Royce Capital Fund-Small-Cap Portfolio Manager Commentary
article 06-30-2023

Royce Capital Fund–Small-Cap Portfolio Manager Commentary

Royce Capital Fund—Small-Cap Portfolio outperformed the Russell 2000 Value for the 1-, 3-, 5-, 20-, 25-year, and since inception (12/27/96) periods ended 6/30/23 while also beating the Russell 2000 for the 1-, 3-, 25-year, and since inception periods through the end of June.


Fund Performance

Royce Capital Fund–Small-Cap Portfolio gained 8.1% for the year-to-date period ended 6/30/23 versus a gain of 2.5% for its primary benchmark, the Russell 2000 Value Index, and an advance of 8.1% for its secondary benchmark, the Russell 2000 Index, for the same period. The Fund also outperformed the Russell 2000 Value for the 1-, 3-, 5-, 20-, 25-year, and since inception (12/27/96) periods ended 6/30/23 while also beating the Russell 2000 for the same 1-, 3-, 25-year, and since inception periods through the end of June.

What Worked… And What Didn’t

Six of the portfolio’s 10 equity sectors made a positive impact on performance in 2023’s first half. The sectors making the largest positive contributions were Information Technology, Industrials, and Consumer Discretionary while the largest negative impacts came from Financials, Health Care, and Consumer Staples. At the industry level, electronic equipment, instruments & components (Information Technology), household durables (Consumer Discretionary), and oil, gas & consumable fuels (Energy) contributed most while banks (Financials), biotechnology (Health Care), and professional services (Industrials) were the largest detractors.

The portfolio’s top contributor at the position level in 2023’s first half was Sterling Infrastructure, which provides advanced, large-scale site development services for data centers, manufacturing facilities, and e-commerce distribution centers. Sterling began to reposition itself six years ago, moving from a highly levered highway builder to its current businesses. Its 2023’s first quarter earnings release highlighted double-digit revenue growth and gross margin expansion. Preformed Line Products manufactures products that support, protect, connect, and secure cables and wires for the energy, communications, cable television, and information industries. The company passed on price increases as raw material costs climbed, which led to improved profitability, as demonstrated by its record earnings per share in 2023’s first quarter. Jabil provides digital prototyping, printed electronics, device integration, circuit designing, and volume board assembly services for the automotive, energy, and defense and aerospace industries. As package preparation and shipping has grown more detailed and specialized, the company’s business has grown, as have profit margins.

Four of the Fund’s top five detractors at the position level were banks. While the challenges faced by small-cap banks were exacerbated by the failures of Silicon Valley and Signature Bank earlier this year, we believe earnings and profits are being pressured to a greater degree, in our estimation, by the stubbornly inverted yield curve and the higher yields offered by money markets. However, credit appears to be in good shape, and we see attributes in each of these positions that should help them when the industry rebounds. Timberland Bancorp is a profitable and, in our view, well-managed bank based in Washington state. Western New England Bancorp has been making an effective transition from a thrift to a more commercial bank, while both CNB Financial and Mid Penn Bancorp have been expanding successfully, the former in an interesting and creative way by setting up local banks in small and mid-sized cities.

The Fund’s advantage over the Russell 2000 Value in 2023’s first half came from sector allocation decisions. At the sector level, much higher exposure to the resurgent Information Technology sector, a lower weighting in Financials (particularly in banks), and a bigger weighting in Consumer Discretionary did most to boost relative results while stock selection in Health Care and Real Estate, along with a much lower weighting in Materials, detracted most from performance relative to the Fund’s primary benchmark.

Top Contributors to Performance Year-to-Date Through 6/30/231 (%)

Sterling Infrastructure1.09
Preformed Line Products0.95
M/I Homes0.69

1 Includes dividends

Top Detractors from Performance Year-to-Date Through 6/30/232 (%)

Timberland Bancorp-0.42
Western New England Bancorp-0.35
CNB Financial-0.33
Mid Penn Bancorp-0.29
SIGA Technologies-0.29

2 Net of dividends

Current Positioning And Outlook

The current environment is uncertain and has so far not been great for small-cap stocks relative to their large-cap peers. 2Q23 saw continued strength for the Nasdaq, especially its mega-cap stocks, which helped companies in the Russell 2000 Growth Index more than those in the Russell 2000 Value Index. Both indexes, however, significantly underperformed large-cap indexes and those that are more broadly based in terms of market capitalization. This extends a trend that began earlier this year, and it’s worth noting that the Russell 2000 remained in a bear market at the end of June, down -20.8% from its most recent peak on 11/8/21. In spite of the skip in June, the Fed remains committed to raising rates until inflation comes down to its 2% target. In addition, as long as employment remains as strong as it has been over the last couple of years, we believe the Fed will stay hawkish. We saw a pronounced falloff in volumes for trucking and transportation companies as economic activity cooled in 2Q23, which strongly suggests that we are still shy of any widespread recovery for cyclicals. Therefore, we believe the bond market properly reflects the current economic circumstances while the equity market looks wrong in that many valuations—even within small cap—still look stretched. In this light, portfolio positioning has not appreciably changed, though we trimmed some semiconductor capital equipment positions and bought a few bulk shipping companies, which looked inexpensive from a long-term perspective.

Average Annual Total Returns Through 06/30/23 (%)

Capital Small-Cap 4.758.1321.2617.963.595.926.398.368.799.40

Annual Operating Expenses: 1.15

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 The Fund's total returns do not reflect any deduction for charges or expenses of the variable contracts investing in the Fund. Operating expenses reflect the Fund's total annual operating expenses for the Investment Class as of the Fund’s most current prospectus and include include management fees and other expenses.

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, 2023, 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, 2023 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 6/30/23, the percentage of Fund assets was as follows: Sterling Infrastructure was 1.9%, Preformed Line Products was 1.3%, Jabil was 1.9%, PulteGroup was 1.8%, M/I Homes was 1.4%, Timberland Bancorp was 1.2%, Western New England Bancorp was 0.6%, CNB Financial was 1.0%, Mid Penn Bancorp was 0.8%, SIGA Technologies was 1.1%.

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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