Fund Performance

Royce Small-Cap Total Return Fund outperformed its benchmark, the Russell 2000 Value Index, for the 1-, 3-, 5-, 10-, 15-, 20-, 25-, 30-year, and since inception (12/15/93) periods ended 6/30/24 while also advancing 1.4% for the year-to-date period ended 6/30/24, again beating its small-cap benchmark, which was down -0.8% for the same period. The Fund also outpaced the Russell 2000 Index for the 1-, 3-, 5-, 10-, 20-, 25-, 30-year, and since inception periods ended 6/30/24.

What Worked... and What Didn’t

Six of the portfolio’s nine equity sectors made a positive impact on year-to-date performance, led by Information Technology, Industrials, and Financials while Consumer Discretionary, Communication Services, and Real Estate detracted. At the industry level, trading companies & distributors (Industrials), insurance (Financials), and electronic equipment, instruments & components (Information Technology) contributed most for the year-to-date period. The biggest detractors were banks (Financials), interactive media & services (Communication Services), and consumer finance (Financials).

At the position level, the top contributor was FTAI Aviation, which was also the Fund’s top contributor in 2023. FTAI is an aircraft engine lessor that also offers a cost-effective engine maintenance, repair, and exchange program that is eagerly sought by smaller airlines. FTAI’s shares rose largely because of strong industry fundamentals—the company beat earnings estimates for 1Q24 and announced large multi-year deals for its workhorse V2500 engines with LATAM Airlines Chile and International Aero Engines—increased earnings power from the internalization of a management agreement, and the purchase of a key manufacturing facility from Lockheed Martin ($50m of annual savings). Coherent is an engineered materials and laser technology company. While its offerings cover many different types of products and end markets, we see as producers of the foundational technologies that enable many technology growth trends, including electric vehicles, accelerating broadband speeds and capacity, autonomous driving, advanced display technologies, and semiconductor capital equipment, among others. Coherent reported strong financial results in February 2024 that underscored that its products going into the datacom networking space were experiencing unprecedented demand due to AI driving massive bandwidth requirements, and that the company is also taking market share in this space. The company also announced in early June that a successor CEO, Jim Anderson, had just been appointed. The market appeared to take this news as validation that he would be able to bring similar strategies for value creation to Coherent that he had achieved at other companies where he’d been an executive.

Kyndryl Holdings is an IT infrastructure services provider. Spun out of IBM in 2021, Kyndryl is often seen as a “legacy” technology company. When Kyndryl was part of IBM, the economic incentives were quite different, and IBM saw it essentially as a loss leader, using the contracts with clients with either no or negative profits to drive the rest of the business. Once Kyndryl was spun out, however, the company was able to go through their portfolio of contracts and renegotiate them, weeding out negative or zero profit business and replacing them with profitable contracts. Bermuda-based Axis Capital Holdings is a specialty property & casualty company that has continued to benefit from strong industry conditions, including attractive pricing. Axis has also meaningfully shifted its book of business towards more specialty, higher margin lines, which has been positively reflected in its results. Repay Holdings provides integrated payment processing solutions and operates through two segments: Consumer Payments and Business Payments. Its shares rose on a strong first quarter that revealed 10% organic revenue growth and 11% gross profit growth, along with rumors that Repay was entertaining offers from private equity/financial buyers interested in buying the business.

The Fund’s top detractor at the position level was Valley National Bancorp, a New Jersey-based regional bank that also has a strong presence in Florida—and a long history of conservate underwriting, as demonstrated by pristine credit performance over many cycles. However, Valley National is also a sizable commercial real estate (“CRE”) lender, and concerns over the state of that industry, coupled with a less liquid balance sheet and resulting net interest margin pressure, hit the stock hard in 2024’s first half. We sold the last of our position in June. Vestis Corporation provides workplace uniforms and supplies, including towels, aprons, linen, floormats, restroom, and first aid products, on a weekly basis to U.S. customers. Shortly before it was spun-off from Aramark in September 2023, Vestis held an analyst day where the company presented a plan to achieve 5-7% organic revenue growth between fiscal 2023 and fiscal 2028 and an 18-20% Adjusted EBITDA (earnings before interest, taxes, depreciation & amortization) margin by fiscal year 2028. In February of this year, Vestis reaffirmed its fiscal 2024 outlook when announcing first quarter results, which indicated that this plan was on track. In May 2024, however, customer retention and sales productivity challenges forced Vestis to revise its outlook sharply lower—specifically revising revenue growth from 4.0-4.5% to -1.0 to 0.0% revenue growth and an adjusted EBITDA margin from 14.3% to 12.0-12.4%.

Kennedy-Wilson Holdings invests directly in commercial real estate, primarily apartment buildings, while also deriving fee income from its growing investment management platform. Its stock fell 29% in the first quarter, in part due to the company incurring another significant downward fair value adjustment for properties in its investment management vehicles, which investors extrapolated to its on-balance sheet holdings. The company is admittedly complex and, in our view, often misunderstood. Concerns about commercial real estate values falling due to higher interest rates have weighed on the company and have been exacerbated by the complexity of its balance sheet. Kennedy-Wilson’s fundamentals, however, have remained relatively strong. Helen of Troy is a collection of well-regarded consumer brands such as HydroFlask, Oxo kitchen products, Osprey backpacks, Braun thermometers, and Revlon and DryBar hair care products. The bulk of the company’s brands benefited greatly during the pandemic, and it continues to see its overall business normalize from these elevated conditions. Although inventories, free cash flow, and the balance sheet have all improved markedly in the last six quarters, organic top line growth has proven elusive. Competition in the insulated beverage category from brands like Stanley has also pressured the company. Fundamentals for Yeti Holdings—which designs and distributes outdoor and recreation products like coolers, bottles, seat cushions, and other related products—were solid during the first half, making it something of a puzzle that its stock performed poorly. More recently, we believe the concerns were related to tariffs, a function of the market beginning to price in a Trump victory in November.

The portfolio’s advantage over the Russell 2000 Value for the year-to-date period ended 6/30/24 was primarily attributable to stock selection, with sector allocation decisions playing a smaller, though still positive role. At the sector level, stock selection in Information Technology, Financials, and Industrials together had the biggest positive impact versus the benchmark, with our overweight in the first and third of those sectors also contributing. Conversely, stock selection hurt relative results in Consumer Discretionary and Communication Services (where our higher weighting also detracted), as did the Fund’s substantially lower exposure to Energy. At the position level, FTAI Aviation, Coherent, and Kyndryl Holdings did best relative to the Russell 2000 Value while the opposite was the case for Vestis Corporation, Valley National Bancorp, and Kennedy-Wilson Holdings.

Current Positioning and Outlook

During April of 2024, we noticed an unusually high number of stocks underperforming during earnings season, a phenomenon typically marked by solid quarterly results with guidance that was either in line with expectations or slightly below, but with stock prices that responded quite negatively in many cases, and well in excess of what the fundamentals might suggest was appropriate. During May and June, the Fund’s tech holdings contributed nicely to performance, led by Kyndryl and Coherent, which are two very different businesses. We purchased several new banks in 2Q24, while exiting a few existing positions in this same industry, the largest of which was a company that announced it would be acquired. In the last four years, the Fund has participated in four IPOs—two of them in 2Q24. One is a diversified financial services company with a focus on clearing, an attractive business with solid growth, declining competitive intensity, and high margins. The other was a healthcare services provider in the skilled nursing facility industry, which we believe we know well via another portfolio holding and view as a potential long-term compounder. In terms of the outlook, we continue to see small-cap banks as one of the best values in the market while also warming up to pockets of Consumer Discretionary, where some businesses, particularly those exposed to middle- and lower-income consumers, have arguably been operating in recession-like conditions for a couple of years. The ensuing difficult operating backdrop has led many to underperform, while also leading in select cases to what we see as attractive valuations.

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

	QTR1	YTD1	1YR	3YR	5YR	10YR	15YR	20YR	25YR	30YR	SINCE INCEPT. (12/15/93)
Small-Cap Total Return	-2.85	1.36	15.42	4.63	8.81	7.26	10.82	7.99	9.01	10.35	10.14

Annual Operating Expenses: 1.26

¹ Not annualized.

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