Royce Smaller-Companies Growth Fund Manager Commentary
article 12-31-2021

Royce Smaller-Companies Growth Fund Manager Commentary

We are highly confident in our current themes, and we see each as offering decade-long opportunities that should hold up well against the ups and downs of valuation.


Fund Performance

Royce Smaller-Companies Growth Fund gained 7.8% in 2021, lagging its primary benchmark, the Russell 2000 Index, which was up 14.8%, but beating the Russell 2000 Growth Index, which rose 2.8% for the same period. The Fund was stronger over longer-term periods, outperforming the Russell 2000 for the 3-, 5-, 10-, 20-year, and since inception (6/14/01) periods ended 12/31/21 and beating the Russell 2000 Growth for the 3-, 5, 20-year, and since inception periods.

What Worked… And What Didn’t

Six of the portfolio’s 10 equity sectors made a positive impact on 2021’s performance. The sectors making the largest positive contributions were Information Technology, Health Care, and Financials while the biggest detractions came from Consumer Discretionary, Consumer Staples, and Communication Services. At the industry level, semiconductors & semiconductor equipment (Information Technology), life sciences tools & services (Health Care), and banks (Financials) contributed most in 2021 while electrical equipment (Industrials), interactive media & services (Communication Services), and diversified consumer services (Consumer Discretionary) were the largest detractors.

InMode, which makes medical devices that emit radio frequencies which allow for minimally and (in some instances) non-invasive ways to perform certain types of plastic surgery, skin care treatments, and other procedures, was the Fund’s top-contributing position. Robust revenue growth driven by the rapid adoption of its innovative devices, along with prospects for recurring revenues going forward, led its stock to lofty heights in 2021. Ambarella develops image processing SoCs (system on chips) and computer vision chips. Its SoCs process photos, videos for cameras, and other gadgets, while its computer vision chips help security cameras identify faces and driverless vehicles avoid obstacles. Its strong niche in these areas drove impressive growth in earnings and revenue in 2021. In a deal announced in August, Canadian sports media and online betting company Score Media and Gaming was acquired for a sizable premium by Penn National thanks to its strong position in the fast-growing online sports media and betting markets.

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The top detractor at the position level was another Canadian media property, Enthusiast Gaming Holdings, which runs digital media platforms that include more than 100 gaming-related websites. A top outperformer from 4Q20 through the first half of 2021, its revenue growth was nothing short of spectacular in 2021. However, that growth was partly due to an acquisition, and the company still has not become profitable, which drove investors to take profits in the second half of 2021. Liking its long-term growth prospects, we added to our stake. allows users to play state-sanctioned lottery games online and on mobile devices, and with more states set to legalize online lotteries, it appeared to be a strong growth opportunity. However, its reverse SPAC merger reported quarterly results using what we thought was aggressive accounting, which raised doubts for us about its ability to achieve near term financial targets, leading us to begin exiting our position in November. American Superconductor manufactures advanced power systems, naval ship protection systems, and wind turbines using superconducting technology. The company enjoyed improved revenue and earnings growth in 2020 that decelerated in 2021—which caused Wall Street estimates to be lowered multiple times during the year. We still like its long-term prospects and added shares in May.

The portfolio’s disadvantage versus the Russell 2000 in 2021 came entirely from sector allocation as our stock selection was modestly positive. At the sector level, stock picking and, to a lesser degree, lower exposure, hurt relative performance in Consumer Discretionary, as did stock selection in Industrials. The Fund’s cash position also detracted from relative results. Conversely, stock selection was a strength in Health Care, easily overcoming the negative impact of our overweight in a poor performing sector within the Russell 2000. Savvy stock picking also provided more modest relative advantages in Materials and Information Technology.

Top Contributors to Performance 20211 (%)

Score Media and Gaming Cl. A1.41
Joint Corp. (The)1.34
ATS Automation Tooling Systems1.13

1 Includes dividends

Top Detractors from Performance 20212 (%)

Enthusiast Gaming Holdings-1.14
American Superconductor-0.66
Aspen Group-0.66

2 Net of dividends

Current Positioning and Outlook

Through most of 2021, faster-growing, higher-multiple, and/or unprofitable companies were particularly hard hit, and that valuation compression has continued into the first weeks of 2022. Underperformance for small-cap growth could continue through the first half of 2022 due primarily to the persistence of high multiples, as well as lingering inflation and the expectations of higher interest rates. Ongoing labor shortages and consequent upward wage pressures should make inflation more lasting. Additionally, aggressive monetary and fiscal stimulus will ease at some point, given the economy would likely be growing faster without recurring COVID outbreaks and their attendant anxieties. Still, our long-term outlook for the portfolio is positive. First, we expect the recent panic-like selling in some of our holdings to stabilize. We also believe COVID will be a less negative factor in 2022. Turning to the portfolio, we are highly confident in our current themes, including cloud computing, enterprise software adoption, electric vehicle/power storage penetration, drug discovery tools and services, and automation/robotics. We see each of these as decade-long opportunities that should hold up well against the ups and downs of valuation. We have been putting cash to work by adding to favorites and taking advantage of lower valuations more generally.

Average Annual Total Returns Through 12/31/21 (%)

Smaller-Companies Growth -4.027.787.7825.7716.0413.628.3311.5012.24

Annual Operating Expenses: Gross 1.51 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, 2022.

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, 2021, 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, 2021 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 12/31/21, the percentage of Fund assets was as follows: InMode was 2.1%, Ambarella was 2.8%, Score Media and Gaming Cl. A was 0.0%, Joint Corp. (The) was 0.4%, ATS Automation Tooling Systems was 2.6%, Enthusiast Gaming Holdings was 2.0%, was 0.0%, American Superconductor was 0.8%, Aspen Group was 0.0%, Neuronetics was 0.6%.

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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