Royce Small-Cap Total Return Fund Manager Commentary
article 12-31-2022

Royce Small-Cap Total Return Fund Manager Commentary

The Fund lost less than both its primary benchmark, the Russell 2000 Value Index, and its secondary benchmark, the small-cap Russell 2000 Index, in 2022 while also beating both indexes for the five-, 25-year, and since inception (12/15/93) periods ended 12/31/22.


Fund Performance

Royce Small-Cap Total Return Fund was down -13.3% in 2022, losing less than both its primary benchmark, the Russell 2000 Value Index, which fell -14.5%, and its secondary benchmark, the small-cap Russell 2000 Index, which declined-20.4%, for the same period.

The Fund also outperformed both indexes for the five-, 25-year, and since inception (12/15/93) periods ended 12/31/22.

What Worked… And What Didn’t

Six of the portfolio’s 10 equity sectors finished 2022 in the red, with the largest detractions coming from Financials, Consumer Discretionary, and Information Technology while the biggest positive impacts came from Energy, Materials, and Communication Services. Insurance (Financials), electronic equipment, instruments & components (Information Technology), and banks (Financials) detracted most at the industry level while containers & packaging (Materials), energy equipment & services (Energy), and professional services (Industrials) were the biggest contributors in 2022.

Top detractor Franchise Group owns four consumer businesses: The Vitamin Shoppe, Pet Supplies Plus, and two discount furniture retailers. In addition to the recessionary concerns that hurt most retailers in the first half of the year, the company’s plans to acquire retailer Kohl’s (a deal that would likely have been highly accretive for Franchise Group) fell through. In the second half of the year, the company suffered from overstocking slow-moving inventory within one of their discount furniture retailers, American Freight, that stemmed from 2021’s supply chain constraints. Our view remains that each of Franchise Group’s core assets has high-quality attributes. Spectrum Brands Holdings is a consumer products company with a variety of products and brands, including pet care, home & garden, and personal care. Entering 2022, an attractive potential catalyst for value creation was the pending divestiture of their Hardware and Home Improvement division to Swedish firm, Assa Abloy, which would have generated a massive influx of cash that would have unlocked multiple capital allocation possibilities. The deal was ultimately opposed, however, by the U.S. Department of Justice, driving Spectrum’s shares down. We were also disappointed in some leadership changes that saw the departure of one executive whom we viewed as critical to the future of the firm. For these and other reasons, we sold our position.

Industrial packaging company Intertape Polymer Group, which makes the black tape used on Amazon boxes, was our top contributor. When we first invested, we saw an industrial packaging company that was an effective backdoor play on e-commerce. Our research was validated in March when Intertape agreed to be taken private by a private equity buyer at an 82% premium to its prior close. We see Cactus as a high-quality company in the oil field services space whose products include wellhead and pressure control equipment. Cactus benefited from a strong year for energy companies as geopolitical factors drove increased volatility within the global supply/demand balance for oil and gas, which led to considerable increases in domestic drilling activity.

The portfolio’s advantage over the Russell 2000 Value came primarily from stock selection in 2022. Stock picks in Materials, our lower exposure to Health Care, and stock selection in Industrials helped relative results most. Conversely, both our lower weighting and stock picking hurt performance versus the benchmark in Energy, as did stock selection in Consumer Staples and Consumer Discretionary.

Top Contributors to Performance 20221 (%)

Intertape Polymer Group1.37
Cactus Cl. A0.77
Pason Systems0.48
CDK Global0.45
Barrett Business Services0.39

1 Includes dividends

Top Detractors from Performance 20222 (%)

Franchise Group Cl. A-1.27
Spectrum Brands Holdings-1.23
GrafTech International-0.97
Vontier Corporation-0.94

2 Net of dividends

Current Positioning and Outlook

The silver lining in 2022’s bear market, based on our own research and that of others, is that down years have often set the stage for solid returns in the subsequent year—and those returns are frequently well above historical averages. We remain confident that the value-led cycle within small cap has legs, in part because prior leadership stints for small-cap value tended to be multi-year events. High quality remains historically inexpensive versus low quality. We believe this is an attractive set up in its own right, and even more so in the context of a possible recession and difficult operating environment. We are therefore particularly optimistic about small-cap value and quality, the twin cornerstones of the Fund’s investment philosophy. Our team continues to find an abundance of opportunity. The carnage in the tech sector in 2022, for example, led to cheap, highly profitable, and cash generative businesses being sold along with their far more expensive, less profitable (often unprofitable), and cash burning counterparts. We capitalized by buying what we believe are high-quality tech assets, particularly in the software space. Certain areas of Consumer Discretionary also look interesting to us, notably those hit hardest by a combination of one or all of the following: a focus on the lower end consumer (whose spending was impacted greatly by inflation, which appears to be rolling over); perceived Covid beneficiaries that we believe have more enduring businesses than the market is giving them credit for; and/or companies impacted by transitory issues, such as inventory de-stocking at large customers, which look highly unlikely to repeat in 2023. Lastly, we are optimistic about holdings that in our view were disproportionately punished in 2022. We believe that we’ve found quite a few of these opportunities—which look poised to deliver strong long-term returns.

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

Small-Cap Total Return 11.71-13.25-

Annual Operating Expenses: 1.26

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, other expenses, and acquired fund fees and expenses. 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, 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: Intertape Polymer Group was 0.0%, Cactus Cl. A was 1.0%, Pason Systems was 1.6%, CDK Global was 0.0%, Barrett Business Services was 1.1%, Franchise Group Cl. A was 1.8%, Spectrum Brands Holdings was 0.0%, Coherent Series A Conv. was 1.8%, GrafTech International was 0.0%, Vontier Corporation was 2.5%.

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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