Fund Performance

Royce Capital Fund–Micro-Cap Portfolio advanced 2.9% for the year-to-date period ended 6/30/24, outperforming its primary benchmark, the Russell Microcap Index, which was down -0.8%, and the Russell 2000 Index, which rose 1.7% for the same period. The Fund also beat its benchmark for the 1-, 3-, 5-, 10-, and 20-year periods ended 6/30/24 and outperformed the Russell 2000 for the 1-, 3-, 5-, 25-year, and since inception (12/31/91) periods ended 6/30/24.

Six of the portfolio’s 10 equity sectors made a positive impact on year-to-date period performance. The sectors making the largest positive contributions were Industrials, Materials, and Energy while the largest negative impacts came from

Financials, Consumer Discretionary, and Information Technology. At the industry level, commercial services & supplies (Industrials), semiconductors & semiconductor equipment (Information Technology), and electrical equipment (Industrials) contributed most for the year-to-date period, while communications equipment (Information Technology), banks (Financials), and specialty retail (Consumer Discretionary) were the largest detractors.

The Fund’s top contributor at the position level was American Superconductor, which supplies advanced technologies designed to enhance energy efficiency across power grids, wind power, and military applications. As the market has increasingly recognized the significant power needs associated with Artificial Intelligence (“AI”) and Electric Vehicles “EVs)”, it has come to see the company as a potentially significant supplier into that energy ecosystem. IES Holdings designs and installs electrical and technology systems into numerous infrastructure segments, including residential housing, commercial buildings, and data centers. Through a thoughtful growth strategy focused on both internal and external opportunities, IES has slowly built scale in each of its four business segments. This has resulted in rapidly improving operating profitability, driving strong growth in earnings before interest, taxes, depreciation & amortization (“EBITDA”). As a company with very little research coverage, IES flew under the radar of most investors, though more began to take note of the company’s improved profitability in 2024’s first half.

Modine Manufacturing, which provides thermal management products and solutions has been transitioning from commoditized products focused on the auto industry to more value-added solutions that target better opportunities in areas such as data center construction and Electric Vehicles (EVs). The stock currently reflects the rapid acceleration in data center construction around demand for AI applications. Camtek designs and manufactures high-end metrology and inspection systems for the semiconductor industry. Both of these systems have become increasingly important parts of the semiconductor supply chain as semiconductors have become increasingly complex, a trend that has been accelerated by the demands for High Band Width Memory associated with Artificial Intelligence applications. Camtek is one of the few companies with the technology to meet these increasing demands. Aspen Aerogels designs and manufactures aerogel insulation products that have many applications for industrial uses, but most importantly for use in EVs. “Thermal runaway,” the phenomenon in which the lithium-ion battery cell enters an uncontrollable, self-heating state causing a vehicle to catch on fire. Aspen’s PyroThin Technology has earned a reputation for preventing thermal runaway, which has been reflected in the number of critical wins for its products in the EV space. After a period of significant investment in building out manufacturing capacity, the company is beginning to ramp production at scale, which in turn is driving strong growth in revenues and operating profitability. We see a very long runway for the company’s technology as EV adoption continues to grow. Each contributor was also a top performer relative to the Russell Microcap Index.

The Fund’s top detractor at the position level was Applied Optoelectronics, which manufactures optical products and components. Its stock rose high in 2023 on the back of a large contract win with Microsoft, which coincided with market enthusiasm for AI opportunities. We think its underwhelming performance so far in 2024 reflects a typical correction. We also believe that we are still in the early stages of the buildout of AI applications and that having Microsoft as a lead account should help Applied Optoelectronics benefit going forward. Harvard Biosciences makes instrumentation products used in clinical and educational healthcare settings and is in the midst of a turnaround focused on rationalizing its product portfolio and reallocating research and development investments to higher growth opportunities. Business results have been hurt by the lingering impacts of Covid and the slowdown in the Chinese economy. As is often the case with micro-cap turnarounds, progress has been slower than initially hoped for, but we believe the company is well positioned to drive accelerating revenue growth and profitability over the intermediate term.

Luna Innovations provides optical test and measurement services. The company ran into serious accounting issues that resulted in a rapid decline in its share price. Normally, we would be sellers of any stock after such a dramatic and unexpected turn. However, Luna’s Board of Directors acted decisively, bringing in an experienced management team. Moreover, our underlying investment case centered on what we believe is highly promising technology that should ultimately provide asset support to the shares. Given the immediate share price reaction and what we view as solid underlying asset collateral, we decided to hold our position until we have more clarity on the underlying accounting issues. Beyond is an internet retailer that had historically been focused on higher price point home and garden products. After buying the rights to the Bed Bath and Beyond brand out of bankruptcy, the company became a much broader based e-commerce retailer. The integration of the Bed Bath and Beyond brand has proven more challenging than originally anticipated, however, while sales of higher priced outdoor furniture remains challenged as a reflection of a Covid hangover. We continue to believe in the company’s decision to broaden its home based retail strategy and therefore maintained our position. Aehr Test Systems provides semiconductor testing equipment that provides unique capabilities for testing where the cost of failure is quite high. While originally a niche product, opportunities began to expand rapidly as semiconductor content became more mission critical, particularly in EVs. After a significant period of adoption of Aehr’s test equipment, there has been a lull as EV adoption has slowed and its customers work to increase the utilization of their existing tools. We see a very open-ended opportunity for Aehr and thus chose to maintain our position.

The portfolio’s advantage over the Russell Microcap came mostly from stock selection in the year-to-date period. At the sector level, both stock selection and our higher weighting boosted relative results in Industrials, as did stock selection in both Materials and Communication Services. Conversely, the portfolio’s significantly lower exposure to Health Care, stock selection in Consumer Discretionary, and lower weight in Consumer Staples detracted most from relative results in 2024’s first half.

Current Positioning and Outlook

Being a micro-cap investor has recently felt like being in an extended production of Waiting for Godot. The market remains focused on when—or if—the Fed will begin to lower rates, and by how much. While earnings for the companies in the portfolio have remained generally solid, it is increasingly clear the economy and inflation are slowing. The market remains hyper-focused on each day to day release of economic data, but we remain focused on what we see as significant intermediate-term opportunities for our holdings. We believe we are in the early innings of secular changes related to opportunities such as the reshoring of U.S. industrial capacity, increased infrastructure spending, and the increased use cases around artificial intelligence, among other technologies. We expect these trends to benefit the “picks and shovel” providers in our portfolio for years to come. Lastly, we would be remiss if we ignored the increasing political uncertainty in the U.S. and throughout the world. As noted, we generally embrace short-term volatility as a longer-term investment opportunity, but the unsettled political environment seems to be increasing potential black swan events.

Average Annual Total Returns Through 06/30/24 (%)

Annual Operating Expenses: 1.18

¹ Not annualized.

Important Performance, Expense and Disclosure Information