Royce Small-Cap Special Equity Fund Manager Commentary
article 06-30-2022

Royce Small-Cap Special Equity Fund Manager Commentary

A strong down-market performance in 2022’s first half was instrumental in helping the Fund to outperform both the Russell 2000 Value Index and the Russell 2000 Index for the one, three-, 15-, 20- year, and since inception (5/1/98) periods ended 6/30/22.


Fund Performance

A strong down market performance in 2022’s first half was instrumental in helping Royce Small-Cap Special Equity Fund to outperform both its primary benchmark, the Russell 2000 Value Index, and its secondary benchmark, the Russell 2000 Index for the one, three-, 15-, and since inception (5/1/98) periods ended 6/30/22. The Fund was down 12.8% for the year-to-date period ended 6/30/22 versus respective declines of 17.3% and 23.4% for the small-cap value and overall small-cap indexes. It was the worst calendar first half since inception (12/31/78) for the Russell 2000 and the second-worst for the Russell 2000 Value.

What Worked… And What Didn’t

Seven of the portfolio’s eight sectors made a negative impact on year-to-date performance. The sectors making the largest negative impact were Information Technology, Industrials, and Consumer Discretionary. The only positive impact came from Communication Services, as well as the Fund’s cash holdings, while Financials detracted least. Semiconductors & semiconductor equipment (Information Technology), leisure products (Consumer Discretionary), and machinery (Industrials) detracted most at the industry level for the year-to-date period, while diversified consumer services (Consumer Discretionary), media (Communication Services), and commercial services & supplies (Industrials) were the largest contributors.

Johnson Outdoors, which makes outdoor recreational products, was the top detractor at the position level in 2022’s first half. The company reported margins well below expectations in early May, primarily due to supply chain disruptions, resulting in a significant share decline. Kulicke & Soffa Industries, a semiconductor packaging equipment manufacturer, has faced a decelerating demand environment following a Covid boom that has been compounded by concerns regarding the overall health of the consumer electronics end market. Specialty chemical manufacturer Huntsman Corporation faced concerns that a more aggressive Federal Reserve will dampen its end market demand in core markets such as housing. Energy costs and consumer demand concerns in Europe also weighed on its stock price. Huntsman Corporation and Kulicke & Soffa were top-10 holdings, while Johnson Outdoors was our eleventh largest at the end of June.

The Fund’s top contributor at the position level for the year-to-date period ended 6/30/22 was H&R Block, a leading tax preparation business. The company reported better-than-expected results, driven by the increasing complexity of tax filings and its ability to raise prices due to improving product quality. Its consistent and sizable cash flow generation also garnered more attention in the first half’s challenging market. It was the Fund’s fourth-biggest position at the end of June. Shares of broadcast company TEGNA began to rise following the late February announcement that the company had agreed to be acquired by a Standard General affiliate for $24 per share, a 39% premium to the pre-announcement share price. Following our previous successful investment in Meredith Corporation, a similar broadcasting business that sold its TV assets to Gray Television, we were attracted to TEGNA due to its cheap valuation and strong cash flow, as well as our view that TEGNA was as an attractive asset in a consolidating industry. Shares of Ennis, which prints business forms and printed electronic media, presentation products, envelopes, and other custom products, rallied in June after the company reported a more upbeat outlook for demand as current market conditions have benefited companies that have proven capable of navigating the paper shortage. Ennis was the portfolio’s thirteenth-largest holding at the end of June.

The portfolio’s advantage over the Russell 2000 Value (its primary benchmark) for the year-to-date period was entirely attributable to stock selection. At the sector level, stock picks in Consumer Discretionary and Communication Services, a lack of exposure to Health Care, and the Fund’s cash position all had a positive impact versus the benchmark. Conversely, our lack of exposure to Energy and Utilities, as well as a higher weighting in Information Technology, detracted most from relative results in 2022’s first half.

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

H&R Block2.06
Resources Connection0.11
Ingles Markets Cl. A0.09

1 Includes dividends

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

Johnson Outdoors Cl. A-1.43
Kulicke & Soffa Industries-1.31
Huntsman Corporation-1.22
Marcus & Millichap-1.08
Encore Wire-0.94

2 Net of dividends

Current Positioning and Outlook

There seems to be a case building for dividend payers and growers. This likely stems from lower expected forward returns. The wherewithal to take such corporate actions stems from those fundamental attributes we strive to have in our holdings, including strong free cash flows, little debt, and pricing power. Should this trend continue, we would expect our names to become more attractive to buyers. We would also expect our performance to improve, as has been the case historically, when high yield spreads grow wider as the economy faces higher interest rates and less favorable activity, and quality is rewarded. If one combines this dynamic with more attractive valuations and high-quality financial metrics, it is probable that a subset of small-caps make attractive investment candidates. Companies with strong financials, little debt, and ample free cash flow—hallmarks of our investing style captured by the term “quality”—have historically done well during times that resemble the current environment. We believe the portfolio is well represented with such companies.

Average Annual Total Returns Through 06/30/22 (%)

Small-Cap Special Equity -7.56-12.83-6.477.304.747.566.457.818.31

Annual Operating Expenses: 1.20

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: H&R Block was 4.9%, TEGNA was 4.1%, Ennis was 3.1%, Resources Connection was 0.7%, Ingles Markets Cl. A was 7.0%, Johnson Outdoors Cl. A was 3.5%, Kulicke & Soffa Industries was 4.0%, Huntsman Corporation was 5.7%, Marcus & Millichap was 3.8%, Encore Wire was 3.4%, Standard General 0.0%, Meredith Corporation 0.0%, Gray Television 0.0%.

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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