Royce Smaller-Companies Growth Fund Manager Commentary
article 12-31-2020

Royce Smaller-Companies Growth Fund Manager Commentary

The Fund’s advance more than doubled the Russell 2000 Index’s gain in 2020, while also beating the benchmark for the one-, three-, five, 10-, 15-year, and since inception (6/14/01) periods ended 12/31/20.


Fund Performance

A very impressive 2020 gave Royce Smaller-Companies Growth Fund an advantage over its benchmark, the Russell 2000 Index, for the one-, three-, five, 10-, 15-year, and since inception (6/14/01) periods ended 12/31/20. The Fund advanced 49.3% for 2020, more than doubling the 20.0% gain for the Russell 2000. We were particularly pleased that the Fund outpaced the small-cap index in all four quarters of 2020, including the very bearish first quarter (-23.8% versus -30.6%)—the worst in the index’s history—and the very bullish fourth quarter (+33.4% versus +31.4%)—which saw the highest quarterly return in its history.

What Worked… And What Didn’t

Seven of the 10 equity sectors in which the Fund held investments finished 2020 in the black. Information Technology and Health Care—its two largest weightings—made by far the biggest positive contributions, followed by Communication Services, where our comparatively low weighting was no bar to a terrific year. Financials, Energy, and Real Estate detracted, and each had relatively low weightings.

Cryoport is a biologic/live cell transportation company that provides specialized temperature-controlled containers known as dewars for drug discovery companies during FDA trials—and at higher volumes after drug approval. This is a “picks and shovels” type of company, in this case supplying a burgeoning, early-stage segment of biotherapeutics, including gene therapies, where the visibility is high given the large number of drug candidates currently under development and in trials. We reduced our position in the latter half of 2020 given the run-up in its shares and the potential business/integration risk from two large acquisitions that were recently announced as part of a horizontal integration effort.

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Headquartered in Singapore, Sea has two established businesses—mobile game platform Garena and e-commerce site Shopee—and an emerging online payments platform/electronic wallet. The company has a leading market share in Southeast Asia, including Indonesia, Malaysia, and the Philippines. With approximately $4 billion in annual revenues, the high margin cash flow from the gaming platform is helping to fund the loss-making e-commerce business. Despite an already strong revenue base for a small company, Sea is still growing about 100% year over year, and its e-commerce business has drawn favorable comparisons to Amazon. It remains a top holding based on what we see as a long potential runway for growth.

The top detractor in the portfolio was GP Strategies, an enterprise training services provider for both classrooms and online instruction. Its business has been in turnaround mode since our original purchase. Built on acquisitions, GPX had to pause M&A growth in order to focus on stabilizing its existing segments and expanding margins—both before the onset of COVID-19. In mid-2020, the company handed over the CEO mantle to a dynamic young executive. While we have seen some signs of improvement, investors have so far not been convinced. Despite what we see as an extreme under-valuation, we chose to reduce our once sizable position as our own confidence in a recovery for the classroom training market has waned. Paylocity Holdings is a human resources/payroll services software-as-a-service company that we have owned since its IPO. Its shares underperformed in 2020 given its focus on small businesses as well as workforce contraction in the U.S.—Paylocity’s revenues are based on a per-member per month formula. While we continue to think very highly of many aspects of Paylocity’s business, its high multiple and decelerating revenue growth led us to reduce our weighting.

The Fund’s advantage versus the Russell 2000 in 2020 came mostly from stock selection, though sector allocation was also additive. Both savvy stock picking and our larger weight helped in Information Technology while stock selection drove our advantage in Communication Services. Conversely, our cash position hurt relative results, as did stock picks and a very low weighting in Materials.

Top Contributors to Performance 20201 (%)

Sea Cl. A ADR3.75
Lovesac Company (The)3.08
Unisys Corporation2.62
Celsius Holdings2.40

1 Includes dividends

Top Detractors from Performance 20202 (%)

GP Strategies-2.01
Paylocity Holding Corporation-1.27
Apyx Medical-1.21
TriState Capital Holdings-1.01

2 Net of dividends

Current Positioning and Outlook

We exited or reduced what we thought were expensive holdings in the second half of 2020, including certain cloud software and other technology companies. We added shares of semiconductors & semiconductor equipment companies, including MagnaChip Semiconductor, Advanced Energy Industries, and Onto Innovation. We also built positions in a new theme of online consumer entertainment, specifically those involved in e-gaming and sports betting. We based these decisions on the growing number of states that are expected to approve gaming and gambling legislation for tax revenue reasons, and so we see this as a multi-year theme. Expecting an industrial recovery in 2021, we also added exposure to companies that specialize in industrial automation and robotics. Many small-cap growth companies look very pricey to us, and valuation compression looks likely for certain segments in 2021. While not wishing for an extreme pullback, a correction would be a positive for our search for growth companies selling at reasonable prices. Having said that, we also believe that the high rates of innovation in multiple areas of the economy continue to provide a favorable backdrop for our theme-based style of investing.

Average Annual Total Returns Through 12/31/20 (%)

Smaller-Companies Growth 33.4049.2649.2618.3416.3811.599.0712.47 06/14/01

Annual Operating Expenses: Gross 1.54 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, 2021.

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, 2020, 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, 2020 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 12/31/20, the percentage of Fund assets was as follows: CryoPort was 0.3%, Sea Cl. A ADR was 1.5%, Lovesac Company (The) was 1.0%, Unisys Corporation was 5.3%, Celsius Holdings was 0.9%, GP Strategies was 0.5%, Paylocity Holding Corporation was 0.7%, Apyx Medical was 0.0%, TriState Capital Holdings was 0.7%, uniQure 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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