Royce Small-Cap Total Return—3Q23 Update and Outlook—Royce
article 10-10-2023

Royce Small-Cap Total Return—3Q23 Update and Outlook

Portfolio Managers Miles Lewis, Chuck Royce, and Assistant Portfolio Manager Joe Hintz update investors their optimistic outlook for their Quality Value Strategy.


How did the Strategy perform through the end of 3Q23?

Chuck Royce: Royce Small-Cap Total Return Fund, the mutual fund that we manage in the Strategy, was up 0.4% in the quarter, outpacing both its primary benchmark, the Russell 2000 Value Index, and its secondary benchmark, the Russell 2000 Index, which fell -3.0% and -5.1%, respectively. The Fund also beat the Russell 2000 Value for the year-to-date, 1-, 3-, 5-, 10-, 15-, 20-, 25-year, and since inception (12/31/91) periods ended 9/30/23 while also beating the Russell 2000 for the each of these periods except the 15-year span.

“Over the past three-plus years, we have worked together to refine our time-tested, repeatable investment process, one that we believe leads to in-depth understanding of the companies we consider for investment by researching the entire ecosystem of the company.”
—Miles Lewis

How was quarterly performance on the sector level?

Miles Lewis: As we’d expect in a down quarter, five of the Fund’s eight equity sectors detracted from performance in 3Q23, with Information Technology, Real Estate, and Materials having the biggest negative effect while Financials, Energy, and Industrials made positive contributions.

What about at the industry level?

Joe Hintz: The industries that detracted most were two groups in Information Technology—electronic equipment, instruments & components and semiconductors and semiconductor capital equipment—and commercial services & supplies in Industrials. The Fund got the biggest positive contributions from insurance, which is in Financials, energy equipment & services from Energy, and trading companies & distributors in Industrials.

What were the best and worst performers at the position level?

CR: The position that detracted most was Healthcare Services Group (“HCSG”), which, in spite of its name, is actually in the Industrials sector. HCSG provides housekeeping, laundry, linen, facility maintenance, and food services to the health care industry. Inflationary pressures have hurt profits, and the company suspended its dividend in February after 77 consecutive dividend increases. We like its core business and rebound potential in an environment with lower inflation.

ML: Our top contributor was International General Insurance Holdings (“IGIC”), which is also a micro-cap company. IGIC specializes in commercial insurance and reinsurance in several industries, including energy, construction & engineering, ports & terminals, and financial institutions. The stock has performed well so far this year, but we still see it as undervalued. It’s recently been trading at just a little over book value and looks cheaper than most of its peers. IGIC has little debt, high returns on equity, and what we see as a great portfolio. It also has very little analyst coverage.

What were the sources of outperformance versus the Russell 2000 Value Index in 3Q23?

JH: Both stock selection and sector allocation contributed, with the former playing a larger role. At the sector level, stock selection and, to a lesser degree, our higher weighting in Financials; having no exposure to Health Care, which did poorly within the benchmark; and stock selection in Industrials did most to contribute to our relative advantage. Conversely, our much lower weighting in Energy, along with stock selection, stock selection in Materials, and our lack of exposure to Consumer Staples impeded relative results most in the third quarter.

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

ML: Five of the nine equity sectors in which we had investments contributed positively to year-to-date results, led by Information Technology, Industrials, and Consumer Discretionary. Communication Services, Real Estate, and Materials detracted most, though modestly.

What about at the industry level?

CR: The top-contributing industries were trading companies & distributors from Industrials, insurance companies in Financials, and electronic equipment, instruments & components from Information Technology while banks, which is also in Financials, containers & packaging from Materials, and interactive media & services from Communication Services detracted most.

Which positions contributed and detracted most for the year-to-date period?

JH: Our top contributor was FTAI Aviation, an aerospace company that provides a complete suite of aviation products that include aircraft leasing, engine leasing, and engine repairs. Independent Bank Group was our top detractor. We like its management teams and strong credit underwriting skills, and investments in differentiated service areas. We’re also confident that the integral role the bank plays in the communities it serves is not likely to be replaced outside the regional banking system.

How did the Strategy perform versus the Russell 2000 Value for the year-to-date period?

CR: As was the case for the quarter, our year-to-date performance edge was fueled mostly by stock selection, helped by our sector allocation decisions. Stock selection in Financials, and the combination of stock selection and our higher weightings in Information Technology and Industrials made the biggest impacts on relative performance. Hampering relative results most in the year-to-date period were stock selection and our much lower weighting in Energy and stock selection in the Materials and Communication Services sectors.

What can you tell us about portfolio positioning and your long-term outlook?

ML: Over the past three-plus years, we have worked together to refine our time-tested, repeatable investment process, one that we believe leads to in-depth understanding of the companies we consider for investment by researching the entire ecosystem of the company. This process may include speaking to suppliers, customers, competitors and/or former employees. We believe this research can yield unique insights that become the foundation for building larger positions in our highest conviction ideas. Our largest holding, International General Insurance Holdings, offers a good example as an underfollowed specialty P&C insurer that boasts some of the highest returns in the industry. It does so with no leverage and, at roughly 1.0x book value, trades at a fraction of better known, high-quality peers. Kyndryl Holdings is another example. Spun out of IBM, its financial statements are optically unattractive. However, our research shows a strong, profitable, and sustainable IT services company with meaningful opportunities to improve margins and free cash flow in the years ahead underlying these messy numbers. At a valuation of less than 3.0x earnings before interest, taxes, depreciations and amortization and an estimated free cash flow yield just north of 20%, its valuation looks compelling to us. In our view, both stocks remain cheap, even after strong share price performances in 3Q23. Each exemplifies the combination of high quality and attractive valuation that we seek for all of our holdings and underscores our confidence that we can continue to generate attractive risk-adjusted returns in the years to come.

Important Disclosure Information

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

NET               GROSS
Small-Cap Total Return 0.42 22.22 14.35 5.31 6.95 9.89 12/15/93  1.26  1.26
Russell 2000 Value
-2.96 7.84 13.32 2.59 6.19 8.98 N/A  N/A  N/A
Russell 2000
-5.13 8.93 7.16 2.40 6.65 8.27 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, other expenses, and acquired fund fees and expenses. Acquired fund fees and expenses reflect the estimated amount of the fees and expenses incurred indirectly by the Fund through its investments in mutual funds and other investment companies.

Mr. Lewis’s, Mr. Royce’s, and Mr. Hintz’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 9/30/23 (%)

  Small-Cap Total Return

Healthcare Services Group


International General Insurance Holdings


FTAI Aviation


Independent Bank Group


Kyndryl Holdings


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. All indexes referenced are unmanaged and capitalization weighted. The Russell 2000 Index is an index of domestic small-cap stocks that measures the performance of the 2,000 smallest publicly traded U.S. companies in the Russell 3000 Index. The Russell 2000 Value index consists of the respective value stocks within the Russell 2000 as determined by Russell Investments. 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.) The Fund’s broadly diversified portfolio does not ensure a profit or guarantee against loss. 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 Foreign Securities" in the prospectus.)



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