The Micro-Cap Universe

Micro-cap stocks (which we define as companies with market capitalizations not greater than that of the largest company in the Russell Microcap® Index at the time of its most recent reconstitution) remain on the fringes of the capital markets. The number of actively managed funds and ETFs that invest solely or primarily in micro-cap stocks remains low—and totals less than 20 as of this writing.

One might have expected that both the continued popularity of ETFs and the emergence of alternative investment options for retail investors might lead to more micro-cap-centered offerings, yet they are still largely unexplored as an investment option in and of themselves, (though many small-cap funds, including most of our own, and ETFs have some exposure to micro-cap stocks). Because we have been managing portfolios that focus on the asset class for more than three decades, we find this lack of investment attention somewhat puzzling.

Of course, micro-cap stocks carry significant risks.

In general, they’re followed by few, if any, analysts, and there tends to be less publicly available information about them than about even larger small caps. They often have more limited trading volumes and are subject to more abrupt or erratic market price moves than bigger small-cap and large-cap stocks. Micro-cap businesses may also have limited markets, financial resources, or product lines. They may also lack management depth and may be more vulnerable to adverse industry or market developments.

However, we think that the micro-cap universe offers numerous opportunities to find companies that are lightly researched and/or appear to be mispriced. Many of the risks involved in micro-cap investing often create promising opportunities for disciplined active management.

Micro-caps have been among the best performing asset classes off the April 8th lows, with the Russell Microcap Index up 47.6% from 4/8/25-9/5/25. Yet micro-caps with earnings were attractively priced at the end of June as measured by the price-to-earnings ratio for the Russell Microcap.

Micro-Cap P/Es Were Below Average
Weighted Harmonic Average Price-to Earnings Ratio (Excluding Non-Earners) for the Russell Microcap, 6/30/00-6/30/25

Source: FactSet
The Price-to-Earnings Ratio is calculated by dividing a company’s share price by its trailing 12-month earnings-per-share (EPS) and excludes companies with zero or negative earnings. 48% of Index holdings were excluded as of 6/30/25). Harmonic Average is a weighted calculation that evaluates a portfolio as if it were a single stock and measures it overall. It compares the total market value of the portfolio to the portfolio’s share in the earnings or book value, as the case may be, of its underlying stocks.

Micro-caps with earnings were also attractively valued relative to the large-cap Russell 1000 Index at the end of June, as measured by our preferred index valuation metric, LTM EV/EBIT, or the last 12 months enterprise value over earnings before interest & taxes.

Relative Valuations for Micro-Caps vs. Large-Caps Were Well Below Their 25-Year Average
Russell Microcap vs. Russell 1000 Median LTM EV/EBIT (ex. Negative EBIT Companies), 6/30/00-6/30/25

Source: FactSet

We typically further examine this metric by looking across the 11 sectors in the micro- and large-cap indexes. As of 6/30/25, eight sectors in the Russell Microcap were undervalued versus the Russell 1000, with the broad and diverse Financials, Health Care, and Industrials sectors especially undervalued relative to the large-cap index.

Breadth of Undervaluation Across 8 of 11 Sectors in the Russell Microcap
Russell Microcap and Russell 1000 Median EV/EBIT (ex. Negative EBIT) by Sector as of 6/30/25

Source: FactSet

Royce’s Approach to Micro-Cap Investing

We manage three portfolios that focus on micro-cap stocks: The open-end Royce Micro-Cap Fund (which is one of the oldest open-end funds dedicated to investing in micro-cap stocks), our closed-end offering, Royce Micro-Cap Trust (one of the only closed-end funds dedicated to investing in micro-cap stocks), and Royce Capital Fund–Micro-Cap Portfolio, a variable annuity product that is one of the only variable annuity products dedicated to investing in micro-caps.

Portfolio Manager Jim Stoeffel and Assistant Portfolio Manager Andrew Palen manage all three portfolios. In each fund, they deploy a core approach, which enables them to identify opportunities in an area of the market that still has minimal research coverage.

Jim and Andrew use multiple approaches in these portfolios, which gives them ample exposure to the entire asset class while the discipline of a long-term investment horizon keeps them focused on the fundamental business strengths that can potentially generate strong long-term performance. They generally focus on micro-cap companies with strong balance sheets, attractive growth prospects, and/or the potential for improved cash flows and internal rates of return and slot portfolio holdings into four categories:

Depressed Earnings

• The company’s current earnings are below normalized levels.
• The company has a very low valuation based on Price/Book and/or Price/Sales ratios.
• The company has specific catalysts for change.

Out-of-Favor Value

• The company has above average profitability.
• The company has lower than average leverage.
• The company has a low valuation and low expectations.

Premier

• The company has a discernible competitive advantage.
• The company has high returns on capital.
• The company has sustainable “moat-like” franchises.

Growth at a Reasonable Price

• The company has superior projected growth.
• The company has support from secular themes.
• The company also has a modest valuation.

In each Fund, their sell discipline is a function of enterprise conviction and market valuation. Jim and Andrew typically sell when a company’s market price exceeds their estimate of its intrinsic worth or when the company is acquired (and is usually sold prior to the deal closing). They will also exit a position when they identify better risk/reward potential in another investment or when they experience a loss of enterprise conviction.

As for the current market moment, they remain constructive that each portfolio’s drivers will persist, even if the market experiences renewed volatility. Recent investment themes, which include reindustrialization, electrification, and the benefits of artificial intelligence, are each in their respective early innings. Jim and Andrew also continue to see many micro-cap businesses with attractive competitive positions and durable long-term growth opportunities in an expanding landscape of idiosyncratic situations at still undemanding valuations that can pave the way for promising long-term returns.

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