Where Are the Best Long-Term Small-Cap Opportunities? —Royce
article 05-30-2023

Where Are the Best Long-Term Small-Cap Opportunities?

Portfolio Managers Jim Stoeffel, Brendan Hartman, Jim Harvey, and Assistant Portfolio Manager Kavitha Venkatraman discuss the industries where they see promising long-term opportunities.


We’ve been finding numerous opportunities in the domestic construction markets thanks to the long-term secular trend of reshoring, which is being catalyzed by the massive investment in semiconductor plants—aided by the CHIPS Act.


We are quite positive on U.S. home builders. Our long-term view is that homebuilders have the inventory required to meet the structural demand for housing in the U.S., even as existing home sales remain depressed because of homeowners being effectively locked into very cheap mortgages.

Shares of U.S. home builders had gotten very cheap in 2022 when interest rates were rising rapidly and negatively impacting demand and affordability. A longer-term historical view serves as a reminder, however, that a 6% rate was widely accepted for U.S. 30-year fixed mortgages—the ultra-low rates of the Covid era were an anomaly. As mortgage and interest rates begin to settle down, we expect the homebuilders we own to be disciplined about price and monetize their inventory profitably. Despite the recent rebound for these stocks, the homebuilders we own are historically cheap and very well capitalized compared to prior economic cycles, which gives us a degree of comfort vis-à-vis the industry’s cyclicality.

Outdoor Recreation

The outdoor recreation space has been hit particularly hard over the past few years—which was not unexpected for this highly discretionary area given the sharp increase in interest rates and the relatively low level of consumer confidence. However, we think that valuations have gotten attractively low, and so it is time to start dipping our toes in the water. We have been buying recreational marine companies both on the retail and the manufacturing side. Our holdings learned how to operate successfully throughout the Covid period to come out leaner and more efficient. The recreational marine side has also experienced consolidation that’s led to certain companies owning a set of very strong brands. In some cases, valuation is backed by a strong set of assets on the balance sheet such as unique waterfront real estate.

We also have exposure to the RV (recreational vehicle) and recreational marine parts and services markets, as well as companies in the hunting, camping, and fishing space. Parts and services businesses are holding up well, after the strong pull forward in demand coming out of Covid. In addition, we have several names on our watch list that we are regularly reviewing to potentially add to the portfolio.


We continue to view technology stocks, particularly semiconductor equipment shares, in a positive light. It’s an industry that has been a longstanding overweight in the Fund. Our current thesis has several key factors. The industry structure has become increasingly attractive, with much of the supply chain having consolidated, which has driven better economics across the industry. We think this supply chain consolidation has benefited several small-cap equipment suppliers that support the industry. These are classic “picks and shovels” companies such as Ichor and Ultra Clean that are supplying the largest original equipment manufacturers (OEMs), including Applied Materials and Lam Research. These systems suppliers have become critical to the success of the large OEMs and their importance in the supply chain was reinforced during the pandemic.

Moreover, capital intensity in the semiconductor industry is increasing as Moore’s law slows, forcing semiconductor companies to find new ways to drive efficiency gains. New advances in technology, including 3D semiconductor design, benefit a number of our companies that provide back-end test and measurement capabilities such as Cohu and Onto Innovation.

The demand for semiconductors keeps growing as they’ve become ubiquitous, as demonstrated by the collapse in auto production that was driven by a lack of bespoke semiconductors. Ongoing advances in technology such as AI (artificial intelligence) will drive new use cases and in our view spur ongoing profitability gains and multiple expansion for the industry. Finally, there has been a realization that semiconductor manufacture and shipping is a key geopolitical concern that, combined with the pandemic-related collapse in supply chains, is generating significant reshoring projects.

Reshoring, the Energy Transition, and Other Secular Domestic Themes

In fact, we’ve been finding numerous opportunities in the domestic construction markets thanks to the long-term secular trend of reshoring, which is being catalyzed by the massive investment in semiconductor plants—aided by the CHIPS Act. Covid created a critical need for supply chain security, as have fears of a Taiwan/China military conflict. There’s an additional need to harden the electrical grid and improve its reliability. Growing power demand for EVs (electric vehicles) and continued data center growth are also driving the need for a reliable power grid. We see each of these long-term trends as driving increasing adoption of semiconductor technology in everyday life and have been investing behind these tailwinds for some time now.

Important Disclosure Information

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

NET               GROSS
Small-Cap Opportunity 5.98 -7.78 32.27 8.89 9.92 11.75 11/19/96  1.23  1.23
Russell 2000 Value
-0.66 -12.96 21.01 4.55 7.22 8.61 N/A  N/A  N/A
Russell 2000
2.74 -11.61 17.51 4.71 8.04 7.87 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 www.royceinvest.com. 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.

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

  Small-Cap Opportunity

Ichor Holdings


Ultra Clean Holdings




Onto Innovation


Applied Materials


LAM Research


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.

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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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