Royce Global Financial Services Fund Manager Commentary
article 02-22-2024

Royce Global Financial Services Fund Manager Commentary

The Fund was up 15.7% in 2023, trailing its broad-based global benchmark, the MSCI ACWI Small Cap Index, which was up 16.8% for the same period.


Fund Performance

Royce Global Financial Services Fund was up 15.7% in 2023, trailing its broad-based global benchmark, the MSCI ACWI Small Cap Index, which was up 16.8% for the same period.

What Worked… and What Didn’t

During 2023, the Fund had investments in five equity sectors, four of which made a positive impact on calendar-year performance. As we would expect, Financials made the biggest positive contribution by far, followed by Real Estate, Industrials, and Information Technology, while Materials was the lone detractor. At the industry level, two groups from Financials were the top contributors—capital markets and banks—followed by real estate management & development (Real Estate). Only two groups detracted in 2023—metals & mining (Materials) and software (Information Technology)—while professional services (Industrials) made the smallest contribution. Holdings in the U.S., Canada, and the United Kingdom made the biggest positive impact on a country level while the biggest detractors were Israel, South Africa, and New Zealand.

The top-contributing position in 2023 was First Citizens BancShares, which we’ve owned for many years, due mostly to its strong liquidity position and stellar deposit franchise. We began adding shares in late 2022 that were trading at roughly 5x earnings per share. In March 2023, First Citizens was chosen by the FDIC to acquire Silicon Valley Bank, most likely owing to its long history of buying failed banks. Silicon Valley’s travails notwithstanding, the purchase was accretive to First Citizens’ tangible book value and earnings, and helped spur a sharp rise in its stock—as did the lack of a banking crisis in the subsequent months. Private equity business KKR & Co. enjoyed a strong finish to the year, with increased sales and earnings to go with a favorably received acquisition announced in November, a more growth-oriented focus in its business segments, and a raised earnings outlook. Rising rates helped the business of Ares Management, an alternative asset manager which also has a business development company that lends money to companies for long-term growth initiatives. It raises capital of its own at attractive rates before lending it at higher ones. In September, Ares released quarterly results that included its second highest quarter of fundraising ever and market share wins from traditional credit providers in a slower market environment.

The top-detracting position was San Francisco-based regional bank, First Republic Bank. It was the third bank to declare insolvency in 2023 (following Silicon Valley and Signature Banks) and the second-largest failure since the fall of Washington Mutual in the 2008 Financial Crisis. It was hurt by having too many uninsured deposits and too many reserves in long-term debt instruments, which began losing value when interest rates began to rise. The result was a bailout by JPMorgan Chase in May. The banking crisis helped drive down the shares of financial services specialist Charles Schwab, which has a banking business in addition to its discount brokerage. Its stock remained underwater as bank deposits declined, net new assets tumbled, and the transition of accounts from TD Ameritrade was rocky. Canada’s Altus Group provides asset and fund intelligence for commercial real estate companies. Revenues and earnings were inconsistent in 2023 as Altus tried to navigate a protracted slump in commercial real estate capital deployment.

The portfolio’s relative performance will typically hinge not just on the performance of financial stocks—which made the fourth biggest impact out of the 11 sectors in the Fund’s benchmark in 2023—but also on those sectors where we have little or no exposure relative to the broad-based global benchmark. The Fund’s relative disadvantage versus its benchmark was rooted in sector allocation. The Fund’s significantly lower weightings in Information Technology and Industrials, along with stock selection in Materials, hurt relative performance most. Conversely, stock selection in Financials, as well as a lack of exposure to both Health Care and Utilities, had the biggest positive effect on relative performance.

Top Contributors to Performance 20231 (%)

First Citizens BancShares Cl. A3.71
KKR & Co.2.23
Ares Management Cl. A1.59
Intermediate Capital Group1.42
FirstService Corporation1.40

1 Includes dividends

Top Detractors from Performance 20232 (%)

First Republic Bank-1.96
Charles Schwab-1.17
Altus Group-0.99
BOK Financial-0.84

2 Net of dividends

Current Positioning and Outlook

Our outlook is constructive. First, we suspect that returns are likely to be spread more widely over the next few years and that the reign of the Magnificent 7—the mega-cap cohort of Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla—may be coming to an end, especially if 2023’s fourth quarter and early January 2024 are any indication. The backdrop of moderating inflation, normalized interest rates, and a still growing U.S. economy also bolsters our belief that global small-cap’s lengthy stretch in the relative performance wilderness has run its course. We believe moderate growth and the more normalized rate environment should support a broadening of equity market returns where small-caps could be clear beneficiaries, especially those businesses that have largely sat out the mega-cap performance regime. Even more important is what we’ve been hearing from management teams—most of whom remain cautiously optimistic about 2024. We see an increasing likelihood, for example, that the U.S. economy will achieve the much-desired soft landing—which is encouraging for many reasons. So, we’re looking forward to what we think should be a favorable cycle for small-cap financial stocks.

Average Annual Total Returns Through 12/31/23 (%)

Global Financial Services 12.7315.7215.723.519.686.4810.487.72

Annual Operating Expenses: Gross 1.99 Net 1.57

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. Shares redeemed within 30 days of purchase may be subject to a 1% redemption fee, payable to the Fund, which is not reflected in the performance shown above; if it were, performance would be lower. Current month-end performance may be higher or lower than performance quoted and may be obtained at Gross operating expenses reflect the Fund's gross total annual operating expenses for the Service Class and include management fees, 12b-1 distribution and service fees, other expenses, and acquired fund fees and 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 Service 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 1.49% through April 30, 2024. Acquired fund fees and expenses reflect the estimated amount of the fees and expenses incurred indirectly by the Fund through its investments in mutual funds and other investment companies.

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, 2023, 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, 2023 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 12/31/23, the percentage of Fund assets was as follows: First Citizens BancShares Cl. A was 4.7%, KKR & Co. was 4.4%, Ares Management Cl. A was 1.9%, Intermediate Capital Group was 3.1%, FirstService Corporation was 4.5%, First Republic Bank was 0.0%, Charles Schwab was 2.6%, Altus Group was 2.8%, BOK Financial was 2.9%, Franco-Nevada was 3.5%.

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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