Fund Performance

Royce Small-Cap Opportunity Fund advanced 3.6% for the year-to-date period ended 6/30/24 versus a loss of -0.8% for its primary benchmark, the Russell 2000 Value Index, and a gain of 1.7% for the small-cap Russell 2000 Index, for the same period. The portfolio outperformed both indexes for the 3-, 5-, 10-, 15-, 20-, 25-year, and since inception (11/19/96) periods ended 6/30/24.

What Worked... and What Didn’t

Five of the Fund’s 10 equity sectors made positive contributions to performance in 2024’s first half, led by Industrials, Energy, and Information Technology while the leading detractors were Consumer Discretionary, Financials, and Real Estate. At the industry level, semiconductors & semiconductor equipment (Information Technology) made the biggest contribution, followed by two groups in Industrials: construction & engineering and aerospace & engineering. The top detractors were communications equipment (Information Technology), professional services, and machinery (both in Industrials).

The Fund’s top contributor at the position level was EverQuote, which operates an online marketplace that connects consumers with both carriers and agents for auto, home, renters, and life insurance. The company generates revenue by selling consumer referrals to providers and from commissions on the policies it sells. Its revenues are highly leveraged to customer acquisition spending patterns of large insurance carriers such as Progressive and Allstate. In the years following the Covid pandemic, these large clients cut back on spending for customer acquisition as supply chain disruptions and inflationary forces pressured profitability. Early in 2024, however, this dynamic pivoted—insurance carriers’ profitability improved, which spurred spending to attract new customers. EverQuote has benefited from this dynamic and announced during its first-quarter earnings call that it expects to see revenue growth in 2024. The company also has a strong cash position that can be used for organic and potentially inorganic growth.

Carpenter Technologies makes specialty nickel and titanium based alloys, which are primarily used by the aerospace & defense industry, as well as gas turbines for power generation and medical implants. Its stock has benefited from demand outpacing supply in the industry as well as Carpenter’s unique asset base, which makes it one of the few global suppliers that can provide the metal used in jet engines and gas fired turbines. While Carpenter is a supplier to Boeing and Airbus—which have been plagued with production problems for new aircraft—it also sells into the aftermarket, where demand has been high as older aircraft fly longer and thus need more maintenance and overhauls. Orion Group Holdings is a specialty construction company that serves the infrastructure, industrial, and building sectors, operating in two segments: Marine and Concrete. In the first of these segments, Orion offers a wide range of marine construction services that include marine transportation facility construction, dredging, repair and maintenance, bridge building, marine pipeline construction, and other specialty services, while the Concrete segment is a local business that serves customers mainly in Texas. In September 2022, a new and highly experienced management team came in to help turn the company around, efforts that began to bear fruit in 2024. During the company’s Q1 earnings call, Orion announced a backlog of $756.6 million, as well as a pipeline of opportunities that grew from $3 billion to more than $11 billion in just over a year. The company cited significant opportunities in marine construction driven by infrastructure bills, port upgrades, and significant U.S. Navy projects while also speaking of a data center construction boom that was benefiting their concrete segment.

American Superconductor supplies advanced technologies designed to enhance energy efficiency across power grids, wind power, and military applications. As the market has increasingly recognized the significant power needs associated with Artificial Intelligence (“AI”) and Electric Vehicles “EVs)”, it has come to see the company as a potentially significant supplier into that energy ecosystem. Modine Manufacturing provides thermal management products and solutions. The company has been transitioning from commoditized products focused on the auto industry to more value-added solutions that target better opportunities in areas such as data center construction and EVs. The stock currently reflects the rapid acceleration in data center construction around demand for AI applications. Each contributor was also a top performer relative to the Russell 2000 Value.

The position that detracted most in 2024’s first half was TTEC Holdings, a provider of customer experience (CX) technology and services to large enterprises primarily in the U.S. TTEC suffers from investors’ perception that its business will be disintermediated by AI, which has hurt its valuation multiple. Taking a contrarian view, we believe that TTEC will benefit from AI and that it is in an advantageous position to help its customers adopt AI within their own customer experience functions. Believing that its valuation has not adequately reflected its long-term growth and profit margin opportunity, we used its stock price volatility opportunistically, adding to our position at what we determined were very attractive prices. Applied Optoelectronics manufactures optical products and components. Its stock rose high in 2023 on the back of a large contract win with Microsoft, which coincided with market enthusiasm for AI opportunities. We think its underwhelming performance so far in 2024 reflects a typical correction. We also believe that we are still in the early stages of the buildout of AI applications and that having Microsoft as a lead account should help Applied Optoelectronics benefit going forward.

Manitex International provides an assortment of lifting equipment for construction applications. The company is in the early stages of building out what we hope will eventually be a national network of dealers. After a strong performance in 2023—driven by the solid execution of its growth strategy—its shares have given back gains due to concerns over a slowing economy. Thinking longer term, we built our position based on what we see as a long runway for growth. Entravision Communications is a small, diversified media company that focuses on television and radio broadcasting, primarily targeting Latino audiences in the U.S., as well as digital advertising where the company acts as a sales agent in emerging markets for large social media companies. In March, the company announced that Meta was planning on bringing its sales effort in house and would be terminating its relationship with Entravision. This led to a sell off since Meta represented both a significant amount of Entravision’s revenues and an area of future growth. We chose to exit our position. Arcadium Lithium is a pure play global lithium chemicals producer formed from the merger of Allkem of Australia and U.S. based Livent. The integration of the two companies is underway, and we view the turnaround situation as making progress, although not as linearly as the Street had hoped, which is often the case with mergers. Lithium prices have also come down sharply given the excess supply resulting from the initial bullish demand expectations for EVs. With the inventory correction well underway, we believe prices are at or close to a bottom and expect that that ongoing integration process will be accompanied by an eventual recovery in lithium prices and drive a recovery in the shares. Each detractor also hurt year-to-date results versus the Russell 2000 Value.

The portfolio’s advantage over its benchmark was primarily attributable to stock selection in 2024’s first half, although sector allocation decisions were also additive. At the sector level, stock selection, along with a lesser impact from our overweights, helped most in Industrials and Information Technology while stock selection in Communication Services also provided a sizable boost to relative results. Conversely, stock selection in Consumer Discretionary detracted from relative year-to-date results, albeit marginally.

Current Positioning and Outlook

With the Federal Reserve holding steady on interest rates steady at its June meeting, the federal funds target rate has remained in the 5.25%-5.50% range since July 2023. We saw weaker economic data in 2Q24, and the Atlanta Fed predicted annualized GDP growth of 1.5% following the 1.4% increase in 1Q24. If the forecasts are accurate, this will result in the two slowest consecutive quarters of economic growth since the first six months of 2022. This weakness is being driven by reduced consumer spending and tempered business investment. Inflation seems to be subsiding, with the Consumer Price Index dropping from 3.5% to 3.3% as of the end of May. All of this suggests that the Fed has room to cut rates, yet is being squeezed on the timing of any cuts as the presidential election draws near.

Our conversations with small-cap management teams keeps us generally optimistic on our positioning, though we have seen continued caution from our Consumer Discretionary holdings. At the end of June, the Fund remained broadly overweight Industrials and Information Technology, and holdings in these sectors were the top contributors to performance in 2Q24. Our outlook for both sectors remains constructive, as each is benefiting from increased spending both by the government and private sector, driven by the ongoing need to maintain and grow U.S. infrastructure, boost our chip-making capabilities, and reshore manufacturing across several industries. AI continued to exert strength in the markets, a trend we expect to continue. AI is driving demand for semiconductor manufacturing, the buildout of physical infrastructure, and the need for energy solutions to power the ongoing buildout of high-power data centers. While most of the talk around AI has focused on the largest companies in the world, we are finding many small-cap companies that are benefiting by providing the ‘picks and shovels’ that enable the infrastructure development required to meet this extraordinary AI driven demand.

Average Annual Total Returns Through 06/30/24 (%)

Annual Operating Expenses: 1.22

¹ Not annualized.

Important Performance, Expense and Disclosure Information