Fund Performance

Royce Small-Cap Total Return Fund advanced 2.4% in 2025, lagging its benchmark, Russell 2000 Value Index, which was up 12.6% for the same period. Longer-term relative performance was better. The Fund beat the Russell 2000 Value for the 3-, 10-, 20-, 25-, 30-year, and since inception (12/15/93) periods ended 12/31/25.

What Worked… and What Didn’t

Three of the portfolio’s 10 equity sectors made positive contributions to calendar-year period performance: Health Care and Financials led by wide margins, followed by Information Technology. Of the seven sectors that detracted, Energy, Real Estate, and Consumer Staples had the biggest negative effects. At the industry level, trading companies & distributors (Industrials), health care providers & services (Health Care), and banks (Financials) contributed most in 2025, while professional services (Industrials), financial services (Financials), and IT services (Information Technology) were the largest detractors.

The Fund’s top contributor at the position level was PACS Group, a skilled nursing facility operator that has more than 300 affiliated post-acute facilities. The company operates by acquiring underperforming facilities and then applying their localized management approach and strong operating culture to drive better care outcomes for patients and improved profitability. PACS had been unable to publish timely financials since late 2024 as they conducted an internal investigation into some accusations around billing practices. The company was then able to report not only stronger-than-expected fiscal 2024 and year-to-date fiscal 2025 results in November of 2025 but also provided a list of the outcomes from the investigation. These results signaled to the market that PACS’s acquisition and operating models remained on track, creating the catalyst that boosted the stock’s outperformance.

FTAI Aviation is an aircraft leasing and aerospace engine maintenance and repair organization (MRO) specializing in the CFM56 engine, the workhorse powering the global aircraft fleet. In the post-Covid era, airlines have seen a significant resurgence in passenger demand, which engine OEMs (original equipment manufacturers) have struggled to meet amid quality issues with new engine families such as the LEAP and GTF. As a result, airlines are running older aircraft with legacy engines, creating significantly higher demand for aircraft engine maintenance. FTAI has benefited even more than traditional MROs, because it saves small- and mid-sized airlines significant time and money by offering a choice of buying, leasing, or exchanging engines. Importantly, FTAI has a significant cost advantage both in engine sourcing and repair, including the use of salvaged parts and cheaper after-market engine components.

FTAI shares significantly outperformed in 2025 due to robust demand for passenger flights and more importantly from strengthening its moat by acquiring a new repair facility in Rome, developing new repair capabilities, and benefiting from the FAA approval of a long-awaited critical part. FTAI also expanded its Strategic Capital Initiative (“SCI”), a joint venture with third-party investors to operate hundreds of aircraft while retaining the maintenance contract on the engines, which is allowing FTAI to build a highly predictable recurring revenue stream at wide margins in an asset-light manner. Looking ahead, FTAI’s revenues and margin look likely to expand thanks to robust underlying demand for aircraft engine maintenance, further expansion of the SCI program, and a recently announced initiative to convert old CFM-56 engines into highly sought after industrial gas turbines that are used to run large language models at data centers.

Another top contributor from the Health Care sector, Healthcare Services Group provides housekeeping and dining services predominantly to skilled nursing facilities (post-acute care) in the U.S. In April, management reported the company’s best quarterly revenue and cash flow performance in five years, and, most importantly, saw significant growth within the housekeeping segment. While cross-selling dining services into existing housekeeping clients provides tremendous growth opportunities, a growing housekeeping segment is the first strong indicator that the company is growing net new client count again for the first time in many years.

Sapiens International provides software for the core operating system of insurance companies. The company operates in a very attractive end market with strong secular growth tailwinds as insurance companies update into modern software move away from quite antiquated legacy systems. Sapiens also has idiosyncratic opportunities to drive growth and profitability through new geographies, expanding the product suite into adjacent areas, and scaling up existing operations. While these secular and idiosyncratic opportunities formed the basis of our investment in the company, we were also cognizant of the disparity between private market and public market valuations in its industry, as several competitors had been taken private at significant premiums to their trading multiples. This indeed was the ultimate outcome for Sapiens as the company was taken private at a 64% premium in December.

Bel Fuse makes a wide variety of products that are integral to electronic circuitry across a diverse range of end markets. One can think of them as providing relatively low-cost inputs to the ultimate end product that the company services, yet those inputs provide critical functionality and therefore demand attractive profit margins. Our ownership of the company was rooted in an operational turnaround. While Bel Fuse had always delivered admirable product quality, it had been family run without much market discipline, which usually resulted in sub-standard returns. Under new leadership, the company has significantly enhanced its return profile and is now pivoting to accelerating growth. We chose to exit the stock as we felt that the market had already priced in a large proportion of future business model improvements with the stock’s strong outperformance in 2025.

Our top detractor was Vestis Corporation, which provides uniform rentals and workplace supplies in the U.S. and Canada. During May, the stock was battered after the company reported significantly lower 2Q25 results, pulled its guidance for the full year 2025, and provided weak guidance for the third quarter (a forecasted revenue decline of between -2.3% and -3.5% and earnings before interest, taxes, depreciation & amortization (EBITDA) decline of -27.4%). Alarmingly, operational progress seemed to have stalled as the retention rate dropped by 50 basis points to 92.4% along with several other key performance indicators. Vestis also announced a new CEO who lacked uniform rental experience (the CFO is also fairly new) and amended its credit agreement to allow a higher degree of leverage for a longer time frame. These developments highlighted the gravity of the company’s operational issues, lack of institutional knowledge, and financial risk, all of which led us to exit the position.

The Hackett Group is an IT services company that specializes in benchmarking data and thought leadership around best-in-class systems and capabilities. The company is in the middle of a strategic pivot to better monetize its benchmarking data and institutional knowledge that has been built over the decades, ultimately moving from a project-based revenue model to one with a higher mix of recurring revenues and software capabilities. The stock underperformed significantly in 2025 as the market lumped Hackett in with other services-oriented firms where the market is assuming there will be intense pricing pressures due to AI upending the business model. We think this is an oversight, as Hackett’s data set is actually enabling the firm to create software tools that will help businesses identify and implement AI agentic processes. In other words, the market is treating Hackett as an “AI loser” while we think it will be a significant “AI winner.”

Franklin Covey provides consulting, seminars, educational materials, publications, and products designed to make organizations and educational institutions more effective through collective behavioral change. The company has been adversely affected by DOGE-related cancellations of government projects and tariff uncertainty, forcing enterprises to dial back on leadership training investments, yet demand in its education segment is robust. While current economic uncertainty is an unwelcome headwind, we expect Franklin Covey’s new go-to-market strategy to result in greater penetration of its customer base and near-term margin expansion. In the meantime, its net cash balance sheet and cost controls should serve the company well as it executes on this strategy.

Insperity is a Professional Employment Organization (PEO) firm, which essentially means that it handles all the back-office needs for small businesses, including becoming the de facto employer for the small business’ employees. As part of these back-office offerings, Insperity offers health care plans that are partially self-insured by the company. This ended up being the main driver of underperformance in 2025 as the entire health insurance industry was hit with unprecedented medical cost trends. The company is also currently going through an investment phase to build out a partnership with Workday that we think will be a win/win for both companies as it will allow them to address the needs of customers that currently sit in between their respective core customer bases. We are optimistic about the Insperity’s prospects in in 2026 as the company has restructured its health insurance contracts and is moving into a robust growth phase of the Workday rollout.

Rounding out the top detractors was Compass Diversified Holdings, an investment company that acquires and manages a group of nine small- and middle-market consumer and industrial businesses. Compass has a track record of acquiring private companies in attractive end markets, providing them with capital to gain share, and exiting the investments at attractive prices. In May, Compass disclosed non-reliance on its fiscal 2024, 2023, and 2022 financial statements amid an ongoing internal investigation into its Lugano subsidiary and a delay in the filing of its 1Q25 10-Q, triggering a 62% stock price decline on May 7th. A high-end jewelry retailer, Lugano is one of nine subsidiaries, accounting for only 21% of fiscal 2024 revenue, but with the highest revenue growth (63% average from 2021-2024) and EBITDA (earnings before interest, taxes, depreciation & amortization) margin (41.4%), which helps to explain the reaction. The issue surfaced when an employee alerted the CEO about how Lugano’s CEO (and 45% owner) might be fraudulently financing inventory. Given our inability to rely on Compass’s numbers and the company’s $1.8 billion in outstanding debt, we exited the position.

The Fund’s relative underperformance versus the Russell 2000 Value was due to stock selection in 2025. At the sector level, stock selection hurt most in Materials, Industrials, and Financials. Conversely, stock selection was a positive relative to the benchmark in Health Care as was the Fund’s significantly lower exposure to Real Estate.

Current Positioning and Outlook

We believe that both small-cap quality and value are poised for meaningful rebounds in 2026. 2025’s returns, particularly off the April lows, were driven primarily by lower quality, speculative stocks, along with anything with an obvious connection to the AI boom. Low quality cycles tend to average about 12 months, suggesting that a regime shift is likely. Additionally, more “traditional” businesses models—those that have healthy margins, generate free cash flow, grow modestly, and have strong, self-funding balance sheets that also trade at attractive valuations (i.e., quality value stocks)—should recapture the interest of investors as the junk rally fizzles. We see businesses in sectors such as Consumer Staples and in industries like packaging, business services, and insurance doing well while also seeing the AI theme broadening from (mostly) CapEx related models to benefit companies that can commercialize AI applications to grow their businesses and/or companies that will see margin improvement by leveraging AI tools.

The long, dark winter of small-cap underperformance has been exhaustively documented. However, we think 2026 could be the year that small-caps reassert themselves. We think the most likely path to outperformance is one in which economic growth accelerates, in part driven by stimulus coming from Washington that could benefit both businesses and consumers, particularly those in the lower half of the income distribution. Should this occur, we’d likely see more widespread economic growth, benefiting a broader array of industries from banks (thanks to loan growth and healthy credit) to select areas in Industrials (due to onshoring and solid general growth) and Consumer Discretionary. The earnings growth of small-caps, already expected to beat large-caps in 2026, would likely accelerate further. A related broadening of U.S. equity market returns also seems likely, in stark contrast to the unprecedented narrow market leadership of the last few years. Historically, when this happens, small-caps have beaten large-caps most of the time and have done so by healthy margins. Of course, narratives, as well as fundamentals, can shift quickly and unexpectedly--and we are prepared to capitalize on opportunities regardless of the macroeconomic backdrop.

Average Annual Total Returns Through 12/31/25 (%)

Annual Operating Expenses: 1.21

¹ Not annualized.

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