risk managers, we have a high disdain for down-market performance periods, but we do take some solace in the fact that we protected extremely well during these heightened volatile times. As it relates to quality in the underlying company attributes that we have, I think again we can use an interesting example in the semiconductor industry.

Down Market Resilience: FormFactor (Nasdaq, FORM) vs. SOX 2/28/22-5/18/22 (%)

-0.77 for FORM US Equity and -14.96 for SOX Index at 5/18/22

Past performance is no guarantee of future results.

So the Semiconductor Index, the SOX, since late February has seen extreme volatility and is down some 15%, FormFactor’s stock price was effectively flat during that time period. It’s a testament to their quality attributes and, importantly, I believe the market coming to appreciate their underlying quality attributes and increasing profit pool.

Premier Fund is an all-weather fund. Our companies are durable, differentiated business models with capital structure strength that are going to protect well during tough times.




Important Disclosure Information

Average Annual Total Returns as of 3/31/22 (%)

  QTD1 1YR 3YR 5YR 10YR 15YR 20YR Since
Premier -7.23 -2.37 11.63 10.88 9.61 8.85 10.32 11.53  12/31/91
Russell 2000 -7.53 -5.79 11.74 9.74 11.04 7.99 8.72 9.70  N/A

Annual Operating Expenses: 1.17

1 Not annualized.

All performance information reflects past performance, is presented on a total return basis, reflects the reinvestment of distributions, and does not reflect the deduction of taxes that a shareholder would pay on fund distributions or the redemption of fund shares. Past performance is no guarantee of future results. Investment return and principal value of an investment will fluctuate, so that shares may be worth more or less than their original cost when redeemed. Shares redeemed within 30 days of purchase may be subject to a 1% redemption fee, payable to the Fund which is not reflected in the performance shown above; if it were, performance would be lower. Current month-end performance may be higher or lower than performance quoted and may be obtained at Operating expenses reflect the Fund's total annual operating expenses for the Investment Class as of the Fund's most current prospectus and include management fees and other expenses.

The thoughts and opinions expressed in the video are solely those of the persons speaking as of May 9, 2022 and may differ from those of other Royce investment professionals, or the firm as a whole. There can be no assurance with regard to future market movements.

The performance data and trends outlined in this presentation are presented for illustrative purposes only. Past performance is no guarantee of future results. Historical market trends are not necessarily indicative of future market movements.

Percentage of Fund Holdings As of 3/31/2022 (%)

Premier Fund



Company examples are for illustrative purposes only. This does not constitute a recommendation to buy or sell any stock. There can be no assurance that the securities mentioned in this piece will be included in any Fund’s portfolio in the future.

Sector weightings are determined using the Global Industry Classification Standard ("GICS"). GICS was developed by, and is the exclusive property of, Standard & Poor's Financial Services LLC ("S&P") and MSCI Inc. ("MSCI"). GICS is the trademark of S&P and MSCI. "Global Industry Classification Standard (GICS)" and "GICS Direct" are service marks of S&P and MSCI.

The Philadelphia Stock Exchange Semiconductor Index (SOX) is an unmanaged, capitalization-weighted index of domestic stocks in the semiconductor industry.

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