Royce Capital Fund-Micro-Cap Portfolio Manager Commentary
article 06-30-2020

Royce Capital Fund–Micro-Cap Portfolio Manager Commentary

We believe the current environment remains highly conducive to sticking with our philosophy of investing in appropriately capitalized, well-managed micro-cap businesses with company-specific growth catalysts.


Fund Performance

For the year-to-date period ended 6/30/20, Royce Capital Fund–Micro-Cap Portfolio declined 11.4%, landing between its two small-cap benchmarks: the Russell Microcap Index fell 11.2% while the Russell 2000 Index lost 13.0% for the same period.

What Worked…And What Didn’t

Only two of the 10 equity sectors in which the Fund held investments finished 2020’s first half in the black. Industrials made the largest negative impact, followed by Financials and Consumer Discretionary. Conversely, Information Technology contributed most to performance. Health Care followed, and the portfolio’s cash position was also slightly additive. Banks (Financials) was the largest industry detractor, followed by machinery (Industrials) and energy equipment & services (Energy). Two of the three top-contributing industries were in Information Technology: semiconductors & semiconductor equipment and electronic equipment, instruments & components. Sandwiched in between was health care equipment & supplies (Health Care).

Newpark Resources, which provides drilling fluid systems and composite matting systems used in oilfield and other commercial markets, detracted most at the position level in the first half of 2020. The company’s shares were negatively impacted by collapsing oil prices as economic activity declined due to coronavirus. We exited our position as the company has financial leverage at the top end of our comfort level. Handbag and luggage design company Vera Bradley also hurt performance. With many retailers shuttering stores during the pandemic, its business suffered. We selectively added to our position given our belief in the long-term viability of the brand, as well as the strength of its pristine balance sheet. Louisiana-based bank holding company Investar Holding detracted as the company was negatively impacted by the public health crisis and its position in the energy belt, which experienced turmoil in the first half. We maintained our position as we believe the company is well positioned to weather the current storm and its direct energy exposure is lower than generally perceived.

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Diagnostic blood testing company Chembio Diagnostics was the top contributor in 2020’s first half as a result of the company being granted FDA Emergency Use Authorization for its rapid COVID-19 antibody finger prick blood test. LightPath Technologies, which manufactures optical and infrared components for telecommunications and industrial end markets, also helped performance. Headed by a new CEO, the company benefited from moving its manufacturing to lower-cost countries. We held our position in the stock as we believe the company is in the early stages of harvesting the gains from its restructuring efforts. Global investment management specialist Sprott consolidated its operations to focus solely on hard assets and found itself well positioned to benefit from the recent appreciation in gold prices. Maintaining our position, we believe the company’s position in hard asset investing provides a sustainable competitive advantage.

Relative to the Russell Microcap Index, the largest positive impact came from Financials because of savvy stock selection and our lower exposure. Our higher weighting and stock selection almost equally helped in Information Technology while Real Estate followed because of savvy stock picks and our lower exposure. Conversely, the Fund was hurt most by Health Care, the largest detracting sector by a wide margin, as a result of our lower exposure and, to a lesser degree, stock selection. Industrials hindered performance due to our higher weighting and ineffective stock picks, while stock selection in Consumer Discretionary also detracted from relative results.

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

B. Riley Financial1.02
Citi Trends0.98
Harvard Bioscience0.83
Shoe Carnival0.83
Ultra Clean Holdings0.80

1 Includes dividends

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

Motorsport Games Cl. A-0.30
LightPath Technologies Cl. A-0.26
CIRCOR International-0.20
American Superconductor-0.16
Unique Fabricating-0.16

2 Net of dividends

Current Positioning And Outlook

We are now six months into the COVID-19 global pandemic and face the possibility of multiple additional waves. As the parameters surrounding coronavirus are becoming better understood, we believe that policy responses will be more effectively targeted and the overall risks will continue declining. We have not appreciably changed our portfolio positions since the end of this year’s first quarter as we made strategic investment decisions in the selloff stage. We are expecting permanent shifts in consumer and business behavior to accelerate the transition into digital communication, so we maintained our higher exposure in Information Technology. We are also adding to non-tech positions across industries where we believe a strong balance sheet will provide opportunities for market share gains against weakened competition. The world will soon turn its attention to the upcoming U.S. elections where the outcome could have wildly divergent market implications. We believe this environment remains highly conducive to sticking with our philosophy of investing in appropriately capitalized, well-managed micro-cap businesses with company-specific growth catalysts. We do not anticipate being immune to short-term volatility but we believe that over time the individual attributes of our investments will win out.

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

Capital Micro-Cap 6.4225.1974.8815.1716.217.146.848.5010.81 12/27/96
Russell Microcap 4.1429.0275.7714.4718.1313.068.739.26N/A N/A

Annual Operating Expenses: Gross 1.37 Net 1.33

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. 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 1.33% 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 June 30, 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 June 30, 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 6/30/20, the percentage of Fund assets was as follows: Chembio Diagnostics was 0.3%, LightPath Technologies Cl. A was 1.0%, Sprott was 1.5%, CyberOptics Corporation was 1.0%, Ameresco Cl. A was 1.5%, Newpark Resources was 0.0%, Vera Bradley was 0.6%, Investar Holding was 0.9%, BayCom Corporation was 0.7%, TriState Capital Holdings was 1.0%

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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