Small-Cap Opportunistic Value Strategy—2Q23 Update and Outlook —Royce
article 07-11-2023

Small-Cap Opportunistic Value Strategy—2Q23 Update and Outlook

Portfolio Managers Jim Stoeffel, Brendan Hartman, Jim Harvey, and Assistant Portfolio Manager Kavitha Venkatraman detail how our Small-Cap Opportunistic Value Strategy performed and update investors and clients on their outlook.


How did the Small-Cap Opportunistic Value Strategy perform in 2Q23 and the first half of 2023?

Jim Harvey: We were really pleased with the way that Royce Small-Cap Opportunity Fund, the portfolio we manage in the Strategy, performed for the quarter and the first half. The Fund advanced 6.8% in 2Q23, ahead of its primary benchmark, the Russell 2000 Value Index (+3.2%) and its secondary benchmark, the Russell 2000 Index (+5.2%). The portfolio increased 13.2% for the year-to-date period ended 6/30/23, versus respective gains of 2.5% and 8.1% for the Russell 2000 Value and Russell 2000.

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

Brendan Hartman: We were even happier with the results for those always important long-term periods. The Fund beat both benchmarks for the one-, three-, five-, 10-, 15-, 20-year, and since inception (11/19/96) periods ended 6/30/23.

What were the Fund’s results on a sector basis in 2Q23?

Kavitha Venkatraman They were very strong. Eight of the Fund’s 10 equity sectors made positive contributions to 2Q23 performance, led by Industrials, Health Care, and Consumer Discretionary. Communication Services and Consumer Staples detracted while the smallest contribution came from Energy.

What happened at the industry level during the quarter?

Jim Stoeffel: The semiconductors & semiconductor equipment and electronic equipment, instruments & components industries—both from Information Technology and both perennial areas of investment interest—along with construction & engineering from the Industrials sector, made the biggest positive contributions. Communications equipment from Information Technology; interactive media & services from Communication Services; and technology hardware, storage & peripherals, which is also from Information Technology, detracted most at the industry level.

How did the Fund perform relative to the Russell 2000 Value on a sector basis in 2Q23?

Brendan Hartman: The Fund’s advantage versus the small-cap value index came mostly from our sector allocation decisions, in particular our significantly lower weighting in Financials—and in that sector’s bank industry—and much higher weighting in Industrials. Stock selection in Consumer Discretionary was also meaningfully additive versus the benchmark. Conversely, stock selection hurt relative results in Information Technology and Communication Services while our cash position also detracted.

How did the Fund perform at the sector level for the year-to-date period ended 6/30/23?

Kavitha Venkatraman: Nine of the Fund’s equity sectors contributed to 2023’s first-half results, with Industrials, Consumer Discretionary, and Information Technology leading. Energy was the only sector that detracted while Communication Services and Real Estate made the smallest contributions.

What were the biggest industry contributors and detractors in the first half of 2023?

Jim Harvey: The industries that contributed most were the same as the leaders from 2Q23: semiconductors & semiconductor equipment companies and electronic equipment, instruments & components stocks from Information Technology and with construction & engineering from Industrials. The three areas that detracted most in the first half were communications equipment—from Information Technology—interactive media & services from Communication Services, and energy equipment & services from the Energy sector.

How did performance stack up at the sector level versus the Russell 2000 Value for the year-to-date period ended 6/30/23?

Brendan Hartman: Sector allocation decisions primarily drove outperformance in the first half of the year. Our meaningfully lower exposure to Financials and much higher weighting in Industrials contributed most to relative results, along with stock selection in Health Care. Conversely, stock picks hurt in Energy, while both our higher weighting and stock selection detracted in Communication Services, as did our substantially lower exposure to Real Estate during the first half of 2023.

What is your outlook for the Strategy?

Jim Stoeffel: Shares have been climbing the proverbial wall of worry as the Fed continues to strike hawkish notes. We believe we have not yet seen the full lagged impact of the Fed’s aggressive rate hikes over the past year. Moreover, as the attempted coup in Russia highlights, the world is always full of potential black swan events that are difficult to underwrite. That said, we believe the Fed is closer to the end of this rate cycle as inflation trends continue to moderate. While employment is also a lagging indicator, trends on this front also remain relatively constructive. With all of this as context, we’re constructive on the outlook for small-cap value stocks, which we believe remain attractively valued relative to the rest of the market. We also see a number of interesting trends that we think should favor our domestically focused portfolio.

Jim Harvey: For example, the portfolio remained overweight in both Industrials and Information Technology at the end of June. While there’s been a lot of hype around the Artificial Intelligence (“AI”) phenomenon, we view AI as one more trend driving the widespread adoption of semiconductors. Many of our technology positions look well positioned to benefit from the infrastructure build-out that’s necessary to support AI. We’ve been adding to our positions in advertising technology companies, which are using AI directly to gain market share as media spending moves from traditional linear TV to more digitally oriented media consumption. We also think AI will help certain of our industrial positions as these companies learn to harness this technology to drive operating efficiency gains. In addition, many industrial companies should benefit from the ongoing move to re-shore industrial production closer to the U.S. as the full impact of the Covid-driven collapse in supply chains remains top of mind. This trend should also be boosted by the ongoing fiscal spending targeting infrastructure. We have also been looking at select financial companies outside the banking industry that appear poised to benefit as interest rates stabilize and capital markets activity resumes as well as at telecommunications equipment companies where the backdrop remains favorable even as the shares of many businesses have been hit hard. Finally, our sector weights and positioning remain broadly consistent with prior quarters.

Important Disclosure Information

Average Annual Total Returns as of 6/30/2023 (%)

NET               GROSS
Small-Cap Opportunity 6.78 20.42 23.76 8.91 10.14 11.91 11/19/96  1.23  1.23
Russell 2000 Value
3.18 6.01 15.43 3.54 7.29 8.65 N/A  N/A  N/A
Russell 2000
5.21 12.31 10.82 4.21 8.26 8.00 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. 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.

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. 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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