How did Royce Small-Cap Total Return Fund in 4Q25 and over longer-term periods?

Miles Lewis: The Fund, which is part of Royce’s Quality Value Strategy, advanced 1.2% for the quarter, lagging its benchmark, Russell 2000 Value Index, which was up 3.3% for the same period. The portfolio also trailed the small-cap value index in 2025, up 2.4% versus 12.6%. Longer-term relative results were much better as the Fund beat its benchmark for the 3-, 10-, 20-, 25-, 30-year, and since inception (12/15/93) periods ended 12/31/25.

How did performance shake out at the sector and industry level in 4Q25?

Joesph Hintz: Five of the portfolio’s nine equity sectors made a positive impact on performance. Health Care contributed the most by far, followed by Financials and Energy. The largest negative impact came from Consumer Discretionary, while Industrials and Materials also detracted meaningfully. At the industry level, health care providers & services (Health Care), insurance (Financials), and leisure products (Consumer Discretionary) contributed most for the quarter, and specialty retail (Consumer Discretionary), professional services (Industrials), and containers & packaging (Materials) were the biggest detractors.

Which holding contributed most in 4Q25?

JH: The Fund’s top contributor was PACS Group, a skilled nursing facility operator that has more than 300 affiliated post-acute facilities. The company operates by acquiring underperforming facilities and then applying their localized management approach and strong operating culture to drive better care outcomes for patients and improved profitability. PACS had been unable to publish timely financials since late 2024 as they conducted an internal investigation into some accusations around billing practices. The company was then able to report not only stronger-than-expected fiscal 2024 and year-to-date fiscal 2025 results in November of 2025 but also provided a list of the outcomes from the investigation. These results signaled to the market that PACS’s acquisition and operating models remained on track, creating the catalyst that boosted the stock’s outperformance.

Which holding detracted most in the fourth quarter?

Jag Sriram: Our top detractor was automotive aftermarket parts provider, Advance Auto Parts, which reaffirmed the midpoint of its guidance but trimmed the high end slightly. The market’s disappointment appeared to be rooted in widespread weakness in spending levels by low to middle income consumers, while management’s comments on a “non-linear” path to 7% operating margins by fiscal 2027 cast doubt on the company’s fiscal 2026 margin profile.

At the sector level, how did the Fund perform versus its benchmark?

JH: Our disadvantage versus the Russell 2000 Value was due to both sector allocation and stock selection in the quarter. At the sector level, stock selection in Consumer Discretionary, Materials, and Industrials (where our heavier weighting also detracted) hurt relative results the most. Conversely, our significantly lower exposure to Health Care, lack of exposure to Real Estate, and stock selection in Information Technology contributed most to 4Q25’s relative results.

How did the Fund perform at the sector level in the calendar year?

ML: Three of the portfolio’s 10 equity sectors had a positive effect on 2025’s performance, with Health Care and Financials have outsized impacts, followed by Information Technology. The largest detractors were Energy, Real Estate, and Consumer Staples.

What were the biggest industry contributors and detractors?

JS: At the industry level, trading companies & distributors (Industrials), health care providers & services (Health Care), and banks (Financials) were our biggest contributors in 2025, while professional services (Industrials), financial services (Financials), and IT services (Information Technology) were the largest detractors.

Which holding contributed most in 2025?

JH: Just as it was in the fourth quarter, PACS Group was our top contributor in 2025.

Which holding detracted most in 2025?

ML: Our top detractor was Vestis Corporation, which provides uniform rentals and workplace supplies in the U.S. and Canada. During May, the stock was battered after the company reported significantly lower 2Q25 results, pulled its guidance for the full year 2025, and provided weak guidance for the third quarter (a forecasted revenue decline of between -2.3% and -3.5% and earnings before interest, taxes, depreciation & amortization (EBITDA) decline of -27.4%). Alarmingly, operational progress seemed to have stalled as the retention rate dropped by 50 basis points to 92.4% along with several other key performance indicators. Vestis also announced a new CEO who lacked uniform rental experience (the CFO is also fairly new) and amended its credit agreement to allow a higher degree of leverage for a longer time frame. These developments highlighted the gravity of the company’s operational issues, lack of institutional knowledge, and financial risk, all of which led us to exit the position.

What were the sources of the Fund’s disadvantage versus the Russell 2000 Value in the calendar year?

ML: The Fund’s relative underperformance versus the Russell 2000 Value was due to stock selection in 2025. At the sector level, stock selection hurt most in Materials, Industrials, and Financials. Conversely, stock selection was a positive relative to the benchmark in Health Care as was the Fund’s significantly lower exposure to Real Estate.

What is the outlook for the Fund?

ML: We believe that both small-cap quality and value are poised for meaningful rebounds in 2026. 2025’s returns, particularly off the April lows, were driven primarily by lower quality, speculative stocks, along with anything with an obvious connection to the AI boom. Low quality cycles tend to average about 12 months, suggesting that a regime shift is likely. Additionally, more “traditional” businesses models—those that have healthy margins, generate free cash flow, grow modestly, and have strong, self-funding balance sheets that also trade at attractive valuations (i.e., quality value stocks)—should recapture the interest of investors as the junk rally fizzles. We see businesses in sectors such as Consumer Staples and in industries like packaging, business services, and insurance doing well while also seeing the AI theme broadening from (mostly) CapEx related models to benefit companies that can commercialize AI applications to grow their businesses and/or companies that will see margin improvement by leveraging AI tools.

The long, dark winter of small-cap underperformance has been exhaustively documented. However, we think 2026 could be the year that small-caps reassert themselves. The most likely path to outperformance would be one in which economic growth accelerates, in part driven by stimulus coming from Washington that could benefit both businesses and consumers, particularly those in the lower half of income distribution. Should this occur, we’d likely see more widespread economic growth, benefiting a broader array of industries from banks (thanks to loan growth and healthy credit) to select areas in Industrials (due to onshoring and solid general growth) and Consumer Discretionary. The earnings growth of small-caps, already expected to beat large-caps in 2026, would likely accelerate further. A related broadening of U.S. equity market returns also seems likely, in stark contrast to the unprecedented narrow market leadership of the last few years. Historically, when this happens, small-caps have beaten large-caps most of the time and have done so by healthy margins. Of course, narratives, as well as fundamentals, can shift quickly and unexpectedly--and we are prepared to capitalize on opportunities regardless of the macroeconomic backdrop.

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