Royce Smaller-Companies Growth Fund Manager Commentary
article 12-31-2019

Royce Smaller-Companies Growth Fund Manager Commentary

Our approach delivered a strong absolute return during 2019, though it fell behind its benchmark for the year.


Fund Performance

Royce Smaller Companies Growth Fund delivered a strong absolute return of 23.7% in 2019, though the Fund lagged its benchmark, the Russell 2000 Index, which advanced 25.5% for the same period.

What Worked… And What Didn’t

Eight of the Fund’s 10 equity sectors finished the year in the black. Information Technology was the top performer, more than tripling the impact of the portfolio’s next best contributor, Industrials. Materials and Energy detracted, but did so on a modest scale. Three industries in Information Technology were among the top-contributors: software, semiconductors & semiconductor equipment, and IT services. Biotechnology (Health Care) was also additive. Conversely, Internet & direct marketing retail (Consumer Discretionary), pharmaceuticals, and health care technology (both in Health Care) were the biggest detractors.

The top-contributing position for the year was software company—and long-time holding—Paylocity Holding Corporation. The company provides cloud-based payroll and HR solutions for smaller companies and benefited from low unemployment and market share wins, which spurred demand for its payroll and human resources software and services. Enphase Energy, another technology holding, makes products that increase the productivity and reliability of solar modules. Enphase has been a significant contributor for two consecutive years as new management has been successful in leading a multi-year transformation with a new set of competitive products for the solar inverter market. It also is expanding its solution footprint to include back-up power/electricity storage solutions. Enphase is part of an expanding group of companies in the portfolio in the “electrification” theme. Genetic testing company Veracyte also made a strong contribution, as the company saw all three of its marketed products that treat lung and thyroid cancer generating revenues at varying above-average rates. Veracyte also announced initial study results from a nasal swab test for lung cancer that could be on the market by 2021.

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Waitr Holdings, a food and restaurant order delivery business that targets smaller communities, was the portfolio’s largest detractor in 2019, the result of its business being hurt by intensifying competition and dropping prices—factors that led us to sell our stake. We also saw poor performance in Evolus, a medical aesthetics company that produces Jeuveau, a drug for the treatment of frown lines which competes with Botox treatments. The company has seen incredible success since its launch in May 2019 as a result of what we thought was a stellar digital launch campaign, but others questioned whether Jeuveau would continue to take share from competitors beyond the early promotional period. While we think these sentiments could crimp share-price growth in 2020, we held our shares at year-end based on our confidence in the appeal of the drug. Inogen also hampered performance during the year as the company struggled to reestablish growth in its portable oxygen concentrator business despite an aggressive ramp up of sales people near the end of 2018. We sold our shares in 2019’s first half.

The Fund’s relative underperformance in 2019 was driven entirely by stock selection—sector allocation was additive. Health Care was the largest source of underperformance due to poor selection in several industries, including health care technology and pharmaceuticals. Consumer Discretionary also hindered relative performance because of stock selection, particularly in internet & direct marketing retail. In addition, the Fund’s cash position hampered performance versus the benchmark. Conversely, we saw strong results in Information Technology due to both savvy stock selection and our overexposure to the sector. Stock selection in Communication Services proved additive, while our lower exposure to Energy also provided positive relative performance. Semiconductors & semiconductor equipment and software (both in Information Technology) yielded the strongest relative results at the industry level, followed by communications equipment (Communication Services).

Top Contributors to Performance 20191 (%)

Paylocity Holding Corporation2.06
Enphase Energy1.30
USA Technologies1.11
KEYW Holding1.11

1 Includes dividends

Top Detractors from Performance 20192 (%)

Waitr Holdings-0.75
Intersect ENT-0.31
Mitek Systems-0.31

2 Net of dividends

Current Positioning and Outlook

The U.S. economy decelerated through 2019 but continues to show slow positive growth, with the overhang of trade and tariff issues impeding acceleration. While there was evidence of an industrial slowdown in the second half of 2019, a recession appears to have been averted. An accommodative Fed, which lowered rates three times between July and October, and the first phase of a possible trade deal with China, both helped to lift returns in the second half of the year. We are more cautious in our outlook for 2020, which we believe could have difficulty repeating the success of 2019. The economic expansion is long in the tooth, political risks are looming, fixed income and high yield markets are sending signs of speculation, and certain segments of the equity market, such as biotechnology and big private equity “unicorns,” are showing signs of fatigue—all of which leads us to a more circumspect view. Still, high-return years can come in twos, especially since 2020 is an election year—which have historically been good ones for stocks—and long-term returns at the end of 2019 were below their rolling averages.

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

Smaller-Companies Growth 8.8623.6723.679.367.039.167.0810.77 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 & 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: Paylocity Holding Corporation was 3.0%, Veracyte was 1.0%, Enphase Energy was 0.8%, USA Technologies was 1.9%, KEYW Holding was 0.0%, Waitr Holdings was 0.0%, Evolus was 0.6%, Inogen was 0.0%, Intersect ENT was 0.0%, Mitek Systems 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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