Royce Small-Cap Value Fund Manager Commentary
article 02-15-2024

Royce Small-Cap Value Fund Manager Commentary

The Fund advanced 26.1% in 2023, handily outperforming its primary small-cap benchmark, the Russell 2000 Value Index, which was up 14.6% for the same period, and the 16.9% gain for its secondary benchmark, the Russell 2000 Index.


Fund Performance

Royce Small-Cap Value Fund advanced 26.1% in 2023, handily outperforming its primary small-cap benchmark, the Russell 2000 Value Index, which was up 14.6% for the same period, and the 16.9% gain for its secondary benchmark, the Russell 2000 Index. The Fund also beat both benchmarks for the 3-year, 20-year, and since inception (6/14/01) periods ended 12/31/23, though it lagged for the 5- and 10-year periods.

What Worked… and What Didn’t

Eight of the portfolio’s 10 equity sectors made a positive impact on calendar year performance, led by Consumer Discretionary, Information Technology, and Industrials. The only negative impacts came from Health Care and Materials while Consumer Staples made the smallest contribution. At the industry level, electronic equipment, instruments & components (Information Technology), household durables (Consumer Discretionary), and specialty retail (Consumer Discretionary) contributed most for the calendar year period, while biotechnology (Health Care), leisure products (Consumer Discretionary), and pharmaceuticals (Health Care) were the largest detractors.

The portfolio’s top contributor at the position level in 2023 was Sterling Infrastructure, which provides advanced, large-scale site development services for data centers, manufacturing facilities, and e-commerce distribution centers. The company continues to execute effectively in fast-growing markets in the U.S. as it has transitioned from primarily being a highly levered highway builder to its current mix of businesses. M/I Homes builds single-family homes primarily in the Midwest and Southeast U.S. The company has a low-debt balance sheet, steady cash flows, and strong earnings. Perhaps counterintuitively, M/I benefited from higher mortgage rates as homeowners put off selling to avoid purchasing a new home at increased rates—which spurred demand for newly built homes for first-time home buyers. PulteGroup, which builds homes all over the U.S., benefited from this same dynamic. Each homebuilder company held by the portfolio was a top-10 holding at the end of December.

Resources Connection was the portfolio’s top detractor in 2023. A professional services firm that provides accounting and finance, human resources management, and information technology professionals to clients on a project-by-project basis, the company faced slumping demand as many businesses cut back on spending for discretionary services. Northwest Pipe makes large diameter, high pressure steel pipe products used for water transmission and smaller diameter, electric resistance welded pipe for a variety of applications. Its stock suffered from the combination of higher steel prices and projects being pushed forward. We held small positions in both Resources Connection and Northwest Pipe at year end. We opted to sell our shares of Financial Institutions, an upstate New York community bank, based on the belief that it was under- capitalized in what we think may continue to be a challenging period for smaller regional players in the banking industry.

Both sector allocation decisions and, to a lesser degree, stock selection contributed to the Fund’s performance edge over the Russell 2000 Value in 2023. All told, eight of 10 equity sectors outperformed the benchmark, with the most impactful advantages coming from stock selection and our higher weighting in Consumer Discretionary, as well as our higher weighting and stock selection in both Information Technology and Industrials. Conversely, stock selection and a lower weight in Materials and stock selection in the Real Estate and Consumer Staples sectors detracted most (though marginally) from relative performance.

Top Contributors to Performance 20231 (%)

Sterling Infrastructure2.11
M/I Homes1.72

1 Includes dividends

Top Detractors from Performance 20232 (%)

Resources Connection-0.33
Northwest Pipe-0.23
Financial Institutions-0.22
Ironwood Pharmaceuticals Cl. A-0.21
Mid Penn Bancorp-0.19

2 Net of dividends

Current Positioning and Outlook

The market rally that ushered out 2023 was rooted more in the momentum fueled by economic hope than in material earnings growth—which in our experience seldom if ever makes for a lasting recovery. This appears particularly true in our current situation as many stocks seem to have priced in significant rate cuts in 2024 in the absence of any clear signals from the Fed about the specific timing and magnitude of those decreases. In our view, the tension between investors’ assumptions and actual Fed actions creates a lot of risk for equity investors. We still do not know whether or not the U.S. economy will achieve the much desired soft landing or slide into recession. As investors are faced with potentially underwhelming or disappointing earnings in the first half of 2024, we could endure a rough first six months. We would argue that an earnings recession is more likely to occur than an economic contraction. However, we also see the probability of more clarity about the state of the U.S. economy in the second half of 2024, which we see as a potentially rewarding period for small-cap investors. We have not made many significant changes to portfolio positioning. We trimmed positions, most prominently in banks, where we felt share prices had climbed past near-term earnings prospects. We added to holdings in trucking and transportation—which we think are well positioned for a stronger second half of the year. We otherwise held sector and industry weights more or less steady.

Average Annual Total Returns Through 12/31/23 (%)

Small-Cap Value 15.9526.0826.0813.309.965.349.588.198.87

Annual Operating Expenses: Gross 1.62 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 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, 2024.

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, 2023, 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, 2023 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 12/31/23, the percentage of Fund assets was as follows: Sterling Infrastructure was 1.3%, M/I Homes was 1.9%, PulteGroup was 1.7%, Jabil was 1.4%, ePlus was 1.7%, Resources Connection was 0.1%, Northwest Pipe was 0.5%, Financial Institutions was 0.0%, Ironwood Pharmaceuticals Cl. A was 0.0%, Mid Penn Bancorp was 1.1%.

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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