Royce Micro-Cap Fund Manager Commentary
article 06-30-2022

Royce Micro-Cap Fund Manager Commentary

The Fund beat the Russell Microcap for the one, three-, and five-year periods ended 6/30/22 while also beating the Russell 2000 for the one-, three-, five-, 25-, and 30-year periods ended 6/30/22.

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Fund Performance

Royce Micro-Cap Fund was down 28.0% for the year-to-date period ended 06/30/22, versus a loss of 25.1% for its primary benchmark, the Russell Microcap Index, and a 23.4% loss for the small-cap Russell 2000 Index, its secondary benchmark. The portfolio outperformed the Russell Microcap for the one, three-, and five-year periods ended 6/30/22 while also beating the Russell 2000 for the one-, three-, five-, 25-, and 30-year periods ended 6/30/22.

What Worked… And What Didn’t

Seven of the portfolio’s nine sectors had a negative impact on year-to-date performance. Information Technology, Industrials, and Consumer Discretionary detracted most at the sector level, while the only positive impact came from Energy and Real Estate—as well as the Fund’s cash holdings. Semiconductors & semiconductor equipment (Information Technology), specialty retail (Consumer Discretionary), and machinery (Industrials) detracted most for the year-to-date period at the industry level, while software (Information Technology), energy equipment & services (Energy), and real estate management & development (Real Estate) were the largest contributors.

The Fund’s top detractor at the position level was value-priced apparel retailer Citi Trends. The company reduced its second-half outlook given inflationary pressures that are crimping the spending patterns of its core customer base. We think its shares offered attractive value at the end of June in light of the successful turnaround engineered by current management and the long-term outlook for continued growth in its niche markets. Although Aspen Aerogels has enjoyed success winning new customers in the electric vehicle original equipment manufacturer (OEM) space for its unique automotive battery insulation materials, its stock fell when the company announced an equity and debt offering to fund a doubling of capacity. The offering was subsequently pulled while the company explored alternative financing options. MeiraGTx Holdings develops ocular gene therapy and has a partnership with Johnson & Johnson. The two companies continue to make progress on a drug that treats retinitis pigmentosa, and data from recent clinical studies was positive. Its shares nonetheless sold off along with many in the Health Care sector when valuations compressed.

The Fund’s top contributor was financial services firm StoneX Group, which benefited from the robust operating environment in its global payments business and strong margin growth rooted in the effective management of its cost structure. Rising interest rates have also benefited the company’s asset sensitivity. Resources Connection is a professional services and consulting firm whose turnaround efforts and execution have been solid in a strong demand climate for its mid-level finance and accounting professionals. Investar Holding Corporation owns Investar Bank. The company successfully reduced costs while favorable loan growth and expanding net interest margin have been driving earnings growth.

The portfolio’s disadvantage versus the Russell Microcap Index came from both stock selection and sector allocation in 2022’s first half. A lower weight in Energy, stock picks in Consumer Discretionary, and much greater exposure to Information Technology had the biggest negative impact versus the primary benchmark. Conversely, our substantially lower weight in Health Care, large weight in Industrials, and the Fund’s cash holdings contributed to relative results.


Top Contributors to Performance Year-to-Date Through 6/30/221 (%)

StoneX Group0.19
Resources Connection0.19
Investar Holding Corporation0.18
Agilysys0.14
Profire Energy0.12

1 Includes dividends

Top Detractors from Performance Year-to-Date Through 6/30/222 (%)

Citi Trends-0.82
Aspen Aerogels-0.82
MeiraGTx Holdings-0.73
Shyft Group (The)-0.70
Bioventus Cl. A-0.66

2 Net of dividends

Current Positioning and Outlook

The ongoing war, rising interest rates, and inflationary pressures presented challenges in the first half. How much the Fed tightens into a slowing economy and whether we enter a recession appear to be the key determinants as to when stock prices recover. There is a strong possibility inflation peaked in 2Q22, as yields and energy prices reached highs in mid-June. Consumer confidence is at an all-time low—which is remarkable, considering it is lower than during the crash of the dot com bubble, the Financial Crisis, and Covid. Current uncertainties notwithstanding, we remain confident in what we are holding. Many of our micro-cap holdings boast strong balance sheets that should help them weather whatever economic slowdown or recession we ultimately endure, as well as help them gain market share and acquire attractive assets as seller expectations are reset. We have been trimming some inflation beneficiaries, most notably in areas such as basic materials. Infrastructure and construction firms continue to benefit from steady demand for steel and other materials to build roads and bridges, and we expect the federal infrastructure bill to begin positively impacting spend in the next several quarters. We also remain constructive on the aerospace OEM build cycle for narrow-body aircraft, which is seeing strong demand. The global need for communications equipment has not diminished, despite current conditions. The same is generally true for many healthcare companies—so we are adding to existing names and researching potential new ideas. Conversely, we see Consumer Discretionary as likely to remain weak, at least until it is clear that inflation is stabilizing. Given the sharp market selloff, we are also looking for new investment opportunities among small-cap companies that have fallen into the micro-cap universe, particularly hard hit small-cap growth companies. As always, we seek companies that we believe offer the best combination of attractively low valuations with strong long-term growth potential.

Average Annual Total Returns Through 06/30/22 (%)

QTR1 YTD1 1YR 3YR 5YR 10YR 15YR 20YR 25YR SINCE INCEPT.
(12/31/91)
Micro-Cap -17.86-27.96-24.668.786.025.674.087.218.3810.09
Russell Microcap -18.96-25.11-30.735.054.559.045.167.45N/AN/A

Annual Operating Expenses: 1.20

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. 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 www.royceinvest.com. Operating expenses reflect the Fund's total annual operating expenses for the Investment Class as of the Fund's most current prospectus and 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, 2022, 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, 2022 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 6/30/22, the percentage of Fund assets was as follows: StoneX Group was 1.2%, Resources Connection was 1.4%, Investar Holding Corporation was 1.4%, Agilysys was 1.2%, Profire Energy was 0.7%, Citi Trends was 0.7%, Aspen Aerogels was 0.4%, MeiraGTx Holdings was 0.5%, Shyft Group (The) was 0.6%, Bioventus Cl. A was 0.7%.


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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