Small-Cap Opportunistic Value Strategy—2Q22 Update and Outlook—Royce
article 07-13-2022

Small-Cap Opportunistic Value Strategy—2Q22 Update and Outlook

Portfolio Managers Jim Stoeffel, Brendan Hartman, and Jim Harvey, along with Assistant Portfolio Manager Kavitha Venkatraman manage our Small-Cap Opportunistic Value portfolios. In this article, the team details how the Strategy performed and updates clients on their outlook.


How did the Small-Cap Opportunistic Value Strategy perform in 2Q22 and the first half of 2022?

Brendan Hartman The mutual fund we manage in the Strategy, Royce Small-Cap Opportunity Fund, declined 18.2% for the quarter, lagging its benchmark, the Russell 2000 Value Index, which was down 15.3% for the same period. This is consistent with the portfolio’s history—where we’ve underperformed in down markets but outperformed when the market rebounded.

How has the Fund done versus its benchmark over longer-term periods?

Jim Stoeffel Picking up on Brendan’s comments, we weren’t surprised that the Fund lagged the small-cap value index for the year-to-date period ended 06/30/22, down 22.1% versus 17.3%. Longer-term relative performance, however, was much better. The portfolio outperformed the Russell 2000 Value for the three-, five, 10-, 15-, 20-, 25-year, and since inception (11/19/96) periods ended 6/30/22.

What were the Fund’s results in 2Q22 on a sector basis?

Jim Harvey Eight of the portfolio’s 10 equity sectors made a negative impact on quarterly performance, with Industrials, Information Technology, and Consumer Discretionary making the biggest detractions. The only positive impacts came from Energy and Consumer Staples while Communication Services made the smallest detraction.

What happened at the industry level during 2Q22?

Kavitha Venkatraman The biggest detractions for the quarter came from metals & mining in Materials; machinery, from the Industrials sector; and semiconductors & semiconductor equipment in Information Technology. These were among our biggest weightings in 2Q22 because we like each group’s long-term prospects. On the positive side, oil, gas & consumable fuels from the Energy sector and food products in Consumer Staples each made a positive impact while personal products in Consumer Staples was flat. So while it was a very challenging quarter, our long-term confidence is high.

How did the Fund perform on a sector basis versus the Russell 2000 Value in 2Q22?

JS Our disadvantage versus the benchmark came primarily from sector allocation in the quarter, although stock picks also hurt. We saw this dynamic in Financials, where our lower weighting detracted considerably more than our stock selection. In Industrials and Materials stock picking hurt more, though our respective overweights in each sector also hampered relative results. Conversely, stock selection gave us a relative advantage in Energy and Communication Services, and our cash position was also a positive versus the benchmark in the quarter.

Which sectors made the greatest impacts on performance for the year-to-date period ended 6/30/22?

BH Nine of our 10 equity sectors made a negative impact on year-to-date performance. The biggest negative impacts came from Industrials, Information Technology, and Consumer Discretionary. Energy made the only positive contribution—along with a marginal one from cash—while Consumer Staples had the smallest negative effect.

What about at the industry level in 2022’s first half?

KV As was the case in 2Q22, semiconductors & semiconductor equipment from Information Technology and machinery in Industrials were significant detractors, as was specialty retail from Consumer Discretionary for the year-to-date period. On the other hand, oil, gas & consumable fuels contributed—as it did in 2Q22. The Fund also got positive impacts from chemicals in the Materials sector and pharmaceuticals from Health Care in 2022’s first half.

What were the sources of underperformance versus the Russell 2000 Value for the year-to-date period?

JH Our disadvantage came almost entirely from sector allocation in the year-to-date period—stock selection had only a marginal negative effect. Our greater relative exposure to Information Technology and Consumer Discretionary made sizable detractions, as did stock selection in Industrials. However, stock picking was a strength in Materials, as was our substantially lower exposure to Health Care. Our cash position also contributed to relative performance in 2022’s first half.

What is your outlook for the Strategy?

JS The ongoing war, rising interest rates, and continued inflationary pressures presented challenges in 2Q22. I think how much the Fed tightens into a slowing economy and whether we enter a recession will be the key determinants as to when stock prices begin to recover. There is a strong possibility that inflation peaked in 2Q22, as yields and energy prices reached highs in mid-June. The University of Michigan Consumer Sentiment Index is at an all-time low—which is remarkable, considering it is lower than during the crash of the dot com bubble, the Financial Crisis, and COVID. Current uncertainties notwithstanding, we remain confident in what we are holding, with many positions having low-debt balance sheets, one of the main factors that should help businesses contend with the current tumultuous environment—even if inflation proves increasingly persistent. We have been trimming some inflation beneficiaries, most notably in areas such as materials and shipping. Infrastructure names continue to benefit from steady demand for steel and other materials to build roads and bridges, as well as to repair and maintain aircraft.

BH We’ve also seen shares of homebuilders tumble as interest rates rise, but many of these companies are very well run, and we think opportunities will emerge. The need for communications equipment throughout the world has not diminished, despite current conditions. The same is generally true for many healthcare companies—so we are adding to existing names and researching potential new ideas. Conversely, we see Consumer Discretionary as likely to remain weak, at least until it is clear that inflation is stabilizing. Of our four investment themes, we continue to look most closely at undervalued growth stocks as many such companies are trading at 52-week lows. As always, we seek companies that we believe offer the best combination of attractively low valuations with strong long-term growth potential.




Important Disclosure Information

Average Annual Total Returns as of 6/30/22 (%) 

Small-Cap Opportunity Fund -18.22 -22.09 12.67 8.32 11.04 7.17 9.77 11.59 11/19/96
Russell 2000 Value -15.28 -16.28 6.18 4.89 9.05 5.58 7.77 8.76 N/A
Russell 2000 -17.20 -25.20 4.21 5.17 9.35 6.33 8.17 7.83 N/A

Annual Operating Expenses: 1.21

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.

Mr. Stoeffel’s, Mr. Hartman’s, Mr. Harvey’s, and Ms. Venkatraman's thoughts and opinions concerning the stock market are solely their own and, of course, there can be no assurance with regard to future market movements. No assurance can be given that the past performance trends as outlined above will continue in the future.

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.

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 University of Michigan Consumer Sentiment Index is a consumer confidence index published monthly by the University of Michigan. The index is normalized to have a value of 100 in the first quarter of 1966. Each month at least 500 telephone interviews are conducted of a contiguous United States sample. Fifty core questions are asked.

Frank Russell Company (“Russell”) is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Frank Russell Company. Neither Russell nor its licensors accept any liability for any errors or omissions in the Russell Indexes and / or Russell ratings or underlying data and no party may rely on any Russell Indexes and / or Russell ratings and / or underlying data contained in this communication. No further distribution of Russell Data is permitted without Russell’s express written consent. Russell does not promote, sponsor or endorse the content of this communication. The Russell 2000 is an unmanaged, capitalization-weighted index of domestic small-cap stocks. It measures the performance of the 2,000 smallest publicly traded U.S. companies in the Russell 3000 index. The Russell 2000 Value and Growth indexes consist of the respective value and growth stocks within the Russell 2000 as determined by Russell Investments. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.

This material is not authorized for distribution unless preceded or accompanied by a current prospectus. Please read the prospectus carefully before investing or sending money. Smaller-cap stocks may involve considerably more risk than larger-cap stocks. (Please see "Primary Risks for Fund Investors" in the prospectus.) The Fund’s broadly diversified portfolio does not ensure a profit or guarantee against loss.



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