Small-Cap Premier Quality Strategy —2Q23 Update and Outlook —Royce
article 07-25-2023

Small-Cap Premier Quality Strategy—2Q23 Update and Outlook

Co-Lead Portfolio Managers Lauren Romeo and Steven McBoyle update investors on the Strategy’s strong first half of 2023 while providing a bright outlook for U.S. small-cap quality.


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

Lauren Romeo: The mutual fund we manage in the Strategy, Royce Premier Fund, advanced 4.5% for the quarter, lagging its benchmark, Russell 2000 Index, which was up 5.2% for the same period. The Fund also decisively beat its benchmark for the year-to-date period ended 6/30/23, increasing 14.3% versus a gain of 8.1% for the Russell 2000 and outperformed the Russell 2000 for the 1-, 3-, 5-, 10-, 20-, 25-, 30-year, and since inception (12/31/91) periods ended 6/30/23.

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

Steven McBoyle: Seven of the portfolio’s nine sectors made a positive impact on quarterly performance. The sectors making the largest positive contributions were Industrials, Materials and Information Technology while the only negative impacts came from Communication Services and Consumer Staples.

What happened at the industry level in 2Q23?

LR: Paper & forest products (Materials), machinery (Industrials), and capital markets (Financials) contributed most for the quarter, while technology hardware, storage & peripherals (Information Technology), professional services (Industrials), and interactive media & services (Communication Services) were the largest detractors.

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

SM: The portfolio’s disadvantage versus its benchmark was attributable to stock selection in the quarter. However, hurting relative performance most was our lower exposure to Health Care--where stock selection also detracted, as it did in Information Technology and Industrials (where our larger weighting was a positive). Conversely, both stock picks and our lower exposure to Financials, stock selection in Materials, and having no exposure to Utilities contributed most to relative quarter results.

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

LR: Eight of the Fund’s nine equity sectors made positive contributions to performance in 2023’s first half, led by Industrials, Information Technology, and Materials. Communication Services was the lone detractor while Health Care and Financials made the smallest contributions.

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

HM: Machinery (Industrials), semiconductors & semiconductor equipment (Information Technology), and electronic equipment, instruments & components (Information Technology) contributed most for the year-to-date period, while professional services (Industrials), interactive media & services (Communication Services), and media (Communication Services) were the largest detractors.

Which holding contributed most for the year-to-date period ended 6/30/23?

LR: Stella-Jones was the portfolio’s top contributor at the position level in 2023’s first half. The company dominates the railway tie and wood utility pole markets and has a growing residential treated lumber business. Stella-Jones has benefited from strong lumber prices and healthy home repair/remodel activity while demand for its rail ties remains largely recession-resistant as some percentage of the installed base is replaced annually as part of railroad track maintenance. Finally, it is seeing a dramatic upswing in utility pole demand, its largest segment, as broadband network expansion, renewable energy, and electric vehicle adoption are secular drivers of electricity usage and the need for utilities to harden their grids.

Which holding detracted most from performance in 2023’s first half?

SM: The Fund’s top detractor for that period was Lindsay Corporation, which provides center pivot irrigation systems for commercial agriculture. Lindsay’s stock retreated as corn and wheat prices came off highs and farm income is forecasted to decline from peak levels. The company also faces difficult year-over-year comparisons later this year because several severe storms in 2022 drove higher pivot-replacement demand. Internationally, Lindsay has faced irrigation order delays in the high growth Brazilian market due to a political transition that pushed out implementation of a government financing program for agricultural products growers.

What were the sources of the Fund’s advantage over the Russell 2000 in 2023’s first half?

LR: Premier’s advantage over its benchmark was primarily attributable to sector allocation in 2023’s first half. Financials, Materials and Consumer Staples made the most significant positive impact versus the benchmark while Communication Services and Health Care were the only detractors from relative results.

What is your outlook?

SM: In general, the outlook remains cloudy with further rate increases designed to curb falling but persistent inflation, continued recession fears, and a banking crisis still memorable to most investors. Cloudy outlooks, however, tend to provide opportunities for the Fund’s all-weather approach given our investments in durable business models that have strong histories of persistent high returns on invested capital, consistent free cash flow generation, and strong balance sheets. While the debate rages on about when the most predicted recession in our history will begin, evidence of decelerating inflation and Fed commentary on the prospect of a more measured pace of rate increases appeared to shift sentiment toward the view that any recession is likely to be mild. Accordingly in June, consistent with the market being a discounting mechanism, investors appeared to take steps to position for an eventual recovery, driving up returns for both the Russell 2000 and large-cap Russell 1000 Indexes, up 8.1% and 6.8%, respectively.

LR: Given our focus on bottom-up stock selection (as opposed to macro-led portfolio construction), our only forecast is that whatever economic environment prevails in the second half of 2023, we believe that the high-quality business models the Fund owns should continue to compound shareholder value. We also anticipate that, as this market cycle progresses, investors will increasingly focus on business fundamentals and valuations. We expect our companies to perform well during this period by leveraging their competitive advantages to pursue strategies such as gaining market share, expanding geographically, and/or consolidating via acquisitions during this uncertain time, as they have done in previous periods of uncertainty.

Important Disclosure Information

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

NET               GROSS
Premier 4.45 19.60 13.07 7.99 9.27 11.19 12/31/91  1.18  1.18
Russell 2000
5.21 12.31 10.82 4.21 8.26 9.05 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.

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.

Percentage of Fund Holdings As of 6/30/23 (%)




Lindsay Corporation


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.

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).

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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