Royce Opportunity Fund Manager Commentary
article 06-30-2019

Royce Opportunity Fund Manager Commentary

Our small-cap deep value strategy performed well on an absolute basis and maintained its long-term advantages against its indexes during the first half of 2019.


Fund Performance

Our deep value strategy performed well on an absolute basis in 2019’s first half, though it lagged one of its benchmarks. Royce Opportunity Fund advanced 15.6% for the year-to-date period ended June 30, 2019, compared to respective gains of 17.0% and 13.5% for its small-cap benchmarks, the Russell 2000 and Russell 2000 Value Indexes, for the same period. The portfolio’s consistent and time-tested deep value approach gave it an advantage over the small-cap value index for the three-, 10-, 15-, 20-year, and since inception (11/19/96) periods ended June 30, 2019. The Fund also beat the Russell 2000 for the three-, 20-year, and since inception periods ended June 30, 2019, while finishing even with it for the 10-year period.

What Worked… And What Didn’t

Ten of the Fund’s 11 equity sectors finished the first half in the black, led by our two largest weightings, Industrials—which made an outsized positive contribution—and Information Technology. Only Real Estate detracted, doing so on a very minor scale, while the smallest positive contribution came from Utilities, our lowest sector weighting at the end of June and one to which we’ve had very little exposure historically. At the industry level, machinery (Industrials) made the biggest contribution to first-half results, followed by semiconductors & semiconductor equipment (Information Technology) and aerospace & defense (Industrials).

The top-contributing position was Herc Holdings, a large equipment rental company in the Industrial sector’s trading companies & distributors group. After finishing 2018 as one of the Fund’s biggest detractors, Herc rebounded in the first half, reporting increased revenues, improved pricing, and an optimistic outlook for the rest of 2019. It was the Fund’s largest holding at the end of June. Two other top contributors were takeover targets: cosmetics company Avon Products was bought by a large Brazilian competitor, while Cray, which provides high-end supercomputing and data solutions, was acquired by Hewlett Packard Enterprises. They joined nine other holdings that were M&A targets during the first half.

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The largest detractors at the industry level were media (Communication Services) and hotels, restaurants & leisure (Consumer Discretionary), though their impact was modest. Evolent Health, which we first purchased late in 2018, detracted most at the position level. This medical technology specialist partners with providers and health plans to offer clinical and financial assistance and mitigate financial risk. An acquisition in May was greeted with skepticism—and a flurry of selling—as investors seemed unconvinced of its accretive value. We, on the other hand, continued to add shares before and after the purchase, consistent with our interest in a number of healthcare companies that are trying to bend the cost curve. We chose a different course with turnaround candidate Tupperware Brands, a global direct seller of consumer products, and began to exit our position in March. Reductions in its sales force and weakness in non-U.S. consumer markets, especially in the emerging markets that have become key to its business, led us to reevaluate its long-term prospects. We also sold our position in oilfield services company Mammoth Energy Services. Depressed revenues and earnings, an uncertain outlook for its industry, and what we saw as better values elsewhere in the market all influenced our decision.

Relative to the Russell 2000, stock selection in Health Care and in several industries within Information Technology hurt performance most, as did our cash position. However, savvy stock selection and an overweight helped to drive outperformance in Industrials, where aerospace & defense and trading companies & distributors contributed most. We also saw outperformance on a smaller, but still notable, scale from Consumer Staples, helped by both stock selection and our underweight in the sector.

Top Contributors to Performance Year-to-Date Through 6/30/191 (%)

Herc Holdings0.54
Avon Products0.43
Triumph Group0.42
Westport Fuel Systems0.39

1 Includes dividends

Top Detractors from Performance Year-to-Date Through 6/30/192 (%)

Evolent Health Cl. A-0.22
Tupperware Brands-0.22
Mammoth Energy Services-0.19
Owens & Minor-0.18
NeoPhotonics Corporation-0.15

2 Net of dividends

Current Positioning and Outlook

Another quarter passed with a familiar ring as macro issues regarding trade, growth, and central bank interventions dominated the headlines. In the U.S. market, growth continued to outpace value, and now more and more players are hinting of a “permanent” change in which value would be a perennial underperformer. Needless to say, we differ. We see the world of small-cap value as one full of companies with very attractive valuations and terrific growth prospects. Strategic and financial buyers appear to agree—M&A activity continues unabated, with healthy premiums being paid. Investors, pundits, and strategists continue to warn about the length of the recovery in the U.S. while the market continues to humble those with such fears by providing consumers and companies alike with ever lower interest rates, cheap energy, and ample public spending. The market has provided us with the opportunity to build a portfolio of stocks that we think are not only cheap, but that we think should also provide healthy returns going forward. We’ve added positions in areas such as health care, consumer, and a host of others that we think should do well under present conditions. We have no idea what will bring better fortune to value investing, but do believe that disciplined stock picking in the small- and micro-cap equity market will pay off in the future.

Average Annual Total Returns Through 06/30/19 (%)

Opportunity 1.1515.63-11.0612.374.1113.387.6910.6311.44 11/19/96

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 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, 2019, 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, 2019 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 6/30/19, the percentage of Fund assets was as follows: Herc Holdings was 1.0%, Avon Products was 0.0%, Triumph Group was 0.6%, Cray was 0.3%, Westport Fuel Systems was 0.7%, Evolent Health Cl. A was 0.3%, Tupperware Brands was 0.2%, Mammoth Energy Services was 0.0%, Owens & Minor was 0.3%, NeoPhotonics Corporation 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 1000 Index is an index of domestic large-cap stocks. It measures the performance of the 1,000 largest publicly traded U.S. companies in the Russell 3000 Index. 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 Midcap Index measures the performance of the mid-cap segment of the U.S. equity universe. It includes approximately 800 of the smallest securities in the Russell 1000 Index. 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 ex USA Small Cap Index is an index of global small-cap stocks, excluding the United States. Index returns include net reinvested dividends and/or interest income. 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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