Royce Small-Cap Opportunity Fund Manager Commentary
article 12-31-2021

Royce Small-Cap Opportunity Fund Manager Commentary

Our theme-based Opportunity Fund not only outperformed the Russell 2000 Value and the Russell 2000 Indexes but also outpaced both benchmarks for the 3-, 5-, 10-, 15-, 20-, 25-year, and since inception (11/19/96) periods ended 12/31/21.


Fund Performance

Royce Opportunity Fund advanced 30.8% in 2021, outpacing both its benchmark, the Russell 2000 Value, which gained 28.3%, and the Russell 2000 Index, which was up 14.8% for the same period. We were even more pleased that the Fund also outperformed both the Russell 2000 Value and the Russell 2000 for the 3-, 5-, 10-, 15-, 20-, 25-year, and since inception (11/19/96) periods ended 12/31/21.

What Worked… And What Didn’t

All of the portfolio’s 11 equity sectors made a positive impact on performance in 2021, with the largest positive impacts contributions coming from Industrials, Information Technology, and Materials while the smallest positive impacts came from Utilities, Consumer Staples, and Communication Services. At the industry level, semiconductors & semiconductor equipment (Information Technology), health care providers & services (Health Care), and chemicals (Materials) contributed most while biotechnology (Health Care), auto components (Consumer Discretionary), and diversified consumer services (Consumer Discretionary) were the largest detractors in the calendar year.

The holding making the largest contribution in 2021 was Alpha & Omega Semiconductor, which designs, develops, and supplies a broad range of power semiconductors. In September, the company reported double-digit growth in each of its market segments, along with record revenue. Next best was Herc Holdings, which provides rental equipment through its subsidiaries in several industries, including construction, manufacturing, refineries, and emergency response. Herc announced in September that it was raising guidance for the rest of 2021 while also offering an optimistic long-term forecast. With plans to expand into urban areas, Herc set goals for organic compound annual growth ranging from 12% to 15% in rental revenue and 17% to 20% in adjusted EBITDA (Earnings before Interest, Taxes, Depreciation, & Amortization) from 2021 to 2024. We reduced our stakes in both companies as their prices rose in 2021.

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The largest detractor at the position level was LL Flooring Holdings, better known as Lumber Liquidators. The company retails hard-surface flooring, including hardwood, laminate, vinyl plank, tile, bamboo, and cork flooring, as well as flooring tools and accessories. Its shares fell in May after the company reported fairly good results but removed guidance due to COVID concerns. Its stock slid again in the fall on pandemic-related supply and inventory replenishment issues and year-over-year sales declines. Confident that it can turn its business around as supply chain delays are worked through, we held shares at year end. Emergent BioSolutions was our second-biggest detractor. It’s a specialty pharmaceuticals company that manufactures the only FDA-approved anthrax vaccine, among other treatments and therapeutics. Its stock fell precipitously in the spring after the FDA discovered cross contamination issues at one of its plants that was preparing COVID vaccines just as the company was ramping up efforts to be included in the vaccine supply chain. Its shares declined again in November on news that the U.S. Department of Health and Human Services had canceled a multimillion-dollar agreement with the company. We held a small position at the end of 2021, believing that the market has not fully recognized the value of its assets or its existing contracts with the U.S. government.

The portfolio’s advantage over the Russell 2000 Value in 2021 was entirely attributable to stock selection, with particular strength from picks in Materials, Health Care, and Information Technology. Conversely, stock selection hindered relative results in Consumer Discretionary. The Fund’s cash holdings and a combination of stock picks and lower exposure to Energy also detracted from 2021’s relative performance.

Top Contributors to Performance 20211 (%)

Alpha & Omega Semiconductor0.78
Herc Holdings0.74
B. Riley Financial0.73
Cross Country Healthcare0.69
Avid Technology0.67

1 Includes dividends

Top Detractors from Performance 20212 (%)

LL Flooring Holdings-0.23
Emergent BioSolutions-0.22
Regis Corporation-0.20
CalAmp Corporation-0.18

2 Net of dividends

Current Positioning and Outlook

Neither positioning nor our outlook has shifted appreciably since mid-year. We still expect generally better performance for B2B than B2C companies over the long run as consumers are likely to continue feeling the bite of inflation. The portfolio’s opportunistic value strategy often leads us to places where few, if any, other investors are looking because the stocks are performing poorly. We believe select areas in consumer retail offer an example where many companies are dealing with much of what investors are avoiding in stocks: the resurgence of COVID, supply chain issues—where shortages are pressuring profit margins—and higher energy prices, all of which are creating what we see as attractive valuations for certain retailers. We’ve also been active in the aerospace & defense industry, which sustained a double whammy in 2021 from COVID and issues around the 737 MAX. These issues created hiccups in production. Neither has righted itself to the extent that many had hoped, though the industry was approaching more historically normal conditions at the end of 2021. We have purchased shares of companies where we see attractively low valuations and the capacity for growth. In addition, we continue to see opportunities in industries in temporary staffing and industrial distributors—both of which have benefited from the otherwise challenging issue of skilled labor shortages. Finally, we see what we think are very promising long-term opportunities in select areas of technology, where supply chain consolidation has helped certain companies gain market share.

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

Small-Cap Opportunity 5.7530.8530.8528.5115.6715.069.8411.3412.7812.94

Annual Operating Expenses: 1.21

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 Operating expenses reflect the Fund's total annual operating expenses for the Investment Class as of the Fund's most current prospectus and include management fees and other expenses.

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: Alpha & Omega Semiconductor was 0.5%, Herc Holdings was 0.4%, B. Riley Financial was 0.7%, Cross Country Healthcare was 0.7%, Avid Technology was 0.6%, LL Flooring Holdings was 0.5%, Emergent BioSolutions was 0.3%, Regis Corporation was 0.1%, CalAmp Corporation was 0.4%, Kirkland's was 0.3%.

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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