Royce Small-Cap Special Equity —3Q23 Update and Outlook—Royce
article 10-17-2023

Royce Small-Cap Special Equity Fund—3Q23 Update and Outlook

Portfolio Manager Charlie Dreifus updates investors on how our Small-Cap Special Equity Strategy performed in 3Q23 and why his outlook remains cautious.


How did Royce Small-Cap Special Equity Fund perform in 3Q23 and over longer-term periods?

The Fund was down -4.0% for the quarter, lagging its primary benchmark, the Russell 2000 Value Index, which fell -3.0%, but losing less than its secondary benchmark, the Russell 2000 Index, which declined -5.1% for the same period. The Fund also beat both benchmarks for the year-to-date, 1-, 5-, 25-year, and since inception (5/1/98) periods ended 9/30/23.

“We maintain our positive outlook for reshoring and onshoring, though we are mindful that Capex is cyclical and is reduced when rates rise, credit is tighter, and profits weaken, so we stand by our expectation for some bumps in near-term progress.”
—Charlie Dreifus

How did the Fund perform at the sector level in 3Q23?

Eight of the portfolio’s nine equity sectors made a negative impact on quarterly performance, with the largest detractions coming from Information Technology, Consumer Staples, and Communication Services. Energy made the only positive contribution while Financials and Consumer Discretionary detracted least.

What about the Fund’s industries?

At the industry level, electronic equipment, instruments & components from Information Technology, broadline retail from Consumer Discretionary, and food products from the Consumer Staples sector detracted most in 3Q23, while diversified consumer services, which is in Consumer Discretionary, energy equipment & services in Energy, and paper & forest products from Materials were the biggest contributors.

Which positions detracted and contributed most in 3Q23?

The portfolio’s top detractor at the position level was Vishay Intertechnology, which manufactures passive and discrete active electronic components such as resistors, capacitors, inductors, diodes, and transistors. Our top contributor was H&R Block—the tax preparation and consumer financial services provider.

How did the Fund perform versus the Russell 2000 Value at the sector level?

The portfolio’s disadvantage versus its benchmark was attributable to both stock selection and sector allocation decisions in the third quarter. Our much lower weightings in Energy and Financials, along with stock selection in Consumer Staples hurt relative performance most. Conversely, our lack of exposure to Health Care, which declined in the benchmark, stock selection in Industrials, and the Fund’s cash holdings contributed most to relative quarterly results.

How did the Fund perform on a sector basis for the year-to-date period ended 9/30/23?

Four of our nine equity sectors made a positive impact on year-to-date period performance, led by Industrials, Information Technology, and Materials, while the sectors that detracted most were Communication Services, Consumer Discretionary and Real Estate.

What happened at the industry level?

The top contributors were electrical equipment from Industrials, semiconductors & semiconductor equipment in Information Technology, and food products, which is in Consumer Staples. Consumer staples distribution & retail from Consumer Staples, broadline retail in Consumer Discretionary), and media from Communication Services were the largest detractors at the industry level for the year-to-date period.

What were the top-contributing and top-detracting positions for the year-to-date period?

Our top contributor was Encore Wire, which manufactures electrical building wire, while the top detractor was Ingles Markets, a regional grocery chain in the Southeastern U.S.

What were the sources of outperformance versus the benchmark on the sector level?

Our advantage over the benchmark came from sector allocation in the year-to-date period. Our much lower weighting in Financials, along with stock selection, our higher weighting and stock selection in Industrials, and lack of exposure to Health Care made the most significant positive impacts versus the benchmark. Conversely, stock selection hurt relative performance in Consumer Discretionary and Communication Services, as did our much lower weighting in Energy.

What is your outlook?

These are new and unsettled times, and there’s much the Fed cannot control, which is a point we believe many are missing. For the Fed to shorten “higher for longer” and thus eventually cut rates, a higher unemployment rate on a sustainable basis is required, absent a crisis that could quickly change the narrative. A sustained downshift in core inflation needs unit labor costs to slow, which can only be accomplished in a labor market with more slack which in turn requires higher unemployment. Yet the current data shows little evidence of rising unemployment. In fact, the four-week average of initial unemployment gains recently made a notable downside breakout. The immediate horizon also faces several headwinds, namely, the restarting of student loan payments and some 70,000 childcare providers facing possible closure as federal aid for those providers comes to an end. The uncertainty (in both directions) as regards the macroeconomic outlook remains elevated. Predictions are prone to error. That, coupled with high valuation levels, suggests caution to us. We maintain our positive outlook for reshoring and onshoring, though we are mindful that Capex is cyclical and is reduced when rates rise, credit is tighter, and profits weaken, so we stand by our expectation for some bumps in near-term progress.

Important Disclosure Information

Average Annual Total Returns as of 9/30/2023 (%)

NET               GROSS
Small-Cap Special Equity -3.96 15.47 11.43 5.34 5.70 8.34 05/01/98  1.21  1.21
Russell 2000 Value
-2.96 7.84 13.32 2.59 6.19 7.17 N/A  N/A  N/A
Russell 2000
-5.13 8.93 7.16 2.40 6.65 6.67 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 9/30/23 (%)

  Small-Cap Special Equity

Vishay Intertechnology


H&R Block


Encore Wire


Ingles Markets Cl. A


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 09/30/23, 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.)



Sign Up