Why the Time Looks Right for Quality—Royce
article 04-27-2023

Why the Time Looks Right for Quality

Co-Lead Portfolio Managers Lauren Romeo and Steven McBoyle on why the case for small-cap quality looks so compelling in today’s uncertain investment environment.


Secular changes in economic trends, interest rates, and monetary and fiscal policies are creating seismic shifts in the investment landscape. The types of companies that benefited most from the past decade’s zero interest rate, low inflation, and low nominal growth regime—specifically, mega-caps and growth stocks—are unlikely to lead going forward. From our perspective, the unfolding macro environment appears to be set for quality small caps to capture and sustain long-term outperformance over large cap through this currently uncertain period of near certain transition.

"Recent short-term periods saw Premier beating its benchmark, the Russell 2000 Index, while over longer-term periods of three years or more, results have been strong on both an absolute and relative basis.”

More specifically, we think that the Small-Cap Premier Quality Strategy we use in Royce Premier Fund offers a particularly compelling opportunity in today’s unsettled climate. In this Strategy, our team—which includes Portfolio Manager Chuck Royce and Assistant Portfolio Manager Andrew Palen—looks for small-cap companies with high returns on invested capital (“ROIC”) and conservative capital structures, among other attributes, that we believe can compound value by reinvesting their current earnings back into the business at durable high rates of return over the long run.

The Fund's portfolio companies typically hold leading positions in markets with attractive growth rates thanks to favorable secular trends for which their products or services are solutions or key enablers—areas such as automation, digitization, infrastructure, and sustainability and renewables. Our investment framework goes beyond screening and involves a comprehensive analysis of a company’s industry, competition, and business model. History is also an important guide to determine how persistent a company’s ROIC has been over time—which is significant because we want companies whose long-term fundamentals indicate consistent levels of ROIC, while allowing for the typical ups and downs of the business cycle. This stability helps to reveal an important and related attribute: the presence of management teams who are effective capital allocators.

We think the effectiveness of the Strategy has been borne out by the Fund’s performance. Premier beat its benchmark, the Russell 2000 Index, during recent short-term periods, while over longer-term periods of three years or more, results were strong on both an absolute and relative basis.

With rising rates, economic uncertainty, and the recent banking sector scare, business fundamentals and valuations appear to be returning to their rightful place as key determinants of investors’ equity investment decisions. This has been—and we believe should continue to be—beneficial to the Fund’s absolute and relative performance given the Strategy’s unwavering focus on identifying companies trading at what we believe are reasonable valuations with durable business models that generate—and appear capable of sustaining—superior ROICs well into the future. Our holdings tend to produce consistent free cash flow and possess the balance sheets strength that provides the financial flexibility to deftly navigate and take advantage of near-term uncertainty. These attributes are especially important because we believe they should help portfolio companies to not just weather a recession but also to go on offense and emerge from any downturn even stronger.

These characteristics also underlie the Fund’s favorable downside capture ratio. While preservation of capital has been a core component of Premier’s long-term total return, the Fund offers more than “winning by losing less,” as is seen by its upside capture ratio.

Royce Premier Fund’s Upside/Downside Capture Ratios for Periods Ended 3/31/23

Capture Ratio
Capture Ratio

Five Year



From 12/31/91 (Start of Fund's First Full Quarter)



These ratios underscore our belief that investing in high-quality small-cap businesses makes for an effective all-weather approach.

We are confident as we look ahead. While the recent small-cap bear market has been challenging, we are pleased that the Fund’s more than three decades of history has shown that low return periods have been followed by double-digit returns on average over the next three years.

100% of the Time, Positive 3-Year Returns Have Followed Low Return Markets Royce Premier Fund’s Positive 3-Year Returns Have Often Followed Low 3-Year Return Periods
Subsequent Average Annualized 3-Year Performance for Premier Fund Following 3-Year Annualized Return Ranges of Less Than 5% from 12/31/94-3/31/23

Russell 2000 vs. Russell 1000 Median LTM EV/EBIT¹ (ex. Negative EBIT Companies)

The reasons we have given above epitomize why we think the time is right for our Small-Cap Premier Quality Strategy.

Important Disclosure Information

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

NET               GROSS
Premier 9.44 -0.16 18.46 7.36 8.92 11.13 12/31/91  1.17  1.17
Russell 2000
2.74 -11.61 17.51 4.71 8.04 8.94 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.

Ms. Romeo’s and Mr. McBoyle’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.

Return on Invested Capital is calculated by dividing a company’s past 12 months of operating income (earnings before interest and taxes) by its average invested capital (total equity, less cash and cash equivalents, plus total debt, minority interest, and preferred stock).

Upside Capture Ratio measures a manager’s performance in up markets relative to the Fund’s benchmark. It is calculated by measuring the Fund’s performance in quarters when the benchmark goes up and dividing it by the benchmark’s return in those quarters. Downside Capture Ratio measures a manager’s performance in down markets relative to the Fund’s benchmark. It is calculated by measuring the Fund’s performance in quarters when the benchmark goes down and dividing it by the benchmark’s return in those quarters.

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 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. The Fund also generally invests a significant portion of its assets in a limited number of stocks, which may involve considerably more risk than a 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.) The Fund may invest up to 25% of its net assets (measured at the time of investment) in securities of companies headquartered in foreign countries, which may involve political, economic, currency, and other risks not encountered in U.S. investments. (Please see "Investing in Foreign Securities" in the prospectus.)



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