Royce Smaller-Companies Growth Fund Manager Commentary
article 12-31-2022

Royce Smaller-Companies Growth Fund Manager Commentary

A very difficult 2022 notwithstanding, we believe we are well positioned for the eventual rebound in small-cap growth stocks, which generally happens the year following a big drawdown.

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Fund Performance

In one of the most difficult years for small-cap stocks in general and small-cap growth stocks in particular since 2008’s Great Financial Crisis, Royce Smaller-Companies Growth Fund was down -32.4%, lagging both its primary benchmark, the Russell 2000 Growth Index, which fell 26.4%, and the Russell 2000 Index, which declined -20.4% for the same period.

What Worked… And What Didn’t

Eight of the portfolio’s nine equity sectors had a negative impact on 2022’s performance, with the largest detractions coming from Information Technology, Health Care, and Industrials. The only positive impact came from Consumer Staples, while Real Estate and Materials detracted least. At the industry level, biotechnology (Health Care), software, and IT services (both in Information Technology) were the largest detractors while beverages (Consumer Staples), communications equipment (Information Technology), and health care equipment & supplies (Health Care) contributed most in 2022.

Our top detractor was Ambarella, a maker of video camera and computer vision semiconductor chips. Like many fabless semi companies, it experienced supply chain disruptions, in addition to some end-market weakness. It remains a key holding, however, given its growing backlog for higher volume, higher priced—and wider margin—automotive and advanced driver assistance system applications. After years of impressive growth, Freshpet hit several speed bumps in 2022, including manufacturing and operational challenges, product quality issues, and ingredient cost inflation, though it remains the leader in the fresh and refrigerated pet food segment. An aggressive, multi-year capital spending forecast and dilutive equity raise to fund this plan also factored into its stock’s difficulties through most of 2022. Its shares began to recover after an activist investor took a 10% stake in the company, which resulted in some senior management changes. Management cut back the aggressive capital plan in order to extend the company’s cash runway, made operational improvements, and implemented additional price increases to help margins—actions that influenced our decision to hold a stake in the company.

TransMedics Group was the Fund’s top contributor. A pioneer in human organ transplantation systems, TransMedics develops equipment that provides continuous blood and oxygen flow, which extends the life of an organ during transport. Management believes—and evidence is suggesting—that their technology could, at a minimum, double transplant volumes in the U.S. In addition, 2022 brought the approval and introduction of two new products (versus one in 2021) that address lung, liver, and heart procedures. Impinj is a leading innovator in the article and inventory tracking industry, selling both reader and endpoint chips with RF (“radio frequency”) capabilities. RFID is proving a powerful tool in inventory management, product logistics, and theft prevention for apparel retailers. And while the retailer market is only about 25% penetrated (both multi-channel e-commerce and Covid accelerated adoption, with Walmart recently rolling it out), Impinj is finding newer and potentially much larger applications in package delivery, non-apparel retailers, healthcare, and counterfeit prevention. For six consecutive quarters, management has said it sees 50% more demand than they have been able to supply due to chip fabrication capacity and supply constraints. We think its runway is long.

The portfolio’s disadvantage versus the Russell 2000 Growth came from stock selection in 2022. At the sector level, stock selection in Industrials, our lack of exposure to Energy, and stock picks in Consumer Discretionary detracted most versus the benchmark. Conversely, our much lower exposure and stock selection in Real Estate, along with the Fund’s cash holdings, contributed most to relative performance.


Top Contributors to Performance 20221 (%)

TransMedics Group2.70
Impinj1.57
Celsius Holdings1.49
Clearfield1.32
Halozyme Therapeutics1.04

1 Includes dividends

Top Detractors from Performance 20222 (%)

Ambarella-1.72
Freshpet-1.41
Matterport Cl. A-1.38
Atlas Technical Consultants Cl. A-1.13
Oxford Biomedica-1.06

2 Net of dividends

Current Positioning and Outlook

We spent much of 2022 trying to reduce portfolio risk by selling earlier stage companies, reducing underperforming holdings, and letting our winners run. As a result of these actions, we held fewer positions at year end, as many companies experienced worsening outlooks or were in an industry that was beginning to see economic pressure. At the end of 2022, we remained overweight in Information Technology, Health Care, and Industrials and underweight in Energy, Consumer Discretionary, Financials, Real Estate, and Utilities. We believe we are well positioned for the eventual rebound in small-cap growth stocks, which generally happens the year following a big drawdown. We still believe in a reversion to the mean, but investors have remained in a risk off mode for some time now, as they await visibility regarding Fed rate hike moderation, inflation deceleration, and the net impact on the economy of New Deal-like heavy fiscal spending. We should also keep in mind that it typically takes 12-24 months for monetary policy to take effect, which may set us up for a mid-2023 recession, the magnitude of which is difficult to predict (as is always the case). The equity market historically moves up ahead of the eventual economic recovery, so we are anticipating more of the same until the second half of 2023, when we expect the market to begin recovering. In the meantime, we continue to seek companies that are benefiting from secular growth tailwinds and that have a sufficiently superior product or service to capture market share.

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

QTR1 YTD1 1YR 3YR 5YR 10YR 15YR 20YR SINCE INCEPT.
(06/14/01)
Smaller-Companies Growth 3.72-32.37-32.372.853.857.725.3210.229.63

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 www.royceinvest.com. 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, 2023.

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: TransMedics Group was 4.6%, Impinj was 4.0%, Celsius Holdings was 3.6%, Clearfield was 2.0%, Halozyme Therapeutics was 3.1%, Ambarella was 2.1%, Freshpet was 2.0%, Matterport Cl. A was 0.0%, Atlas Technical Consultants Cl. A was 1.1%, Oxford Biomedica 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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