Royce Small-Cap Special Equity Fund Manager Commentary
article 12-31-2022

Royce Small-Cap Special Equity Fund Manager Commentary

Consistent with its long-term history, the Fund lost less in 2022 than both its primary benchmark, the Russell 2000 Value Index, and the Russell 2000 Index, its secondary benchmark while also beating both indexes for the three-, five-, 15-year, and since inception (5/1/98) periods ended 12/31/22.


Fund Performance

Consistent with its long-term history, Royce Small-Cap Special Equity Fund lost less in 2022 than both its primary benchmark, the Russell 2000 Value Index, and the Russell 2000 Index, its secondary benchmark. The Fund fell -6.3% for the calendar year versus -14.5% for the small-cap value index and -20.4% for the Russell 2000.

The Fund also beat both indexes for the three-, five-, 15-year, and since inception (5/1/98) periods ended 12/31/22.

What Worked… And What Didn’t

Four of the portfolio’s nine equity sectors detracted from performance in 2022, with the biggest negative effects coming from Consumer Discretionary, Real Estate, and Materials. The sectors making the largest positive contributions were Consumer Staples, Communication Services, and Industrials. At the industry level, auto components, leisure products (both in Consumer Discretionary), and real estate management & development (Real Estate) detracted most while the biggest positive contributions in 2022 came from diversified consumer services (Consumer Discretionary), food & staples retailing (Consumer Staples), and commercial services & supplies (Industrials).

Standard Motor Products, a manufacturer primarily of aftermarket auto repair parts, was the largest detractor in 2022. While end market demand remained strong, margins were pressured from increasing supply chain related costs and the impact of rising interest rates on the company’s receivables factoring program. Johnson Outdoors, which makes outdoor recreational products, reported margins well below expectations in early May, primarily due to supply chain disruptions that persisted throughout the year. While demand has remained strong, concerns surrounding the strength of the consumer have weighed on its shares. Rising interest rates are likely to have had an impact on the level of transactions for real estate brokerage Marcus & Millichap, which weighed on its stock throughout the second half of the year. Shares of Kulicke & Soffa Industries, a semiconductor packaging equipment manufacturer, were weak through most of the year amid concerns about slower consumer electronics demand and consequent capacity digestion by the company’s customers.

Tax preparation business H&R Block was the largest contributor to performance in 2022. The company reported much better-than-expected results in their key tax filing quarter, and provided guidance to multi-year double-digit earnings per share growth. The company’s consistent and sizeable cash flow generation have also made it more appealing in the current environment. Grocery retailers have historically fared well during inflationary periods thanks to their ability to pass on costs and benefit from consumers looking to save money relative to dining out—two developments that helped the performance of grocery retailer Ingles Markets. The company also has a favorable geographic position to benefit from net migration. Shares of Ennis, a business form and other graphic printing company, rallied following better-than-expected results reported in mid-June, which continued throughout the year, due in part to the company’s strong supplier relationships amid industry shortages and a favorable competitive environment. The Fund’s fourth largest contributor to performance was Atkore, which manufactures electrical conduits. Its stock rose following results reported in mid-November in which the company raised earnings guidance for fiscal 2025, alleviating concerns that the company had reached an earnings peak.

The portfolio’s advantage over its benchmark was attributable to stock selection in 2022, most impactfully in Industrials and Consumer Staples. The Fund’s cash position also contributed to our relative advantage in 2022. Conversely, the Fund’s lack of exposure to Energy and Utilities detracted from relative results.

Top Contributors to Performance 20221 (%)

H&R Block2.73
Ingles Markets Cl. A0.95
Sylvamo Corporation0.41

1 Includes dividends

Top Detractors from Performance 20222 (%)

Standard Motor Products-2.04
Johnson Outdoors Cl. A-1.83
Marcus & Millichap-1.45
Kulicke & Soffa Industries-1.37
Huntsman Corporation-1.29

2 Net of dividends

Current Positioning and Outlook

We expect a global recession to hit earnings hard. As of this writing, central bank actions around the world are impacting the overall outlook, which remains challenged in our view. There is, in addition to this, the uncertain trajectory for a post-Covid China, where many are expecting renewed growth. Fed Chair Powell has acknowledged that there is no pain-free way to tame inflation. The market must at some point more fully grasp this difficult truth, which will almost certainly come with a downward recalibration of earnings. The transition from quantitative easing (QE) to quantitative tightening remains underway. We had 12 years of QE, so should we not expect the transition to take a while? Investors expect a quick fix—but is that reasonable? During previous recessions, the stock market did not bottom before the start of the recession. With the likelihood of a recession occurring in 2023, therefore, we do not believe that we have reached a durable bottom yet. During the current bear market, seller exhaustion has occurred from time to time, especially on any news that suggests lower interest rates. The market pounces on any remotely positive development. We continue to view these as temporary reprieves. More important, we believe we need lower multiples, higher credit spreads, consistently higher volatility, and a considerably higher unemployment rate to reach a durable bottom for stocks. We also are still of the belief that the market will favor short duration equities that are self-funding and return capital to their shareholders. We believe our portfolio is well represented with such names—which in our estimation have additional attractive features.

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

Small-Cap Special Equity 11.48-6.33-6.337.224.597.427.398.398.45

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, 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: H&R Block was 3.1%, Ingles Markets Cl. A was 7.6%, Ennis was 3.7%, Atkore was 1.8%, Sylvamo Corporation was 2.1%, Standard Motor Products was 5.5%, Johnson Outdoors Cl. A was 1.4%, Marcus & Millichap was 4.1%, Kulicke & Soffa Industries was 0.9%, Huntsman Corporation was 4.0%.

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.)



Sign Up