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

Royce Small-Cap Fund Manager Commentary

Our Flagship portfolio, Royce Pennsylvania Mutual Fund, beat its small-cap benchmark, the Russell 2000 Index, for the year-to-date, 1-,3-, 5-, 10-, 15-, 20-, 25-, 30-, 35-, and 40-year periods ended 6/30/23. The Fund’s average annual total return for the 50 years through the end of June was 12.9%.


Fund Performance

Royce Pennsylvania Mutual Fund beat its small-cap benchmark, the Russell 2000 Index, for the 1-, 3-, 5-, 10-, 15-, 20-, 25-, 30-, 35-, and 40-year periods ended 6/30/23. The Fund’s average annual total return for the 50 years through the end of June was 12.9%. The Fund also gained 15.4% for the year-to-date period ended 6/30/23, well ahead of the Russell 2000, which was up 8.1% for the same period.

What Worked… And What Didn’t

Nine of the Fund’s 10 equity sectors contributed to 2023’s first-half results, led by Industrials, Information Technology, and Consumer Discretionary. Communication Services detracted while Energy and Health Care contributed least. The top-contributing industries were semiconductors & semiconductor equipment (Information Technology), followed by machinery and building products (both in Industrials). Interactive media & services (Communication Services) detracted most, followed by biotechnology and pharmaceuticals (both in Health Care).

The top-contributing position in 2023’s first half was First Citizens BancShares, which the Fund has owned for many years due mostly to its strong liquidity position and stellar deposit franchise. Its valuation looked attractive to us in late 2022, when we began adding shares that were trading at roughly 5x earnings per share. More recently, First Citizens was chosen by the FDIC to acquire Silicon Valley Bank, most likely owing to its long history of buying failed banks. Silicon Valley’s travails notwithstanding, the purchase was accretive to First Citizens’ tangible book value and earnings, and helped spur a sharp rise in its stock. Builders FirstSource manufactures building products for professional homebuilders. It has been helped by its merger with BMC Stock Holdings, which expanded both its value-added product footprint in fast growing markets and share gains in key product categories. Preformed Line Products makes products for overhead or underground networks for the energy, telecom, and cable industries. Increased activity in these markets, notably the U.S. transmission and distribution market, has driven increased demand, record backlogs, and increased investor interest, which helped the company report record quarterly financial results in March and May.

The Fund’s top detractor was Texas-based Independent Bank Group. The shares of most regional banks declined due to the failure of Silicon Valley and Signature Banks. However, our conviction for Independent Bank remains strong because we believe the strength of its local relationships will not be replaced outside the regional banking system. Pason Systems has a dominant market share in Electronic Drilling Recorders, a network of sensors, software, and displays that are integrated into the workflow on oil rigs and are low-cost, mission critical features for drillers. Although Pason reported strong financial results in March and May, its shares were caught up in the broad downturn for energy stocks. FARO Technologies is a global leader in 3D measuring equipment and software for industrial and construction applications. Early in 2023, FARO announced a costly convertible debt offering and additional restructuring actions to bolster liquidity and help with the cost of two acquisitions. In 2Q23 the stock plunged again when the CEO announced his plan to retire on July 1. He had been the architect of FARO’s plan to move toward a more software and subscription-driven model, which was proving more complex and time-consuming than initially thought. Unsure of its subsequent direction, we reduced our stake in June.

Both stock selection and sector allocation drove the Fund’s outperformance relative to the benchmark in 2023’s first half. Stock selection in Financials, stock picks and a much higher weighting in Industrials, and greater exposure to the resurgent Information Technology sector contributed most to relative results. Conversely, stock picks hurt in Health Care and Communication Services.

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

First Citizens BancShares Cl. A1.50
Builders FirstSource0.95
Preformed Line Products0.68
Onto Innovation0.55

1 Includes dividends

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

Independent Bank Group-0.20
Pason Systems-0.19
FARO Technologies-0.19
Lindsay Corporation-0.18
Forrester Research-0.16

2 Net of dividends

Current Positioning and Outlook

We see an array of potential triggers that could possibly jumpstart small-cap performance in the coming months. First, a soft landing looks more and more likely to us, and a recession—specifically the kind of deep and potentially lengthy contraction many have been anticipating since late 2021—looks less likely. We have already seen promising developments that seem to suggest a nascently robust economy: durable goods orders rose for the fourth consecutive month in June—and hit a record high for nondefense capital goods (excluding aircraft or core capital goods, a proxy for business equipment investment)—while homebuilding rose by 21.7% in May, a record monthly surge that also defied expectations for a slowdown. Importantly, in our view, is the ongoing sense of cautious optimism we have been hearing from many management teams—which was reflected by generally solid earnings for many holdings for the second quarter. Amid the difficulties of bear markets and periods of economic uncertainty, we think it’s crucial to remind investors of the opportunity to build their small-cap allocation at attractively low prices. History shows that investors who had the necessary patience and discipline to stay invested during periods of sluggish or negative performance have been rewarded. We continue to see the currently unsettled period as an opportune time to invest in select small-caps for the long run.

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

QTR1 YTD1 1YR 3YR 5YR 10YR 15YR 20YR 25YR 35YR 45YR
Small-Cap 6.6815.3721.5015.517.589.098.479.699.3310.2311.98
Russell 2000 5.218.0912.3110.824.218.268.438.897.269.03N/A

Annual Operating Expenses: 0.94

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, other expenses, and acquired fund fees and expenses. Acquired fund fees and expenses reflect the estimated amount of the fees and expenses incurred indirectly by the Fund through its investments in mutual funds and other investment companies.

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: First Citizens BancShares Cl. A was 2.3%, Builders FirstSource was 1.5%, Preformed Line Products was 0.9%, Arcosa was 1.8%, Onto Innovation was 1.0%, Independent Bank Group was 0.3%, Pason Systems was 0.6%, FARO Technologies was 0.1%, Lindsay Corporation was 0.2%, Forrester Research was 0.6%.

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.)



Sign Up