What factors led you to join Royce in 2020?

Miles Lewis: To be honest, I was not looking to leave my prior firm, American Century. We had a good team, performance was strong, and we were gaining momentum on raising assets. Most importantly, I was happy there. When a headhunter approached me about this opportunity, I was a bit awestruck. I’ve long admired Royce, and Chuck, who has been incredibly influential in shaping who I am as an investor today. Lots of investors have famous ones they study and admire. For many people, that’s Warren Buffett. For me, it was—and still is—Chuck Royce.

I actually tried to get a job at Royce when I was in business school in 2009-10—impeccable timing on my part. I had been a voracious reader of all the content Royce published, as well as interviews and articles with Chuck. So, when I agreed to take a first meeting, I went into it with the mindset that I had nothing to lose given how well things were going for me professionally. I saw it as an opportunity to meet a legend in the business; someone I looked up to (from afar) for many years. Obviously, that first meeting went well.

As I learned more about the opportunity to help run the Quality Value Strategy that we use in Small-Cap Total Return, a few things really stood out. First, the philosophies in the Royce Strategy were familiar to me. That was critically important for me, as my investment philosophy was well cemented at that point in my career. Second, I felt that were a lot of similarities between the situation I’d be stepping into on Small-Cap Total Return and when I became a portfolio manager at my old firm in 2014. The two biggest ones, however, were the process and the large number of names each portfolio held.

Once at Royce, I felt that I could improve upon the already strong process I had developed. I also loved the fact that Royce was a pure play small-cap investment manager because I do believe that that emphasis confers several benefits to investment teams—and thus to clients. Finally, and perhaps this is obvious, but having an opportunity to work closely with Chuck was something I viewed as a once in a lifetime opportunity. I have learned so much from him and feel blessed to be in his orbit. Chuck is one of the kindest, most thoughtful people I’ve ever met.

When I added those things up, it became clear that joining Royce was a no-brainer. I am so grateful for the opportunities that were given to me at my old firm and for the incredible people I worked with there, many of whom I keep in touch with regularly. And the last five years at Royce have been outstanding. I have no regrets about my decision, which was the biggest of my professional career.

What are some changes you’d highlight on Royce Small-Cap Total Return over the 5 years you’ve been with Royce?

ML: Oh my goodness—we’ve been very busy these last five years! The first thing I’d highlight is the investment process we’ve built. One of the unintended benefits of coming here is that it gave me a chance to reflect on many things, including how my approach might be improved. I believe the research we are doing now is more in depth and rigorous than before, which is saying a lot because I felt we did great research. We’ve simply added more rigor and focus on the things that matter most to us, and, importantly, our team has continued to improve the process, which I expect will continue in the future.

Building out this team was a big, big deal. None of this would be possible if it weren’t for our incredible team: Portfolio Manager Joe Hintz, Assistant Portfolio Manager Jag Sriram, and Analyst Matt Fedorjaka. Joe joined us in the fall of 2021. Jag joined Royce shortly after I did, and as we got to know each other, it became very clear that he was a perfect fit for our process. Matt joined us a little over a year ago and really hit the ground running. We couldn’t be happier with his ramp-up and meaningful contributions, especially in such a short time. Another change was in the portfolio. When I joined Royce, this portfolio held more than 180 stocks. As of the end of 1Q25, that number was 61. The robust process we use simply isn’t conducive to running a strategy with 180 holdings, so we have gradually reduced that total over the last few years. (By the way, I think we are probably at or near the bottom of the range we’d expect to operate in going forward.) The last thing I’d highlight is that we’ve broadened the Fund’s historical focus from dividends being the sole source of capital return to one that embraces both dividends and share repurchases. We think that this subtle shift has allowed us to apply our process to a wider range of companies while staying true to our core investment philosophy.

What elements have you and the team kept in place?

ML: That’s a great question, and probably as important as what has changed! The most important thing that remains, and will always remain, is our core investment philosophy—which is to buy high-quality companies that are out of favor for transitory or cyclical reasons. That philosophy is truly the starting point for everything we do on our team. The investment process is simply the expression of that philosophy in our research activities. As we were making the aforementioned changes over the last few years, we were very intentional about preserving what we call the “historical performance contour” of Small-Cap Total Return, meaning how we expect the portfolio to behave in certain market environments. We’ve tracked these changes using data at the portfolio level, including fundamental metrics focused on quality and valuation. We’re thrilled to report that the portfolio has consistently behaved as we would have expected.

For better or worse, we’ve had a wild ride in small-caps over the last five years. In the 2021-23 cycle, our downside capture was approximately 56%, which is not only consistent with the Fund’s prior track record of providing downside protection in bad markets, but the best downside capture ratio since 1998 for market drawdowns of 15% or more. In the most recent drawdown through mid-March, we were at 77%, which is right around the Fund’s historical average.

Upside/Downside Capture Ratios, Periods Ended 3/31/25 (%)

Upside Capture Ratio measures a manager’s performance in up markets relative to the Fund’s benchmark (Russell 2000 Value). It is calculated by measuring the Fund’s performance in quarters when the benchmark goes up and dividing it by the benchmark’s return in those quarters. Downside Capture Ratio measures a manager’s performance in down markets relative to the Fund’s benchmark (Russell 2000 Value). It is calculated by measuring the Fund’s performance in quarters when the benchmark goes down and dividing it by the benchmark’s return in those quarters.

Related to this is the Fund’s historically low volatility profile. That was something we focused on preserving. While volatility has ticked up slightly—which is to be expected with the number of names falling in the manner that it did—the Fund’s volatility remains in the bottom quintile of its small cap-peer group, and meaningfully below the Russell 2000 Value Index.

Low Volatility¹
5-Year Relative Standard Deviation vs. all Small-Cap Funds tracked by Morningstar as of 3/31/25

¹Royce Small-Cap Total Return Fund was in the lowest volatility quintile compared with all funds in Morningstar’s Small Growth, Small Blend, and Small Value Categories with at least five years of history, a total of 459 funds as of 3/31/25. The universe consists of each fund’s oldest share class only. Volatility quintiles are based on the average five-year standard deviation for each of the last four calendar quarters. Higher volatility is usually associated with higher risk.

We’ve been able to preserve this low volatility profile by continuing to focus on owning high-quality business models, and, again, there is data we track meticulously to support that assertion. So in summary, I’d say that the manufacturing process has changed, but the end product—while more streamlined and aerodynamic—is the same as it was before, if not better, in my opinion.

What accomplishments in running the Fund are you most proud of over the last five years?

ML: I’ve touched on a few already, so I’ll answer that question from a different angle. I love our team and am so proud of how we’ve come together. We have a great rapport with one another. We challenge each other in a healthy and respectful way. We know our biases, both personally and from an investing perspective. We get along so well, and I truly cherish the moments when all of us are together, even if it’s virtually. I mentioned our process, but I think the biggest accomplishment is how we’ve improved the original process which, to be clear, Joe and I thought was outstanding.

Every member of the team has made significant contributions to improving our approach. It’s become more focused, deeper, and more efficient. Lastly, and this kind of dovetails with my last comment on process, I’m incredibly proud of how our team has embraced a mindset of continuous improvement. We all want to get better individually as investors, while also helping each other to improve. That requires a team-first mentality. It requires us to be humble, introspective, and eager to improve. In our business, there are always mistakes. What’s important to us are the opportunities to learn from them. We do that on our own and also do it collectively as a team. By the way, I intentionally did not mention performance, which has been solid. But even if we were first decile versus our peer group, we’d still be looking to improve.

You mentioned the evolution of the focus from dividend payers to capital return; can you walk us through the thought process for why that change was made?

ML: That’s an interesting story and needs a bit of a longer answer. Let’s start with why Small-Cap Total Return has always focused on dividends. There are two primary reasons for this: first, research—both our own and academic research—shows that small-cap dividend payers outperform the small-cap market over the long run and do so with less risk. So empirically, and somewhat counterintuitively, it’s a good pond to fish in. The second reason, which ties back to our bottom-up process, is that dividends can be a crude starting point for quality and potentially provide important signals. Initiating and/or growing a dividend suggests that the business generates more cash than it consumes—and we love companies that generate strong free cash flow.

The payment of a dividend may also signal to the market that management is confident in the durability of those cash flows and that they appear to be thoughtful about how they allocate capital—again, two things we care a lot about. But dividends are simply a form of capital return. Classic finance theory holds that investors should be indifferent about the choice between receiving dividends as a form of capital return and share repurchases. That takes us to share repurchases, which are simply another form of capital return. As we were applying our process, we were consistently coming across ideas that checked all but one of the boxes we look for in an ideal investment. We saw that certain companies were repurchasing shares, sometimes in significant volumes, instead of paying dividends. We asked ourselves: would it make sense to focus on both forms of capital return? The first thing we did to help answer that question was some back testing, and we found that high quality small-cap companies that return capital in the form of dividends and/or share repurchases also outperformed the small-cap market with less risk.

We then studied how companies in this landscape were returning capital to shareholders over time. What we found was striking: from 1993 to 2021 (we first did the analysis in 2022), the number of companies in the Russell 2000 Index that paid dividends decreased by almost 15%. Conversely, the number of companies that were repurchasing shares and—this is important—actually reducing the share count (versus simply offsetting the dilution of stock-based compensation), but that did not pay a dividend, had increased dramatically, by over 130% (off an admittedly small base). We thought it made sense to widen our lens in order to take advantage of this cohort of companies. We also feel that, like dividend payers, companies that reduce their share counts are providing two important signals: the first centers on thoughtful capital allocation. The second is that management, who have a better understanding of their business than public equity investors, believe that the company’s shares are undervalued. I know that was a long-winded response, but it’s a nuanced answer!

Why is having a team so critical?

ML: I am a firm believer in the team-based approach to investing, though I readily admit there are other time-tested investment approaches. While I’m the team member doing this interview, make no mistake: I’m just one member of an incredible four-person team. Our team-based research process is the cornerstone of why we believe so strongly in working together. We believe that the whole is greater than the sum of its parts. This is especially true for our team because it’s quite diverse. Joe is a classically trained violinist (and a Grammy Award winning one to boot!). Jag was originally a software engineer and later worked in credit. Matt was a high-performing collegiate lacrosse player at an elite program and worked as an analyst on the sell-side. I started my career in tech consulting before moving into the distressed credit world. Our different backgrounds, beliefs, and experiences mean we have diverse ways of analyzing companies.

It also means we have broad and unique professional networks we can tap into throughout our due diligence and ongoing maintenance processes. It never ceases to amaze me how one member of the team, who has never studied the business we are considering, will bring a unique insight or line of questioning to the table. When one of us employs a new analytical tool while researching a company, the rest of us can learn from it while adding it to our toolkit. I see so many benefits. Our approach, however, requires the right people. We can challenge each other’s assumptions because we do so in a supportive way that’s not confrontational. And I believe everyone on the team does that very well. The common threads we share are a passion for small-cap investing, a high degree of intellectual curiosity, and an ethos of constantly trying to improve. We all believe deeply in this Strategy’s core principles of owning high-quality, undervalued assets. Having those shared values is so critical to the team performing at a high level and, at the end of the day, we are all incentivized to see this Strategy be successful.

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