Royce Micro-Cap Fund Manager Commentary
article 12-31-2020

Royce Micro-Cap Fund Manager Commentary

The Fund delivered a strong absolute and relative return, beating both of its benchmarks for the calendar year.


Fund Performance

Royce Micro-Cap Fund delivered a strong absolute and relative return of 24.5% for 2020, outpacing both of its benchmarks, the Russell Microcap and the Russell 2000 Indexes, which returned 21.0% and 20.0%, respectively, for the same period. This year’s strong performance also allowed the Fund to beat both indexes for the three-year period ended 12/31/20.

What Worked… And What Didn’t

Five of the 10 equity sectors in which the Fund held investments finished 2020 in the black. Information Technology, the Fund’s largest weighting, generated the largest positive impact by far, followed by Health Care and Consumer Discretionary. Conversely, Energy, Financials, and Consumer Staples detracted most. At the industry level, two of the top contributors were in Information Technology—semiconductors & semiconductor equipment and electronic equipment, instruments & components—while construction & engineering (Industrials) followed. On the other hand, banks and thrifts & mortgage (both in Financials) detracted, with energy equipment & services (Energy) sandwiched in the middle.

The top contributing security was Ameresco. The company provides services for energy efficiency, asset sustainability, infrastructure upgrades, and renewable energy. Its strong performance was driven by the maturation of a number of early-stage projects, the addition of a new CFO, exceeding earnings expectations, and widespread support for sustainability projects. Ameresco is considered the premier company that provides green energy, efficiency, and sustainability solutions. Also contributing to results was online advertising technology firm Magnite. The company was created this year following a merger between digital online advertising exchange platform Rubicon and Telaria. Magnite benefited from increased advertising spending in online channels, particularly in the growing connected television sector. Diagnostic blood testing company Chembio Diagnostics was also additive. The company’s performance was driven by its receipt of FDA Emergency Use Authorization for its rapid COVID-19 antibody finger prick blood test. However, we reduced our position meaningfully after its shares appreciated sharply due to uncertainty regarding the effectiveness and accuracy of COVID-19 tests.

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The position that detracted most for the year was Newpark Resources, which provides drilling fluid systems and composite matting systems used in oilfield and other commercial markets. The company was negatively impacted by collapsing oil prices as economic activity declined due to the pandemic. We exited the position earlier this year as the company had financial leverage at the top end of our comfort level. Astronics Corporation also hampered results for the calendar year. Astronics is a New York based aerospace electronics corporation known for its lighting and electronics integrations on military, commercial, and business aircraft and semiconductor test systems. The company’s shares underperformed in 2020 due to the prospects for aerospace suppliers being severely impacted by both the COVID-19 travel shutdown and the grounding of the Boeing 737 MAX airplane. Investar Holding, which provides commercial banking products to individuals and small- to medium-sized south Louisiana businesses, negatively impacted performance. The company was hurt by a combination of the public health crisis and its exposure to the energy industry, which suffered through most of 2020.

Sector allocation decisions contributed to relative outperformance versus the Russell Microcap Index for 2020—stock selection was marginally negative. Our lower exposure and savvy stock selection in Financials gave the Fund a sizable relative advantage, as did our higher exposure and, to a lesser degree, stock selection in Information Technology. In addition, our lower weighting and stock picks aided in Real Estate. Conversely, our lower exposure to Health Care and, to a lesser degree, our ineffective stock selection hurt in the sector. Stock picking also hampered relative results for Industrials and Materials.

Top Contributors to Performance 20201 (%)

Ameresco Cl. A1.90
Chembio Diagnostics1.80
LightPath Technologies Cl. A1.66
American Superconductor1.64

1 Includes dividends

Top Detractors from Performance 20202 (%)

Newpark Resources-1.08
Astronics Corporation-0.85
Investar Holding-0.79
TriState Capital Holdings-0.77
Ardmore Shipping-0.73

2 Net of dividends

Current Positioning and Outlook

The country has made its way through a contentious election, and, despite the tumultuous transition, we expect policy priorities to rapidly become clear. We are hopeful that the most arduous tax proposals on profits and capital will be difficult to implement. However, we do expect that priorities will shift to infrastructure, with an emphasis on environmental concerns, as regulatory burdens and spending increase. Although our investment decisions remain company specific, we will continue to take into account the rapidly changing political environment as an important investment consideration. We are pleased that the news on effective treatments for COVID-19 remains increasingly positive as numerous vaccines have been approved. Despite the fits and starts in distribution, we believe the effect will be highly positive. The bottom line: Our value orientation tends to make our portfolio pro cyclical. We believe the combination of the gradual reopening of the world’s economies and an increase in fiscal stimulus will provide a cyclical tailwind to the positive attributes in our portfolio investments.

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

Micro-Cap 36.9324.5024.5011.1611.645.206.578.8610.86 12/31/91
Russell Microcap 31.3920.9620.968.7811.8910.557.348.95N/A N/A

Annual Operating Expenses: Gross 1.34 Net 1.24

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 total gross annual operating expenses and 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 1.24% through April 30, 2021.

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: Ameresco Cl. A was 1.4%, Magnite was 1.9%, Chembio Diagnostics was 0.3%, LightPath Technologies Cl. A was 0.9%, American Superconductor was 1.6%, Newpark Resources was 0.0%, Astronics Corporation was 0.0%, Investar Holding was 0.6%, TriState Capital Holdings was 0.9%, Ardmore Shipping 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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