Royce Global Financial Services Fund Manager Commentary
article 12-31-2020

Royce Global Financial Services Fund Manager Commentary

Three reasons underpin our belief that global small caps, including those in financial services, are well positioned going forward.


Fund Performance

Royce Global Financial Services Fund gained 15.3% in 2020, a fine absolute return that nonetheless lagged the 20.0% advance for its primary benchmark, the Russell 2000 Index, and the 16.3% increase for its global small-cap benchmark, the MSCI ACWI Small Cap Index, for the same period. The Fund ceded the relative advantage it had over both indexes during the more bullish second half of 2020 after losing less than each benchmark for the year-to-date period ended 6/30/20 (down 7.0% compared to a loss of 13.0% for the Russell 2000 and a decline of 12.8% for the MSCI ACWI Small Cap). In the second half of 2020, the Fund advanced 23.9%—again, a strong absolute return—versus respective gains of 37.9% and 33.5% for the domestic and global small-cap indexes.

What Worked… And What Didn’t

The portfolio’s top-contributing position in 2020 was U.S. Global Investors, an asset manager that primarily runs international and domestic equities, fixed income, and precious metals focused portfolios. Like most asset managers, US Global’s business rebounded strongly through the dynamic upswing for most of the globe’s equity markets following the March lows. This rebound featured a risk-on mentality that helped to lift the company’s stock as its unrealized losses have narrowed materially through 9/30/20 to a nearly negligible amount. The second top contributor was MarketAxess Holdings, which operates an electronic, multi-dealer trading platform for investment grade and high-yield corporate and emerging market bonds. Its business benefited from robust year-over-year increases in the average daily volume of high-yield and investment grade bond trading as well as from strong network benefits, especially in open trading. We also think the firm can continue to reap the rewards of credit market dislocation, which seems to have driven market share gains for the company.

The top detractor on a position basis was Air Lease. As a lessor of aircraft, Air Lease’s business suffered greatly as flights ground to a halt, an unprecedented event, even for the firm’s highly experienced management team. The drying up of the asset-backed securities market further hindered Air Lease’s ability to sell its aging aircraft to its joint ventures, making it more difficult for the firm to manage the age of its fleet and to strategically retain clients from its competitors. Concerned about the likelihood of a prolonged road to recovery for the airline industry, we opted to exit our position in June.

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Also detracting was Capital City Bank Group, which operates Capital City Bank, a regional player with branches in Florida, Georgia, and Alabama. Its net interest margin declined steadily throughout 2020, and its ratio of reserves to loans held for investment was much lower than its industry peers, both of which appeared to keep investors selling its stock. Although we reduced our stake in March, we held shares in the hope of a recovery rooted in our confidence that regional banks should bounce back in 2021. We maintained our position in BOK Financial for similar reasons. This leading Oklahoma-based bank saw its business suffer from exposure to the oil & gas, retail commercial real estate, and healthcare industries.

Top Contributors to Performance 20201 (%)

U.S. Global Investors Cl. A2.83
MarketAxess Holdings2.69
Tel Aviv Stock Exchange2.55
Canaccord Genuity Group2.45

1 Includes dividends

Top Detractors from Performance 20202 (%)

Air Lease Cl. A-1.27
Capital City Bank Group-0.94
BOK Financial-0.76
Eagle Point Income-0.74
Garrison Capital-0.72

2 Net of dividends

Current Positioning and Outlook

We continued to prune the number of positions in the portfolio throughout 2020, moving from 68 to 61 holdings as we focused on the business models in which we had the highest conviction. The portfolio has always leaned more toward capital markets businesses, including traditional and alternative asset managers, as well as having exposure to insurance and companies that specialize in financial technology. While these industries have faced challenges of their own over the last several years, near-zero interest rates have created even more significant difficulties for banks, as have increased loan loss provisions caused by the pandemic. However, we are cautiously optimistic about our bank holdings. Regional banks in particular have held up very well during the pandemic, consistent with our thesis that the industry’s risk profile was reduced dramatically following the Financial Crisis and that robust capital levels would prove a source of strength. We expect earnings to be strong in 2021 as provisions for credit losses drop sharply, loan growth resumes, and stronger economic growth steepens the yield curve.

More generally, we are optimistic about the prospects for global small caps, including those in financial services. Three factors underpin our optimism: First, we expect a stronger recovery than many think due to pent up services demand, limited excess capacity, a healthy U.S. consumer, and strong corporate balance sheets; second, stronger-than-expected operating leverage should accentuate the recovery as many companies have permanently reduced their cost structures; and finally, we see reasonable, and in some cases quite attractive, valuations for many of our holdings. The vaccine roll-out should spur economic growth, though we suspect it will initially be unevenly distributed—and that is where we think active managers can offer an edge. The ability to recognize patterns, understand industry dynamics, and evaluate management teams should all prove crucial in such a climate.

Average Annual Total Returns Through 12/31/20 (%)

Global Financial Services 21.2515.2515.257.4111.379.897.818.48 12/31/03

Annual Operating Expenses: Gross 2.07 Net 1.68

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, 2021. 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, hedge funds, private equity 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, 2020, 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, 2020 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 12/31/20, the percentage of Fund assets was as follows: U.S. Global Investors Cl. A was 3.0%, MarketAxess Holdings was 2.7%, Sprott was 3.9%, Tel Aviv Stock Exchange was 4.1%, Canaccord Genuity Group was 3.3%, Air Lease Cl. A was 0.0%, Capital City Bank Group was 1.2%, BOK Financial was 2.1%, Eagle Point Income was 0.8%, Garrison Capital was 0.0%

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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