Royce Small-Cap Opportunity Fund Manager Commentary
article 12-31-2022

Royce Small-Cap Opportunity Fund Manager Commentary

Our theme-based Small-Cap Opportunity Fund beat both the Russell 2000 Value Index and the Russell 2000 Index for the three-, five-, 10-, 15-, 20-, 25-year, and since inception (11/19/96) periods ended 12/31/22.


Fund Performance

Royce Small-Cap Opportunity Fund was down -17.1% in 2022, lagging its primary benchmark, the Russell 2000 Value Index, which fell -14.5%, but ahead of the Russell 2000 Index, its secondary small-cap benchmark, which declined-20.4% for the same period.

The Fund outperformed both indexes for the three-, five-, 10-, 15-, 20-, 25-year, and since inception (11/19/96) periods ended 12/31/22.

What Worked… And What Didn’t

Eight of the portfolio’s 10 equity sectors finished 2022 in the red, with Consumer Discretionary, Information Technology, and Industrials detracting most. Energy and Materials made positive impacts while Consumer Staples detracted the least. At the industry level, specialty retail (Consumer Discretionary), semiconductors & semiconductor equipment, and software (both from Information Technology) detracted most while oil, gas & consumable fuels (Energy), metals & mining (Materials), and energy equipment & services (Energy) were the biggest contributors.

The top detractor was Horizon Global, which manufactures towing, trailering, cargo management, and other accessories. The company benefited during the early stages of Covid, when demand grew for aftermarket parts serving original equipment manufacturers (OEM)and the aftermarket. However, the company’s debt load proved too heavy when its OEM business declined as auto manufacturers were struggling with supply chain delays. Covid-driven demand also moderated when retailers had to work off excess inventory. We sold most of our shares in 4Q22. Shares of medical device company Bioventus declined following disappointing earnings that indicated greater complexity in integrating Misonix, which Bioventus acquired in October of 2021. We initially believed that the new entity’s greater scale could accelerate earnings growth, a view that shifted with November’s announcement that yearly guidance was being lowered, leading us to exit the stock. We added to our position in B. Riley Financial as its stock fell when dealmaking dried up in its investment banking and brokerage business, leading to earnings declines. The diversity of its business mix and the fact that the firm retains

employees in down periods so they can react quickly when markets improve give us confidence that earnings will recover.

The Fund’s two top contributors, Scorpio Tankers and Ardmore Shipping, ship refined petroleum products. Disruptions stemming from the Ukraine war and the shutdown of many high-cost refineries in Europe led to significant increases in shipping distances and shipping rates that helped both companies. These “yellow cabs of the sea” are also enjoying a tight market where no new vessel supply is expected for the next several years. Modine Manufacturing provides thermal management systems for several industries and is in the midst of a turnaround, moving from commoditized areas to higher-growth and margin segments, such as electric vehicles and data center infrastructure. We believe the turnaround is in its early stages and not yet fully appreciated by investors.

Our disadvantage versus the Russell 2000 Value resulted from sector allocation in 2022 while stock selection was additive. Both our higher weighting and, to a lesser extent, stock picking detracted in Consumer Discretionary. Our substantial underweight and stock selection also hurt relative results in Financials. In Information Technology, the positive effects of our stock selection could not overcome the negative effect of our significantly higher weight. Conversely, stock selection was additive in Materials, as were our lower exposures to both Real Estate and Health Care during 2022.

Top Contributors to Performance 20221 (%)

Scorpio Tankers0.71
Ardmore Shipping0.66
Modine Manufacturing0.63
Dorian LPG0.46
Mammoth Energy Services0.45

1 Includes dividends

Top Detractors from Performance 20222 (%)

Horizon Global-0.57
Bioventus Cl. A-0.54
B. Riley Financial-0.52
Glatfelter Corporation-0.41

2 Net of dividends

Current Positioning and Outlook

The continued decrease in money supply and easing supply chain constraints—helped in part by a general slowdown in demand—have combined to make a material dent in inflation, which we anticipate will continue through 2023. The Fed has nevertheless said it will continue to raise rates, with its eyes focused squarely on a labor market that has so far held up during a period of rapid rate increases. We expect that managing increased labor costs and availability will likely remain challenges for our companies in 2023. Throughout 2022, we sought to take advantage of the wide dispersion in valuations to position the portfolio to benefit from a revival in business and consumer sentiment when the Fed reverses course, and when the business cycle improves. In the meantime, supply chain improvements should help small caps that have been facing higher costs or have been on allocation for inventory and have had to forego revenues. The past two years saw the beginning of the end of globalization. Re-shoring, near-shoring, and onshoring are real trends from which many of our companies should benefit.?In addition, the Omnibus Spending Bill outlines a 10% increase in defense spending from which certain holdings appear poised to benefit. Taking a longer-term perspective, the normalization of interest rates away from the 0% paradigm of the last decade will put an end to free money and growth at any cost. In our minds, this is undoubtedly a positive outcome for small caps in general, more so for those management teams that are superior capital allocators, as well as for disciplined value investors such as ourselves.

Average Annual Total Returns Through 12/31/22 (%)

Small-Cap Opportunity 12.35-17.08-17.0811.147.0910.658.6211.3311.0911.62

Annual Operating Expenses: 1.23

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, 2022, 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, 2022 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 12/31/22, the percentage of Fund assets was as follows: Scorpio Tankers was 0.4%, Ardmore Shipping was 0.6%, Modine Manufacturing was 0.8%, Dorian LPG was 0.7%, Mammoth Energy Services was 0.6%, Horizon Global was 0.0%, Bioventus Cl. A was 0.0%, B. Riley Financial was 0.6%, Unifi was 0.4%, Glatfelter Corporation 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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