How did Royce Smaller-Companies Growth Fund perform in 3Q25?

Chip Skinner: The quarter was somewhat disappointing: the Fund advanced 4.7%, lagging its benchmark, Russell 2000 Growth Index, which was up 12.2% for the same period.

I think 3Q25 represented a continued rebound from the significant sell-off early in the second quarter following ‘Liberation Day.’ Every area of the stock market seemed to do well in the third quarter, despite a host of concerns that, at least for now, investors appear to be shrugging off, including the potential impact of tariffs on inflation; a softening job market (despite a lack of government employment data due to federal agency firings to confirm); the impact of AI on labor markets given the huge investments in data centers and processing power by the hyper-scalers (although likely a meaningful positive in terms of productivity); geopolitical tensions in between the U.S., Russia, and China, along with ongoing wars in the Ukraine and Middle East; and social and political unrest here in the U.S. That’s a pretty long lists of risks that investors seem comfortable ignoring right now.

How has the Fund done over longer-term periods?

CS: I’m pleased that the portfolio was ahead of the Russell 2000 Growth for the year-to-date period ended 9/30/25, up 12.2% versus 11.7%. The Fund also beat its benchmark for the 1-, 3-, 5-year, and since inception (6/14/01) periods ended 9/30/25.

How did the Fund do on a sector basis in 3Q25?

CS: Seven of the portfolio’s nine equity sectors made a positive impact on quarterly performance, led by Health Care, Information Technology, and Energy. The only negative sector impacts came from Consumer Discretionary and Communication Services.

What about at the industry level?

CS: At the industry level, the top three contributors were semiconductors & semiconductor equipment (Information Technology), aerospace & defense (Industrials), and biotechnology (Health Care), while software (Information Technology), hotels, restaurants & leisure (Consumer Discretionary), and commercial services & supplies (Industrials) were the largest detractors.

What was the source of the Fund’s underperformance versus the Russell 2000 Growth in 3Q25?

CS: The portfolio’s disadvantage versus its benchmark was mostly attributable to stock selection. Sector allocation detracted only marginally in the quarter. At the sector level, stock selection detracted most meaningfully in Industrials, Information Technology, and Consumer Discretionary. Conversely, stock selection and, to a lesser extent, a lower weighting in Financials were additive. Stock selection in Energy and Health Care also helped, as did lower exposure to the latter sector, although with a smaller positive effect.

How did the Fund do at the sector level for the year-to-date period ended 9/30/25?

CS: Seven of the portfolio’s nine equity sectors made a positive impact on year-to-date period performance. Health Care, Industrials, and Energy made the largest positive contributions while the only negative impacts came from Consumer Staples and Financials.

How were year-to-date results on an industry basis?

CS: Aerospace & defense (Industrials), pharmaceuticals (Health Care), and health care providers & services (Health Care) contributed most year-to-date through the end of September, while software (Information Technology), commercial services & supplies (Industrials), and food products (Consumer Staples) were the largest detractors.

How did the Fund perform at the sector level versus the Russell 2000 Growth for the year-to-date period?

CS: The portfolio’s advantage over the small-cap growth index came from stock selection in the year-to-date period. At the sector level, stock selection in Health Care made by far the biggest relative impact. It was primarily driven by holdings in the pharmaceuticals industry like Corcept Therapeutics. Hims & Hers Health, which is in the health care providers & services industry, also provided a meaningful boost. Stock selection in Energy also contributed to our relative advantage as did the combination of stock picks and a much lower weighting in Communication Services. Conversely, stock selection in Industrials, Information Technology and Consumer Staples detracted most from relative year-to-date period results. However, we hold high-confidence positions in all three sectors.

How do you see the current small-cap landscape?

CS: I’m still enthusiastic about small-cap’s potential to power ahead over the next several years, but there are pockets of speculative activity where valuations have raced ahead of fundamentals in what looks like performance chasing. These include crypto miners, quantum computing, early stage biotech, space-related companies, electric vertical take-off and landing vehicle public companies—an area of growing interest for us—AI-related private company valuations, massive capital spending into data centers and, finally, stepped-up IPO activity.

Some of this enthusiasm is warranted, given some of the technology breakthroughs we’ve discussed in the past, but sometimes markets get ahead of reality, which appears to be happening now. The bottom line? I’m cautious, but optimistic. The earnings potential for small-cap growth is looking quite promising as well—which bolsters my positive view on the long-term.

Average Expected Earnings Growth for 2025-2026
Index Aggregate Estimated Two-Year EPS Growth

Earnings per share (EPS) is calculated as a company’s profit divided by the outstanding shares of its common stock. The EPS Growth Estimates are the pre-calculated mean two-year EPS growth rate estimates by brokerage analysts. Estimates are the average of those provided by analysts working for brokerage firms who provide research coverage on each individual security as reported by FactSet. All non-equity securities, investment companies, companies without brokerage analyst coverage are excluded. Source: FactSet.

How have you been positioning the portfolio?

CS: Portfolio positioning continues to reflect our focus on growing companies in growth industries that are past the start-up stage but not yet at the point where their life-cycle has matured. These include holdings in three categories: companies that are direct beneficiaries of their own innovations (what I call our “better mousetraps” theme); companies that appear to have a tailwind of industry growth, including defense sector retooling, electricity generation expansion and reinvestment, and drug and medical device development; and companies that are consolidating a fragmented industry.

As we reduce exposure to some long-time favorites that have graduated into mid-cap territory, we’ve also identified new names that we believe are the next generation of winners.

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