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

Royce Capital Fund–Small-Cap Portfolio Manager Commentary

The Fund outpaced both the Russell 2000 Value and the Russell 2000 indexes in 2021. In addition, we expect that 2022 will be a good year for small-cap value as all signs point to continued economic strength.


Fund Performance

Royce Capital Fund–Small-Cap Portfolio advanced 28.8% in 2021, narrowly outpacing its primary benchmark, the Russell 2000 Value Index, which was up 28.3%, and beating the Russell 2000 Index, which rose 14.8% for the same period.

What Worked… And What Didn’t

All of the portfolio’s nine equity sectors made a positive impact on calendar-year performance. The sectors making the largest positive contributions were Industrials, Information Technology, and Consumer Discretionary while the smallest positive impacts came from Consumer Staples, Real Estate, and Energy. At the industry level, specialty retail (Consumer Discretionary), electronic equipment, instruments & components (Information Technology), and road & rail (Industrials) contributed most in the calendar year period while communications equipment (Information Technology), insurance (Financials), and consumer finance (Financials) were the largest detractors.

The portfolio’s top contributor at the position level for 2021 was Arkansas-based freight and logistics solutions provider ArcBest. The company achieved record quarterly revenue and operating income, which was announced in its third-quarter earnings release, with consolidated quarterly revenues of more than $1 billion. ArcBest also benefited from its acquisition of MoLo Solutions, a Chicago-based truckload brokerage. Shoe Carnival, a discount footwear retailer, was the second top contributing position for the calendar year. Many of the company’s competitors have shut their doors, helping its business. In addition, Nike consolidated the number of stores that can sell its products, which included Shoe Carnival. Stronger demand allowed the company to discontinue deep discounting, leading to margin expansion. The third contributor was Kulicke & Soffa Industries, a leader in manufacturing equipment and tools used to assemble and package semiconductor devices. A full 60% or more of all semiconductors processed utilize the company’s wire bonding equipment. Kulicke is benefiting from record industry wafer fab equipment spending and a structural increase in the complexity of chip packaging due to increased advanced packaging or multi-die packaging techniques. Further, Kulicke has been benefiting from new product introductions in the mini-LED packaging market, which is growing quickly.

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The portfolio’s biggest detractor was Nautilus, which manufactures fitness equipment. The company’s third-quarter results were hurt by inflation as well as global shipping and supply chain challenges. With profitability unlikely this year, we chose to exit our position. The portfolio’s next biggest detractor, James River Group Holdings, focuses on the “Excess & Surplus” insurance niche. Its stock saw its most severe dip in 2021’s first half. The company then took a charge in the fourth quarter related to its non-core reinsurance division that, while fairly small, came on the heels of the much larger charge taken earlier in the year in its commercial auto business (specifically Uber), which led its shares to drift lower. Current management has been trying to fix the problems created by the prior team, though our own concerns about the timing and extent of the fixes led us to significantly reduce our position.Heritage Insurance Holdings, a super-regional property and casualty insurance holding company, also detracted. The company, which has significant business in coastal areas, was hurt by poor weather in Florida during 2021. We believe that Heritage Insurance can benefit from premium rate increases. The stock is inexpensive, and we maintained our position at year end.

The portfolio’s very narrow advantage over its benchmark was attributable to stock selection in 2021, which was especially strong in Industrials, Health Care, and Information Technology. Our underweight in the second sector was also beneficial. Conversely, Financials detracted due to stock selection while our cash position also hurt relative results, as did our significantly lower exposure to Real Estate.

Top Contributors to Performance 20211 (%)

Shoe Carnival1.93
Kulicke & Soffa Industries1.70
OneWater Marine Cl. A1.65

1 Includes dividends

Top Detractors from Performance 20212 (%)

James River Group Holdings-0.42
Heritage Insurance Holdings-0.40
Haverty Furniture-0.36

2 Net of dividends

Current Positioning And Outlook

We expect that 2022 will be a good year for small-cap value as all signs point to continued economic strength, though we’re mindful that continuing COVID resurgences could disrupt this positive backdrop. In addition, we believe the Fed has clearly signaled that interest rates will rise in 2022, which should bode well for value investors like us. There had been a disconnect between the stagnant 10-year Treasury yield and the Fed’s language until recently. The 10-year yield, however, is beginning to rise. We believe the equity market is incorporating this view, as seen by the weak performance of many long-duration assets like richly valued, non-earning, story-based growth stocks. We see the semiconductor supply chain issue lasting through most of 2022, and labor shortages and wage pressures look likely to continue. Inflation is with us now and is real. In this context, we have been buying selectively, adding, for example, to our technology weighting, pharmaceutical companies with proven products and promising pipelines, and homebuilders and other housing related companies in the area of home furnishings.

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

Capital Small-Cap 8.2228.8228.8212.386.518.636.508.2710.0310.07

Annual Operating Expenses: Gross 1.11 Net 1.08

1 Not annualized.

Important Performance, Expense, 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 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 1.08% 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: ArcBest was 1.4%, Shoe Carnival was 2.4%, Kulicke & Soffa Industries was 2.5%, OneWater Marine Cl. A was 2.6%, Rent-A-Center was 2.4%, Nautilus was 0.0%, James River Group Holdings was 0.3%, Heritage Insurance Holdings was 0.5%, NETGEAR was 0.0%, Haverty Furniture was 1.5%.

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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