Royce Small-Cap Opportunity Fund Manager Commentary
article 06-30-2022

Royce Small-Cap Opportunity Fund Manager Commentary

Our theme-based Opportunity Fund beat the Russell 2000 Value Index for the three-, five, 10-, 15-, 20-, 25-year, and since inception (11/19/96) periods ended 6/30/22 while also beating the Russell 2000 Index for each of these periods and the year-to-date and one-year periods ended 6/30/22.


Fund Performance

Royce Small-Cap Opportunity Fund outpaced its primary benchmark, the Russell 2000 Value Index, for the three-, five, 10-, 15-, 20-, 25-year, and since inception (11/19/96) periods ended 6/30/22, while also beating the Russell 2000 Index, its secondary benchmark, for each of these periods and the year-to-date and one-year periods ended 6/30/22. The Fund was down 22.1% for the year-to-date period ended 6/30/22 versus respective losses of 17.3% and 23.4% for the Russell 2000 Value and Russell 2000 for the same period. First-half results were consistent with the Fund’s history. When the portfolio has underperformed in previous down markets, it has outperformed through subsequent rebounds.

What Worked… And What Didn’t

Nine of the 10 equity sectors in which the Fund held investments detracted from year-to-date performance, led by Industrials, Information Technology, and Consumer Discretionary. Energy made the only positive contribution—along with a marginal gain from cash—while Consumer Staples had the smallest negative effect. At the industry level, semiconductors & semiconductor equipment (Information Technology) machinery (Industrials), and specialty retail (Consumer Discretionary) detracted most. Each was also among our four largest weightings at the end of June because we like each group’s long-term prospects. On the positive side, oil, gas & consumable fuels (Energy), chemicals (Materials), and pharmaceuticals (Health Care) were the top contributors.

Horizon Global manufactures custom-engineered equipment for towing, trailering, and other related uses. Its shares fell due to ongoing supply chain issues that hampered its efforts to obtain inventory, coupled with disruptions to its auto and trucking customers’ production schedules, which created the need for additional working capital. The Shyft Group makes commercial vehicles, including trucks and trailers. Earnings for its fiscal first quarter came in below consensus estimates and included a cautious near-term outlook, leading its shares downward. B. Riley Financial operates across various financial areas such as investment banking and wealth management while also managing the companies it acquires. The company reported significant declines in revenues and earnings for 1Q22 amid an inhospitable climate for both its underwriting business and its investment portfolios. Management nonetheless offered a confident outlook for its M&A, capital management, and direct lending activities. At the end of June, we thought that all three top detractors possessed both attractive valuations and robust long-term growth prospects.

Two of the Fund’s top contributing positions—Scorpio Tankers and Ardmore Shipping—ship refined petroleum products. Shares of both companies benefited from rising freight rates amid global disruptions to fuel supplies that led to increased shipping activity. The lack of new vessel builds helped reinforce the improved rate environment. LSB Industries benefited from higher prices for domestic chemicals and fertilizers caused, in part, by rising natural gas prices in Europe and the resulting global fertilizer shortages during a high-demand period that saw higher grain prices and low inventories (as did Intrepid Potash).

The Fund’s relative disadvantage versus its primary benchmark for 2022’s first half came almost entirely from sector allocation—stock selection had a marginally negative effect. Our greater relative exposure to Information Technology and Consumer Discretionary detracted, as did stock selection in Industrials. However, stock picking was a strength in Materials, as was our substantially lower exposure to Health Care and our cash position.

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

Scorpio Tankers0.44
LSB Industries0.26
Intrepid Potash0.25
Ardmore Shipping0.22
Allegheny Technologies0.21

1 Includes dividends

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

Horizon Global-0.41
Shyft Group (The)-0.41
B. Riley Financial-0.38
Avaya Holdings-0.36
Comtech Telecommunications-0.36

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 that 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, with many positions having low-debt balance sheets, one of the main factors that should help businesses contend with the current tumultuous environment—even if inflation proves increasingly persistent. We have been trimming some inflation beneficiaries, most notably in areas such as materials and shipping. Infrastructure names continue to benefit from steady demand for steel and other materials to build roads and bridges, as well as to repair and maintain aircraft. We have also seen shares of homebuilders tumble as interest rates rise, but many of these companies are very well run, and we think opportunities will emerge. 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. Of our four investment themes, we continue to look most closely at undervalued growth stocks as many such companies have been trading at 52-week lows. 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 (%)

Small-Cap Opportunity -18.22-22.08-22.0912.678.3211.047.179.7711.2211.59

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, 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: Scorpio Tankers was 0.5%, LSB Industries was 0.1%, Intrepid Potash was 0.0%, Ardmore Shipping was 0.4%, Allegheny Technologies was 0.7%, Horizon Global was 0.2%, Shyft Group (The) was 0.4%, B. Riley Financial was 0.7%, Avaya Holdings was 0.0%, Comtech Telecommunications was 0.4%.

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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