Royce Small-Cap Value Fund Manager Commentary
article 12-31-2019

Royce Small-Cap Value Fund Manager Commentary

The Fund generated a strong positive return in 2019, however, it trailed its benchmarks for the year.


Fund Performance

Royce Small-Cap Value Fund, which uses a disciplined contrarian value approach, increased 18.2% in 2019, trailing respective gains of 25.5% and 22.4% for its small-cap benchmarks, the Russell 2000 and Russell 2000 Value Indexes, for the same period.

What Worked… And What Didn’t

For the calendar year, seven of the portfolio’s 11 equity sectors finished in the black. Three sectors dominated the positive contributors—Information Technology, Industrials, and Financials—while Utilities were flat, and Energy, Consumer Staples, and Communication Services detracted. At the industry level, electronic equipment, instruments & components (Information Technology) led by a wide margin, followed by banks and thrifts & mortgage finance (both in Financials), as well as machinery (Industrials). Oil, gas & consumable fuels (Energy) was the largest detractor at the industry level in 2019, followed by specialty retail, textiles, apparel & luxury goods (both in Consumer Discretionary), and food & staples retailing (Consumer Staples).

The portfolio’s largest holding at year-end, Insight Enterprises contributed most at the position level, as it did for the six-month period ended 6/30/19. The company provides information technology hardware and software for large and small enterprises and was key to the electronic equipment, instruments & components group’s strong performance in 2019. Insight continued to execute profitably in 2019, with steadily increasing revenues and better-than-expected earnings. The company also saw its sales grow as a result of its acquisition of PCM in August, which expands the firm’s reach into higher-margin end markets that are expected to drive additional improvement in the future and which are a large part of Insight’s optimistic outlook for 2020.

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Another company in the same industry was also a top contributor in 2019—PC Connection, a direct marketer of a technology products and services, including computer systems, software and peripheral equipment, and networking communications. The company beat earnings estimates in both the second and third quarters while also exceeding consensus revenue estimates in three out of the last four quarters—both evidence of the kind of successful execution we like from our holdings. Genworth MI Canada, which provides private residential mortgage insurance in that nation, also stood out. Its stock began to rise in July when Genworth Financial, a related U.S. firm, agreed to sell its shares of Genworth MI Canada to Brookfield Business Partners in order to win regulatory approval for its own acquisition by a Chinese company. The firm also had steadily growing revenues and net income throughout 2019.

The specialty retail industry was home to the Fund’s worst performing position, footwear retailer Designer Brands (formerly known as DSW). The company has faced challenges as many leading brands are opting for more direct customer relationships. In December, the company also reported a decline in its gross margins related to unseasonably warm fall weather, which hindered performance, and tariff concerns that led to an inventory pullback and a cut in marketing investments in anticipation of lower spending by consumers that didn’t materialize. Confident that the company can right itself and navigate the secular shifts affecting retailers, we added shares in 2019. Low-fare airline operator Spirit Airlines grappled with lower fares throughout the industry and poor weather (including hurricanes). Spirit also opted to aggressively schedule more flights, which left little room for error when mechanical or weather-related problems arose. Seeing these as solvable short-term issues, we built our position. ArcBest is a freight and logistics solutions specialist that saw its business stall in 2019, though we think its long-term prospects are solid, especially if the economy reaccelerates in 2020.

Both stock selection and, to a lesser degree, sector allocation hurt performance versus the Russell 2000 in 2019. Consumer Discretionary and Health Care detracted most. Underperformance in the first sector was almost entirely the result of poor stock selection while in Health Care both our lower exposure and ineffective stock picks created a disadvantage. Specialty retail (Consumer Discretionary) fared worst on an industry basis, followed by biotechnology, which dominated results in Health Care. The portfolio’s cash position also detracted from relative results. Conversely, our overweight in Information Technology and underweight in Utilities helped relative results.

Top Contributors to Performance 20191 (%)

Insight Enterprises1.46
Genworth MI Canada Inc.1.34
PC Connection1.25
Miller Industries0.91

1 Includes dividends

Top Detractors from Performance 20192 (%)

Designer Brands Cl. A-0.64
Spirit Airlines-0.53
G-III Apparel Group-0.46
Alliance Resource Partners L.P.-0.46

2 Net of dividends

Current Positioning and Outlook

The market’s shift to value proved short-lived as the Russell 2000 Value trailed its growth counterpart in 2019’s fourth quarter. Whether growth’s resurgence will last or value can reassert itself is of course an open question. The fear of recession appears to have diminished, with green shoots indicating that the global slowdown may have bottomed. Details on a China trade deal are still vague, however, and this is not the first time that an agreement has appeared close, so economic reacceleration may remain elusive. In the meantime, the Fed is holding the line on rates, and yield curve inversion is over for now. In other words, the outlook remains uncertain before we even consider geopolitical tensions or the November elections. In this environment, we been adding select positions that look attractively valued and capable of rebounding in energy services and pharmaceuticals.

Average Annual Total Returns Through 12/31/19 (%)

Small-Cap Value 6.6918.2118.214.924.357.206.879.06 06/14/01

Annual Operating Expenses: Gross 1.55 Net 1.49

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 Gross operating expenses reflect the Fund's gross total annual operating expenses for the Service Class and include management fees, 12b-1 distribution and service fees, and other expenses. Net operating expenses reflect contractual fee waivers and/or expense reimbursements. All expense information is reported as of the Fund's most current prospectus. Royce & Associates has contractually agreed, without right of termination, to waive fees and/or reimburse expenses to the extent necessary to maintain the Service Class's net annual operating expenses (excluding brokerage commissions, taxes, interest, litigation expenses, acquired fund fees and expenses, and other expenses not borne in the ordinary course of business) at or below 1.49% through April 30, 2020.

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, 2019, 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, 2019 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 12/31/19, the percentage of Fund assets was as follows: Insight Enterprises was 2.6%, Genworth MI Canada was 2.5%, PC Connection was 1.5%, Meritor was 1.7%, Miller Industries was 2.5%, Designer Brands Cl. A was 2.1%, Spirit Airlines was 2.2%, ArcBest was 1.5%, G-III Apparel Group was 1.8%, Alliance Resource Partners L.P. 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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