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

Royce Small-Cap Opportunity Fund Manager Commentary

Royce Small-Cap Opportunity Fund beat both its primary benchmark, the Russell 2000 Value Index, and its secondary benchmark, the Russell 2000 Index, for the year-to-date, 1-, 3-, 5-, 10-, 15-, 20-, 25-year, and since inception (11/19/96) periods ended 6/30/23.


Fund Performance

Royce Small-Cap Opportunity Fund beat both its primary benchmark, the Russell 2000 Value Index, and its secondary benchmark, the Russell 2000 Index, for the 1-, 3-, 5-, 10-, 15-, 20-, 25-year, and since inception (11/19/96) periods ended 6/30/23. The Fund also decisively outperformed both indexes for the year-to-date period ended 6/30/23, up 13.2% versus respective gains of 2.5% and 8.1% for the Russell 2000 Value and Russell 2000.

What Worked… And What Didn’t

Nine of the Fund’s 10 equity sectors contributed to 2023’s first-half results, with Industrials, Consumer Discretionary, and Information Technology leading. Energy was the only sector that detracted while Communication Services and Real Estate made the smallest contributions. At the industry level, two areas in Information Technology—semiconductors & semiconductor equipment and electronic equipment, instruments & components—contributed most, along with construction & engineering (Industrials). Communications equipment (Information Technology), interactive media & services (Communication Services), and energy equipment & services (Energy) were the biggest detractors.

The Fund’s top contributor at the position level in 2023’s first half was commercial contractor Limbach Holdings, which has been moving from acting as a general contractor to having more direct relationships with its customers, resulting in higher gross margins for each contract. This has become a larger portion of Limbach’s business, one that allows the company to be more selective about pricing, which has been recognized by other investors. Modine Manufacturing provides heat transfer systems that provide benefits across numerous end markets such as electric vehicles and data center applications. In the midst of a multi-year business transformation that has focused on driving higher returns and growth across its end markets, Modine was our largest holding at the end of June because we believe its business improvements are in the early stages and its valuation still looked attractive to us.

The top detractor in 2023’s first half was DZS, which manufactures communications network equipment that helps deliver high speed fiber access. DZS lowered earnings guidance and was in non-compliance with loan covenants that are being renegotiated while also dealing with a revenue recognition issue. We held a small position at the end of June. QuinStreet is a digital performance marketing company with broad diversification across financial services verticals, but with a strong presence in the auto insurance industry—which has been challenged by underlying inflation pressures as higher costs have led to higher claims losses while pricing is subject to the inherent inertia associated with governmental insurance agencies. However, we expect this negative environment to reverse in the intermediate term and added slightly to our position in 2023’s first half.

Sector allocation decisions primarily drove the Fund’s outperformance versus the Russell 2000 Value in 2023’s first half. Our meaningfully lower exposure to Financials and much higher weighting in Industrials contributed most to relative results, along with stock selection in Health Care. Conversely, stock picks hurt in Energy, while both our higher weighting and stock selection detracted in Communication Services, as did our substantially lower exposure to Real Estate.

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

Limbach Holdings0.56
Modine Manufacturing0.50
Arlo Technologies0.46
Astronics Corporation0.44
CIRCOR International0.42

1 Includes dividends

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

Victoria's Secret & Co.-0.29
Mammoth Energy Services-0.28
EverQuote Cl. A-0.28

2 Net of dividends

Current Positioning and Outlook

We believe we have not yet seen the full impact of the Fed’s rate hikes. Moreover, as the attempted coup in Russia showed, the world remains subject to potential black swan events. That said, we believe the Fed is closer to the end of this rate cycle as inflation continues to moderate. While employment is another lagging indicator, the trends also remain relatively constructive. In this context, we have a positive outlook for small-cap value stocks, which we believe remain attractively valued relative to the rest of the market. We also see several trends that we think should favor our domestically focused portfolio. For example, the portfolio remained overweight in both Industrials and Information Technology at the end of June. While there’s been considerable hype around Artificial Intelligence (“AI”), we see it as one more long-term trend driving widespread semiconductor adoption. Many of our technology positions look well positioned to benefit from the infrastructure build-out that’s necessary to support AI. We’ve also been adding to positions in advertising technology companies, which are using AI directly to gain market share as media spending moves from TV to more digitally oriented media consumption. We also anticipate that AI will help certain industrial positions as these companies harness this technology to drive operating efficiency gains. In addition, we believe many industrial companies should benefit from the ongoing re-shoring of industrial production closer to or in the U.S., a shift that should be further boosted by fiscal spending on infrastructure. Finally, we have been looking at select financial companies outside banking that, to us, appear poised to benefit as interest rates stabilize and capital markets activity resumes, as well as at telecommunications equipment companies where we feel the backdrop remains favorable even as many stocks have been hit hard.

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

Small-Cap Opportunity 6.7813.1620.4223.768.9110.1410.3910.8311.3211.91

Annual Operating Expenses: 1.23

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, 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: Limbach Holdings was 0.6%, Modine Manufacturing was 0.9%, Arlo Technologies was 0.6%, Astronics Corporation was 0.8%, CIRCOR International was 0.0%, DZS was 0.3%, QuinStreet was 0.5%, Victoria's Secret & Co. was 0.2%, Mammoth Energy Services was 0.3%, EverQuote Cl. A was 0.2%.

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