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

Royce Small-Cap Special Equity Fund Manager Commentary

Royce Small-Cap Special Equity 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-, 5-, 15-, 25-year, and since inception (5/1/98) periods ended 6/30/23.


Fund Performance

Royce Small-Cap Special Equity Fund beat both its primary benchmark, the Russell 2000 Value Index, and its secondary benchmark, the Russell 2000 Index, for the 1-, 5-, 15-, 25-year, and since inception (5/1/98) periods ended 6/30/23. The Fund also decidedly outperformed the Russell 2000 Value for the year-to-date period ended 6/30/23, up 7.9% versus 2.5%.

What Worked… And What Didn’t

Led by Industrials, Information Technology, and Materials, the Fund had four of its eight equity sectors make positive contributions to performance in 2023’s first half. The biggest detractors were Communication Services, Consumer Discretionary, and Real Estate. At the industry level, the largest contributions came from electrical equipment (Industrials), food products (Consumer Staples), and semiconductors & semiconductor equipment (Information Technology), while consumer staples distribution & retail (Consumer Staples), media (Communication Services), and broadline retail (Consumer Discretionary) detracted most.

The Fund’s top contributor at the position level was John B. Sanfilippo & Son, which processes and distributes nut products. The company posted excellent results in the first half, introduced promising products to the market, and appears to be more focused on investor communications to raise awareness of its attributes. Vishay Intertechnology manufactures a broad line of active and passive electronic components. Its shares increased on better-than-anticipated results reported in early May alongside an overall boost for many semiconductor stocks. Its shares may also have risen in part due to Vishay’s diverse product base in light of escalating U.S./China tensions in the semiconductor supply chain. NVE Corporation specializes in magnetically sensitive materials with integrated circuits such as sensors and isolators. Its shares spiked in early May after the company reported record revenue and earnings in the quarter, aided by the tech rally that spanned much of 2023’s first half. Encore Wire manufactures electrical building wire. Its stock rose significantly following strong results announced in February. It regained momentum more recently on improved sentiment supporting building products.United States Lime & Minerals, a supplier of lime and limestone, saw its shares rally in the latter half of the second quarter on optimism around favorable macro data points and improving construction end markets. Each of these companies was also a top portfolio contributor relative to the Russell 2000 Value.

The top detractor at the position level was Ingles Markets, a regional grocery in the Southeastern U.S. whose stock declined following quarterly results reported in early May, which showed stagnating revenue growth and deteriorating margins due to cost inflation and raw material shortages. The acquisition of television broadcasting company, TEGNA, by Standard General was effectively blocked by the FCC at the end of February, removing the stock’s acquisition premium. Omnichannel retailer Macy’s saw its shares pressured throughout 2023’s first half by concerns over consumer spending levels and peer’s earnings reports in the second quarter that did not inspire confidence in consumer demand. Shares of Movado Group, which makes watches and jewelry, fell following worse-than-expected results in mid-March and have remained under pressure amid worries surrounding U.S. consumers. Sylvamo Corporation manufactures bulk paper and pulp products. Its shares moved lower as demand slackened while capacity permanently exited the industry following a post-Covid spike in demand and pricing. All five of these stocks were among the Fund’s top detractors relative to the Russell 2000 Value.

The Fund’s advantage over the Russell 2000 Value was attributable to sector allocation decisions in the first half of 2023. Our much lower exposure to Financials—including no exposure to underperforming banks—did most to boost relative performance. The Fund’s higher weighting, as well as a smaller advantage from stock selection, was additive in Industrials, while both stock picks and a higher weighting helped in Information Technology. Conversely, stock selection detracted in Consumer Discretionary, Communication Services, and Real Estate.

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

John B. Sanfilippo & Son1.97
Vishay Intertechnology1.81
NVE Corporation1.76
Encore Wire1.66
United States Lime & Minerals1.22

1 Includes dividends

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

Ingles Markets Cl. A-1.08
Movado Group-0.46
Sylvamo Corporation-0.36

2 Net of dividends

Current Positioning and Outlook

The rally off the lows reached in the fall of 2022 seemed unsupported by fundamentals. It was therefore not a big surprise to us that most of 2023’s first-half advance was caused by only a few stocks. Related to this is our observation that the equity markets are much more optimistic than the Fed regarding the pace and degree of inflation falling. In our estimation, the markets have priced in a near impossibility of inflation meeting the Fed’s 2% target soon. One market pundit described this error pithily by saying that investors are still anticipating “an immaculate disinflation.” Too many equity prices appear to have left much of the market with no margin of safety, a characteristic we insist be present in our own holdings and new purchases. We believe that this insistence has served our clients well over the years. Our better down market results, for example, have typically been rooted in this insistence on absolute, as opposed to relative, valuations. We are prepared to use the cash in the portfolio when we can purchase securities on these terms, a strategy that we think has worked well in the past.

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

Small-Cap Special Equity 4.317.8515.8913.896.256.988.528.408.718.60

Annual Operating Expenses: 1.22

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: John B. Sanfilippo & Son was 4.5%, Vishay Intertechnology was 5.8%, NVE Corporation was 4.0%, Encore Wire was 6.4%, United States Lime & Minerals was 3.3%, Ingles Markets Cl. A was 5.8%, TEGNA was 3.9%, Macy's was 2.8%, Movado Group was 3.3%, Sylvamo Corporation was 1.8%.

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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