Royce Capital Fund-Small-Cap Portfolio Manager Commentary
article 06-30-2021

Royce Capital Fund–Small-Cap Portfolio Manager Commentary

We believe the market still has an upward, though more modest, trajectory, allowing us to position the portfolio with companies we believe will hold up well in the current uncertain climate, even if they’re currently out of favor for reasons we see as likely to prove short lived.

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Fund Performance

Royce Capital Fund–Small-Cap Portfolio gained 23.5% for the year-to-date period ended 6/30/21, underperforming the Russell 2000 Value Index (+26.7%) while outpacing the Russell 2000 (+17.5%) Index for the same period.

What Worked… And What Didn’t

All nine of the equity sectors in which the portfolio held investments made positive contributions to performance in 2021’s first half. Industrials made the most sizable positive contribution. Consumer Discretionary and Information Technology, our third and fourth largest weightings, respectively, were also additive to results. Real Estate, Consumer Staples, and Energy made the smallest positive contributions to performance for the year-to-date period ended 6/30/21.

Discount footwear retailer Shoe Carnival was the top contributing position, benefiting from substantial sales growth as high demand allowed it to sell shoes at full price rather than resort to discounting, boosting the company’s profits and expanding its margins. Kulicke & Soffa Industries—which designs and manufactures capital equipment and packaging materials used to assemble semiconductor devices—reported strong results for its fiscal second quarter in May, citing increased global reliance on semiconductors and the growing capital intensity within the assembly process as the primary drivers behind its recent success. Kulicke & Soffa’s business also benefited from restoked demand for chips and was added to the Russell 2000 in May, helping to further lift its stock price. Our third best contributor was lease-to-own retailer The Aaron’s Company. Tightening credit for lower income Americans was relieved to a large degree by PPE money, which helped the company’s key rent-to-own furniture and appliance business. Aaron's also reported first-quarter results in April that included higher revenues, much improved earnings, and raised guidance for the rest of 2021.


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Conversely, specialty insurer and reinsurer James River Group Holdings caused the biggest drag on performance for the year-to-date period ended 6/30/21. Its shares were hit hard in May when the company announced a significant reserve charge related to its commercial auto business, specifically Uber, which led James River to stop writing new policies with the ride share company at the end of 2019. A larger-than-expected number of Uber-related legacy claims, however, led the company to meaningfully add to these reserves, which created a consequent negative impact on capital levels that in turn saw James River issue equity, the dilutive effect of which led its shares rapidly downward. Hopeful for an eventual turnaround, we held shares at the end of June. We also held a position in Florida-based Heritage Insurance Holdings at the end of the period. Stormy weather in the Southeast U.S. led to higher-than-anticipated losses that crimped profits. However, its competitors are facing considerable financial pressure, and Florida is implementing price increases for home insurance, both of which should help Heritage to rebound. Like many appliance and furniture companies, furniture manufacturer La-Z-Boy experienced issues with short-term supply chains and attracting labor, which created long lead times and a growing backlog. However, La-Z-Boy hasn’t experienced many order cancellations—demand remains strong. Our expectation, then, is that its stock will rebound once its supply chain challenges are rectified.

Relative to the Russell 2000 Value, sector allocation decisions and ineffective stock selection equally hampered first-half performance. Energy, the sector with the most sizable negative impact, detracted due to our lower weighting. Financials and Communication Services followed as a result of our ineffective stock picks, with sector allocation equally detracting in the latter. On the other hand, Information Technology benefited from savvy stock selection, while our lack of exposure to Utilities and our lower weighting in Real Estate were also additive.


Top Contributors to Performance Year-to-Date Through 6/30/211 (%)

Shoe Carnival1.60
Kulicke & Soffa Industries1.53
Aaron's Company (The)1.16
Rent-A-Center1.14
ArcBest1.13

1 Includes dividends

Top Detractors from Performance Year-to-Date Through 6/30/212 (%)

James River Group Holdings-0.31
Heritage Insurance Holdings-0.15
La-Z-Boy-0.12
PROG Holdings-0.12
BioDelivery Sciences International-0.10

2 Net of dividends

Current Positioning And Outlook

Given the backdrop of ample liquidity and a rebounding economy, we believe that inflation is likely to grow, with Fed policy crucial to managing its effects. We think earnings for 2021 should remain strong as they’re being measured off 2020’s recession. However, the earnings picture for 2022 is unclear due to current market uncertainty. We’re populating the portfolio with companies we believe will hold up well in the current murky climate, even if they’re currently out of favor for reasons we see as likely to prove short lived. Our heavy exposures to Industrials, Consumer Discretionary, and Financials best exemplify this. Industries such as construction & engineering in Industrials look attractive to us as they seem best positioned to deal with current supply chain issues and look more than capable of passing on costs in our inflationary environment. Constricted supply and high demand in Consumer Discretionary has attracted us to companies involved in household goods and furniture, because we anticipate that sales should remain robust. While rising rates and a steeper yield curve may bode well for banks, loan growth remains weak. However, a strengthening economy may fix that and, moreover, we believe the market still has an upward, though more modest, trajectory.

Average Annual Total Returns Through 06/30/21 (%)

QTR1 YTD1 1YR 3YR 5YR 10YR 15YR 20YR SINCE INCEPT. DATE
Capital Small-Cap 2.1223.4860.245.229.077.266.908.1210.10 12/27/96

Annual Operating Expenses: Gross 1.19 Net 1.08

1 Not annualized.

Important Performance, Expense, 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. Current month-end performance may be higher or lower than performance quoted and may be obtained at www.royceinvest.com. The Fund's total returns do not reflect any deduction for charges or expenses of the variable contracts investing in the Fund. Gross operating expenses reflect the Fund's total gross operating expenses for the Investment Class and include include management 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 Investment 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 1.08% 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 June 30, 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 June 30, 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 6/30/21, the percentage of Fund assets was as follows: Shoe Carnival was 2.3%, Kulicke & Soffa Industries was 2.4%, Aaron's Company (The) was 2.0%, Rent-A-Center was 2.3%, ArcBest was 1.9%, James River Group Holdings was 0.6%, Heritage Insurance Holdings was 0.8%, La-Z-Boy was 2.0%, PROG Holdings was 2.0%, BioDelivery Sciences International was 0.7%, Uber 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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