Fund Performance

Royce Capital Fund–Micro-Cap Portfolio advanced 13.7% in 2024, essentially even with the Russell Microcap Index, which rose 13.7%, and beating the Russell 2000 Index, which was up 11.5%, for the same period. The portfolio outperformed the micro-cap index for the 3-, 5-, 10-, and 20-year periods ended 12/31/24—and also beat the Russell 2000 for the 3-, 5-, 25-year, and since inception (12/27/96) periods (while lagging for the 10-year period).

What Worked… and What Didn’t

Eight of the portfolio’s 10 equity sectors made a positive impact on calendar-year performance, led by Industrials, Information Technology, and Health Care. The only negative impacts came from Consumer Discretionary and Real Estate while Consumer Staples made the smallest positive impact. At the industry level, construction & engineering (Industrials), energy equipment & services (Energy), and electronic equipment, instruments & components (Information Technology) contributed most in 2024, while specialty retail (Consumer Discretionary), professional services (Industrials), and textiles, apparel & luxury goods (Consumer Discretionary) were the largest detractors.

The Fund’s top contributor at the position level was IES Holdings, which provides critical infrastructure and electrical services to key end markets such as the communications, infrastructure, and residential marketplaces. The company finds itself at the intersection of many key macroeconomic trends, including the demand for data center infrastructure and increasing power demand. A thoughtful consolidation strategy focused on accretive acquisitions that management can leverage across its existing infrastructure efforts has led to an almost fourfold increase in EBITDA over the past couple of years, with the associated share price appreciation.

Through a series of strategic acquisitions, eyecare pharmaceutical company Harrow has benefited by moving from a lower margin drug compounding business to a higher margin branded drug company. Its business has benefited as its drugs, which address numerous ophthalmic needs, have gained FDA approval and begun to be commercialized.

American Superconductor supplies advanced technologies designed to enhance energy efficiency across power grids, wind power, and military applications. As the market has increasingly recognized the significant power needs associated with AI and EVs, it has come to see the company as a potentially significant supplier into that energy ecosystem. Increased demand for its products has driven sales to the point where the company is break even from a cash flow perspective. We see this as one of those micro-cap companies at the center of key macroeconomic trends around power efficiency, which should continue to benefit its shares.

Graham Corporation designs and manufactures fluid, heat transfer, and vacuum technologies for the defense and energy industries, among others. Based on its technological capabilities, the company is the sole source on most of its projects for the U.S. Navy and is at the forefront of what we expect to be a significant rebuild of the U.S.’s naval capabilities. Profitability in Graham’s U.S. Navy business was severely hampered by “first article”—that is, custom—production on newly let contracts. As the company began to drive efficiency on additional production, profitability expanded significantly. The company also remains well positioned to benefit from a potential reacceleration in its chemical/petrochemical segment, as well as from the increased profitability and visibility in its naval backlog.

Applied Optoelectronics manufactures optical products and components. Its stock rose high in 2023 on the back of a large contract win with Microsoft, which coincided with market enthusiasm for AI opportunities. The company should continue to benefit from the rapid adoption of Artificial Intelligence (AI), and the associated demand for data center build outs. Applied Optoelectronics has relationships with many of the hyperscale data center companies, which should drive strong demand in the intermediate term. In addition, about 30% of its business is associated with cable broadband networks, an area that has been depressed for the past few years. We see that business accelerating in the intermediate term, which should provide a second source of revenue and earnings growth.

The Fund’s biggest detractor was Beyond, an online retailer, once called Overstock.com, that is in the process of transforming itself after the company bought certain assets from Bed, Bath and Beyond when the latter was in bankruptcy. The company has a new, highly competent management team led by a well-regarded CEO. Market enthusiasm and expectations looked too high coming into 2024, and its shares sold off when it became apparent that the turnaround effort was going to take some time. We sold most of our position but have recently been slowly adding again as we feel its shares have been overly punished.

Stoneridge designs and manufactures engineered electrical and electronic components, modules, and systems primarily for the automotive, medium and heavy duty truck, and agricultural vehicle markets. Its shares underperformed due to continued end market weakness in its core heavy truck transportation and agriculture end markets. However, Stoneridge continues to advance its new technology offerings to reduce cost, increase safety, and lower insurance costs for its customers, but end market recovery is likely necessary for the stock to move higher.

Luna Innovations provides advanced optical technology for test and measurement applications. The company ran into internal accounting issues that have kept it from filing financial statements, resulting in being delisted from Nasdaq (and now trading on the OTC Market). While we are deeply disappointed in the company’s inability to file current financial statements, we maintained a small position in the shares as we believe its products have immense technological value, either as a standalone company if Luna can right size operations, or as part of another company. To that latter point, management has announced that they are seeking strategic alternatives and have indicated they will provide some clarity on broad financial trends in the intermediate future.

Research and discovery technology company Harvard Bioscience is in the midst of a long-term repositioning of its business focused on consolidating its operating footprint, divesting from non-core assets, and investing R&D dollars to expand from its core academic research institutions and contract research organizations (CROs) into higher growth areas such as biotechnology and pharmaceuticals. In our opinion, the company has been fairly successful in this transformation, but it has been hidden by short-term weakness in China and the funding environment for CRO’s. As those headwinds subside, we expect the company to move toward double-digit revenue growth with meaningful improvements in profitability.

Commercial Vehicle Group provides cab and electrical systems, as well as after market systems for various heavy duty and medium duty trucks. A new management team is in the process of restructuring the business, but as is often the case, this is taking longer than initially expected and has been compounded by a downturn in the commercial vehicle market. While the company does have some debt, a recent restructuring effort gave us the confidence to maintain our position.

Relative to the Russell Microcap in 2024, the portfolio enjoyed an advantage from sector allocation decisions while stock selection hindered performance vis-à-vis the index. At the sector level, stock selection and, to a lesser extent, our significantly lower exposure to Health Care did the most to help relative results, followed by stock selection in Communication Services and Energy (where our lower weighting was also additive). Conversely, stock selection in Information Technology hampered relative results, as did stock selection and a higher weighting in Consumer Discretionary and stock selection and a lower weighting in Financials. (Our substantially higher weighting in Information Technology was additive, though not enough to overcome what we expect should be a short-lived disadvantage in stock selection within the sector.)

Current Outlook and Positioning

With the election in the rearview mirror, we now have more clarity on the outlook for fiscal and regulatory policies, which we view as generally positive for equities. Smaller companies in particular should benefit from a lighter regulatory touch. There will still be much to monitor around the new administration, particularly as it relates to tariffs and their impacts on trade and inflation. We continue to see a significant opportunity set associated with broad macroeconomic trends. The reindustrialization of the U.S. economy and the rapid adoption of Artificial Intelligence are providing investment opportunities across a broad spectrum of the micro-cap universe and inform our overweight positions in Industrials and Information Technology. These opportunities often arise in tangential areas such as the significant increase in power demand associated with AI data centers. These trends fit well with our U.S.-centric microcap universe. While the election has brought an increased level of certainty around government policy, there remain numerous areas of potential volatility outside our control. First among these is the pace of future interest rate cuts, but the outside geopolitical world also remains highly volatile. As always, we will seek to use these periods of volatility to our advantage.

Average Annual Total Returns Through 12/31/24 (%)

Annual Operating Expenses: 1.18

¹ Not annualized.

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