Royce Capital Fund-Micro-Cap Portfolio Manager Commentary
article 12-31-2021

Royce Capital Fund–Micro-Cap Portfolio Manager Commentary

We are pleased the Fund outpaced both its benchmarks as well as held its long-term advantages for the periods ended 12/31/21.

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Fund Performance

Royce Capital Fund–Micro-Cap Portfolio gained 30.0% in 2021, outpacing both the Russell Microcap Index (+19.3%), its primary benchmark, and the Russell 2000 (+14.8%) for the same period. The portfolio also beat both indexes for the 3- and 5-year periods ended 12/31/21. Additionally, the portfolio outpaced the Russell 2000 for the since inception period (12/27/96) ended 12/31/21 (Data for the Russell Microcap only goes back to June 2005).

What Worked… And What Didn’t

All 10 equity sectors made positive contributions to performance for the calendar year. The most sizable positive impacts came from Information Technology, Industrials, and Financials while Consumer Staples, Real Estate, and Communication Services made the smallest.At the industry level, semiconductors & semiconductor equipment (Information Technology), specialty retail (Consumer Discretionary), and professional services (Industrials) contributed most. Auto components (Consumer Discretionary), electronic equipment, instruments & components (Information Technology), and electrical equipment (Industrials) were the largest detractors for the calendar-year period.

At the position level, the portfolio benefited most from Aehr Test Systems, which is a worldwide supplier of systems for testing and burning-in logic, memory, photonic, power devices and SiC (silicon carbide) wafers.The company is beginning tosee significant traction in applications such as electric vehicles, where the cost of semiconductor failure is extremely high.Although we have trimmed shares given their significant price appreciation, we believe we are at the early stages of adoption in many of the company’s key end markets, which led us to hold a meaningful position at year-end. The next top contributor was Aspen Aerogels. Aspen sells proprietary insulation materials to the energy market—which rebounded in 2021—and to developing markets such as electric vehicles. In 2021, the company was able to meet its growing demand because it secured the necessary financing to double its production capacity over the next several years. In addition, it has several exciting new product applications in the research and development phasethat hold potential growth opportunities.We continue to hold a large position as we believe electric vehicles are a significant long-term growth opportunity. B. Riley Financial, a capital markets firm that boasts operations spanning from investment banking to retailer bankruptcy liquidations, was the third top contributing position in 2021 as it continued to benefit from market share gains in its brokerage business.


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On the other hand, Motorsport Games, which develops gaming software, detracted most for the calendar year. Unfortunately, a NASCAR-themed game that was its first software release following its IPO had technical glitches that resulted in lower-than-expected sales. We have been selling our position as we wait for more clarity as to whether this game’s failed launch has permanently damaged the company’s game development reputation. American Superconductor is an energy technologies company specializing in the design and manufacture of power systems and superconducting wire. As a smaller company dealing with state and local governments, utilities, and the U.S Navy, order flows and revenue generation tend to be unpredictable. Following a strong year in 2020, new flows were less robust in 2021, resulting in the shares declining. We view the company’s technology as vibrant and critical to improving electric grids and believe that as business opportunities gain scale, the company’s results will become less volatile.We have been adding to our position. In addition, Profound Medical develops and commercializes technology for the treatment of localized prostate cancer. It was impacted by limitations to sell its product given COVID restrictions in many hospitals.

The portfolio’s advantage over the Russell Microcap was primarily attributable to stock selection in 2021, though sector allocation was also additive. Our substantially lower exposure and stock selection in Health Care gave the portfolio its biggest advantage over the benchmark, followed by savvy stock picking in both Information Technology and Industrials. Conversely, our lower exposure to Financials—which was strong within the benchmark—caused a drag on relative results for the calendar year. Consumer Discretionary and Real Estate each detracted because of our lower weightings and stock selection.


Top Contributors to Performance 20211 (%)

Aehr Test Systems2.41
Aspen Aerogels1.33
B. Riley Financial1.28
Transcat1.20
Citi Trends1.10

1 Includes dividends

Top Detractors from Performance 20212 (%)

Motorsport Games Cl. A-0.66
American Superconductor-0.48
CIRCOR International-0.35
Profound Medical-0.35
Stoneridge-0.35

2 Net of dividends

Current Positioning And Outlook

Micro-cap stocks began the year with very strong returns before struggling through the second half of 2021, which has created considerable opportunities in many sectors. In particular, we are optimistic about long-term opportunities in technology, where supply chain consolidation has allowed certain micro-cap names to secure greater market share in a growing, high-demand industry. We have added exposure on the margin to banks, where we remain underweight, as well as companies involved in energy. This latter group is mostly on the services side, with some holdings categorized in Industrials. Value names have been attractive to us due to both their long-term prospects and current valuations. We believe there is pent-up demand for autos and other consumer areas. With the global economy looking sound—especially once supply chain issues are resolved and COVID becomes more manageable—we are optimistic about the current environment, in particular for disciplined stock pickers with a long-term investment horizon like ourselves.

Average Annual Total Returns Through 12/31/21 (%)

QTR1 YTD1 1YR 3YR 5YR 10YR 15YR 20YR SINCE INCEPT. DATE
Capital Micro-Cap 6.6229.9829.9824.3712.979.246.528.5410.74 12/27/96
Russell Microcap -2.6619.3419.3420.9011.6913.627.519.04N/A N/A

Annual Operating Expenses: Gross 1.12 Net 1.08

1 Not annualized.

Important Performance and Disclosure Information

Important Performance and Expense Information

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. Current month-end performance may be higher or lower than performance quoted and may be obtained at www.royceinvest.com. The Fund's total returns do not reflect any deduction for charges or expenses of the variable contracts investing in the Fund. Gross operating expenses reflect the Fund's total gross operating expenses for the Investment Class and include include management fees and other expenses. Net operating expenses reflect contractual fee waivers and/or expense reimbursements. All expense information is reported as of the Fund’s most current prospectus. Royce has contractually agreed, without right of termination, to waive fees and/or reimburse expenses to the extent necessary to maintain the Investment Class's net annual operating expenses (excluding brokerage commissions, taxes, interest, litigation expenses, acquired fund fees and expenses, and other expenses not borne in the ordinary course of business) at or below 1.33% through April 30, 2022.

Current month-end performance may be obtained at our Prices and Performance page.

Notes to Performance and Other Important Information

The thoughts expressed in this report concerning recent market movements and future prospects for small company stocks are solely the opinion of Royce at December 31, 2021, and, of course, historical market trends are not necessarily indicative of future market movements. Statements regarding the future prospects for particular securities held in the Funds’ portfolios and Royce’s investment intentions with respect to those securities reflect Royce’s opinions as of December 31, 2021 and are subject to change at any time without notice. There can be no assurance that securities mentioned in this report will be included in any Royce-managed portfolio in the future.


As of 12/31/21, the percentage of Fund assets was as follows: Aehr Test Systems was 1.0%, Aspen Aerogels was 0.8%, B. Riley Financial was 1.2%, Transcat was 1.1%, Citi Trends was 1.2%, Motorsport Games Cl. A was 0.1%, American Superconductor was 0.6%, CIRCOR International was 0.8%, Profound Medical was 0.6%, Stoneridge was 0.7%


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.

All indexes referred to are unmanaged and capitalization weighted. Each index’s returns include net reinvested dividends and/or interest income. 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 Index is an 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 Russell 2000 Value and Growth Indexes consist of the respective value and growth stocks within the Russell 2000 as determined by Russell Investments. The Russell Microcap Index includes 1,000 of the smallest securities in the Russell 2000 Index, along with the next smallest eligible securities as determined by Russell. The Russell 2500 is an unmanaged, capitalization-weighted index of the 2,500 smallest publicly traded U.S. companies in the Russell 3000 index. The returns for the Russell 2500-Financial Sector represent those of the financial services companies within the Russell 2500 index. Source: MSCI. MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indexes or any securities or financial products. This report is not approved, endorsed, reviewed or produced by MSCI. None of the MSCI data is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such. The MSCI ACWI Small Cap Index is an unmanaged, capitalization-weighted index of global small-cap stocks.The MSCI ACWI ex USA Small Cap Index is an index of global small-cap stocks, excluding the United States.The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index. Returns for the market indexes used in this report were based on information supplied to Royce by Russell Investments. Royce has not independently verified the above described information.

This material contains forward-looking statements within the meaning of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that involve risks and uncertainties, including, among others, statements as to:

-the Funds’ future operating results,

-the prospects of the Funds’ portfolio companies,

-the impact of investments that the Funds have made or may make, the dependence of the Funds’ future success on the general economy and its impact on the companies and industries in which the Funds invest, and

-the ability of the Funds’ portfolio companies to achieve their objectives.

This discussion uses words such as “anticipates,” “believes,” “expects,” “future,” “intends,” and similar expressions to identify forward-looking statements. Actual results may differ materially from those projected in the forward-looking statements for any reason.

The Royce Funds have based the forward-looking statements included in this commentary on information available to us on the date of the commentary, and we assume no obligation to update any such forward-looking statements. Although The Royce Funds undertake no obligation to revise or update any forward-looking statements, whether as a result of new information, future events, or otherwise, you are advised to consult any additional disclosures that we may make through future shareholder communications or reports.

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.)

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