Royce Small-Cap Special Equity—1Q23 Update and Outlook—Royce
article 04-18-2023

Royce Small-Cap Special Equity Fund—1Q23 Update and Outlook

Portfolio Manager Charlie Dreifus updates investors on how our Small-Cap Special Equity Strategy performed in 1Q23 and throughout small cap’s current bear market.


How did Royce Small-Cap Special Equity Fund perform in 1Q23 and over longer-term periods?

We were pleased that the Fund has performed well during a very challenging bear market for small cap stocks. The Fund advanced 3.4% for the quarter, outperforming its benchmark, the Russell 2000 Value Index, which was down -0.7% for the same period. The portfolio also beat its benchmark for the 1-, 5-, 15-year, and since inception (5/1/98) periods ended 3/31/23, as well as the Russell 2000 for each of these periods except the 15-year period.

“To emphasize the Fund’s strength in the recent bear market, Small-Cap Special Equity was down -3.6% from the most recent small-cap peak on 11/8/21 versus respective declines of -19.7% and -24.7% for the Russell 2000 Value and Russell 2000 Indexes.”
—Charlie Dreifus

This is consistent with the Fund’s history of strong down-market results. To emphasize the Fund’s strength in the recent bear market, Small-Cap Special Equity was down -3.6% from the most recent small-cap peak on 11/8/21 versus respective declines of -19.7% and -24.7% for the Russell 2000 Value and Russell 2000 Indexes.

How was performance at the sector level in 1Q23?

Five of the portfolio's nine sectors made a positive impact on quarterly performance, with Industrials, Information Technology and Consumer Staples making the largest positive contributions while the largest negative impacts came from Communication Services, Consumer Discretionary, and Real Estate.

How did the Fund perform at the industry level in the first quarter?

The top contributors at the industry level were two areas in Industrials—electrical equipment and machinery, which were followed by the semiconductors & semiconductor equipment group from Information Technology. Media, which is in Communication Services, detracted most, along with consumer staples distribution & retail (from Consumer Staples) and textiles, apparel & luxury goods from Consumer Discretionary.

What were the portfolio’s top contributor and detractor at the position level for the quarter?

Our top contributor was Encore Wire, which manufactures copper electrical building wire and cable. The company supplies residential wire for interior wiring in homes, apartments, and manufactured housing. Encore also manufactures wire for commercial and industrial buildings. Its customers are wholesale electrical distributors that serve both the residential and commercial wire markets. TEGNA, the top detractor in 1Q23, is a broadcasting, digital media, and marketing services company that owns and operates television stations which deliver news and informative content. TEGNA also provides marketing solutions and services to individuals and businesses of all sizes. Its stated purpose is to serve the greater good of its communities. Each was a top-10 holding at the end of March.

At the sector level, how did the Fund perform versus the Russell 2000 Value in 1Q23?

Our advantage over the benchmark was entirely attributable to sector allocation decisions in the quarter. At the sector level, our significantly lower exposure to Financials—and our lack of exposure to banks—helped most versus the Russell 2000 Value. Stock selection was highly additive in Industrials, where our higher weighting also helped. Our lack of exposure to Health Care also contributed to our quarterly advantage, as did our cash holdings. Conversely, our higher weighting in Consumer Discretionary and stock picks in Communication Services and Real Estate hurt relative results.

What is your outlook for the economic and market environment?

In navigating the macroeconomic seas, credit spreads are perhaps the most useful guide. They have widened, though not by as much as perhaps they should have. As more and more strains filter through the economy, however, they are likely to widen further. We are also watching for any widening in investment grade corporate bonds. When this occurs, and people become increasingly concerned about the duration and intensity of the looming recession, equities typically decline. Against this uncertain backdrop, small caps look very attractively priced relative to the market as a whole. In fact, they are as relatively inexpensive now as they were at the beginning of the pandemic. The headlines likely caused this, with fears about a looming recession, the availability of credit, and the inherent lower market liquidity in small caps. Yet there are high-quality small caps (we believe we own many) that have been marked down in the exit from the asset class. Remaining selective will be the key, and our discipline reinforces that. Once there are more attractively priced small caps on an absolute basis, we are ready to pounce, as we have during previous opportunities.

Important Disclosure Information

Average Annual Total Returns as of 3/31/2023 (%)

NET               GROSS
Small-Cap Special Equity 3.39 2.71 19.13 6.37 6.89 8.51 05/01/98  1.20  1.20
Russell 2000 Value
-0.66 -12.96 21.01 4.55 7.22 7.31 N/A  N/A  N/A
Russell 2000
2.74 -11.61 17.51 4.71 8.04 6.82 N/A  N/A  N/A
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. Dreifus’s thoughts and opinions concerning the stock market are solely his 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.

Percentage of Fund Holdings As of 3/31/23 (%)

  Small-Cap Special Equity

Encore Wire




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.

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 Value and Growth indices consist of the respective value and growth stocks within the Russell 2000 as determined by Russell Investments. 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 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. The Fund invests primarily in small-cap stocks which may involve considerably more risk than investing in larger-cap stocks. (Please see "Primary Risks for Fund Investors" in the prospectus.) As of 3/31/23, the Fund invested a significant portion of its assets in a limited number of stocks, which may involve considerably more risk than more broadly diversified portfolio because a decline in the value of any one of these stocks would cause the Fund's overall value to decline to a greater degree. (Please see "Primary Risks for Fund Investors" in the prospectus.)



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