Small-Cap Opportunistic Value Strategy—4Q23 Update and Outlook —Royce
article 01-16-2024

Small-Cap Opportunistic Value Strategy—4Q23 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 in 2023 and update investors and clients on their outlook.


How did the Small-Cap Opportunistic Value Strategy perform in 4Q23 and in 2023?

Jim Harvey: We were really pleased with the way that Royce Small-Cap Opportunity Fund, the portfolio we manage in the Strategy, performed in both periods, although relative results for the quarter could have been better. The Fund advanced 11.2% in 4Q23, a strong performance on an absolute basis even though it lagged both its primary benchmark, Russell 2000 Value Index, which was up 15.3% for the same period, and the Russell 2000, which gained 16.9%. In 2023, the Fund advanced 19.6%, well ahead of both the Russell 2000 Value and the Russell 2000, which were up 14.6% and 16.9% respectively for the same period.

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 3-, 5-, 10-, 15-, 20-, 25-year, and since inception (11/19/96) periods ended 12/31/23.

What were the Fund’s results on a sector basis in 4Q23?

Kavitha Venkatraman: They were very strong. Eight of the portfolio’s 10 equity sectors made a positive impact on quarterly performance, led by Industrials, Consumer Discretionary, and Information Technology. The only negative impacts came from Energy and Real Estate while Consumer Staples made the smallest contribution.

What happened at the industry level during the quarter?

Jim Stoeffel: Aerospace & defense from Industrials, household durables in Consumer Discretionary, and banks in Financials contributed most for the quarter, while energy equipment & services in Energy, electrical equipment from Industrials, and pharmaceuticals in Health Care were the largest detractors.

How did the Fund perform relative to the Russell 2000 Value on a sector basis in 4Q23?

Brendan Hartman: The Fund’s disadvantage versus the small-cap value index came mostly from stock selection, though sector allocation also detracted. Both our significantly lower weighting and stock selection in Financials hurt relative results, as did stock selection in Industrials and Health Care. Conversely, our lower weighting in Energy, lack of exposure to Utilities, and higher weighting in Consumer Discretionary all were additive versus the Russell 2000 Value.

How did the Fund perform at the sector level in 2023?

Kavitha Venkatraman: Eight of the Fund’s 10 equity sectors made positive contributions to calendar year results, led by Industrials, Consumer Discretionary, and Information Technology. Communication Services and Real Estate detracted, though only slightly, while Consumer Staples made the smallest contribution.

What were the biggest industry contributors and detractors in the calendar year?

Jim Harvey: The industries that contributed most were construction & engineering from Industrials, household durables in Consumer Discretionary, and metals & mining, which is in Materials. Communications equipment in Information Technology, pharmaceuticals in Health Care, and energy equipment & services in Energy were the largest detractors.

How did performance stack up at the sector level versus the Russell 2000 Value in 2023?

Brendan Hartman: The Fund’s advantage came from sector allocation. Our much lower weighting in Financials, higher weighting in Industrials, and both a lower weighting and stock selection in Health Care drove our edge at the sector level. Conversely, stock selection in Information Technology, a higher weighting and stock selection in Communication Services, and stock selection in Energy hurt relative performance most.

What is your outlook for the Strategy?

Jim Stoeffel: We continue to find new investment ideas that fit our theme-based investment framework. With inflation rolling over and the U.S. economy remaining healthy, it appears the “soft landing” scenario may actually play out. It also seems increasingly likely that the Fed rate hike cycle has ended with the markets anticipating significant rate cuts in 2024. However, there are a variety of “expert” views on when this will occur and how aggressive these cuts might be. Despite wars in the Ukraine and Middle East—and related disruptions to global shipping lanes—energy prices have remained stable but were creeping higher as of this writing and bear watching as we enter 2024. With all this in mind, we remain generally optimistic on the state of the U.S. economy and remain broadly overweight in Industrials and Information Technology.

Brendan Hartman: Many of our portfolio companies are reporting that supply chains have returned to normal or near normal conditions after several years of Covid-related disruptions. Despite our view that the long-term competitive dynamics of the industry are challenging, we have been slowly adding to our bank exposure given the outlook for lower rates in 2024, which should help alleviate the risks associated with credit quality issues. We also continue to look for opportunities to take advantage of unprecedented investments from both the private and public sectors in U.S. infrastructure spending. This investment is being fueled by the realization that companies need shorter and more secure supply chains, as well as the concerns about strategic imperatives around semiconductor production capabilities. The increasing demand for Artificial Intelligence (AI) capabilities is accelerating these trends, which in addition to driving demand for semiconductor capabilities, are driving significant demand for energy efficiency. We view this investment thesis as being in the early innings.

Important Disclosure Information

Average Annual Total Returns as of 12/31/2023 (%)

NET               GROSS
Small-Cap Opportunity 11.17 19.58 9.07 16.05 8.65 11.90 11/19/96  1.23  1.23
Russell 2000 Value
15.26 14.65 7.94 10.00 6.76 8.93 N/A  N/A  N/A
Russell 2000
14.03 16.93 2.22 9.97 7.16 8.16 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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