Fund Performance

For the year-to-date period ended 6/30/25, Royce Small-Cap Total Return Fund was down -3.4%, slightly behind the Russell 2000 Value Index, which fell -3.2% for the same period. However, the Fund outperformed its benchmark for the 3-, 5-, 10-, 15-, 20-, 25-, 30-year, and since inception (12/15/93) periods ended 6/30/25.

What Worked… and What Didn’t

Seven of the Fund’s 10 equity sectors made a negative impact on year-to-date period performance, with Consumer Discretionary, Energy, and Industrials detracting most while the largest positive impacts came from Financials, Information Technology, and Health Care. At the industry level, professional services (Industrials), financial services (Financials), and energy equipment & services (Energy) detracted most for the year-to-date period, while capital markets (Financials), trading companies & distributors (Industrials), and banks (Financials) were the largest contributors.

The top detractor at the position level in the first half of 2025 was Vestis Corporation, which provides uniform rentals and workplace supplies in the U.S. and Canada. During May, the stock was battered after the company reported significantly lower 2Q25 results, pulled its guidance for the full year 2025, and provided weak guidance for the third quarter (a forecasted revenue decline of between -2.3% and -3.5% and earnings before interest, taxes, depreciation & amortization (EBITDA) decline of -27.4%). Alarmingly, operational progress seemed to have stalled as the retention rate dropped by 50 basis points to 92.4% along with several other key performance indicators. Vestis also announced a new CEO who lacked uniform rental experience (the CFO is also fairly new) and amended its credit agreement to allow a higher degree of leverage for a longer time frame. These developments highlighted the gravity of the company’s operational issues, lack of institutional knowledge, and financial risk, all of which led us to exit the position.

Coming next was Compass Diversified Holdings, an investment company that acquires and manages a group of nine small and middle-market consumer and industrial businesses. Compass has a track record of acquiring private companies in attractive end-markets, providing them with capital to gain share, and exiting the investments at attractive prices. In May, Compass disclosed non-reliance on its fiscal 2024, 2023, and 2022 financial statements amid an ongoing internal investigation into its Lugano subsidiary and a delay in the filing of its 1Q25 10-Q, triggering a 62% stock price decline on May 7th. A high-end jewelry retailer, Lugano is one of nine subsidiaries, accounting for only 21% of fiscal 2024 revenue, but with the highest revenue growth (63% average from 2021-2024) and EBITDA (earnings before interest, taxes, depreciation & amortization) margin (41.4%), which helps to explain the reaction. The issue surfaced when an employee alerted the CEO about how Lugano’s CEO (and 45% owner) might be fraudulently financing inventory. Given our inability to rely on Compass’s numbers and the company’s $1.8 billion in outstanding debt, we exited the position.

Academy Sports & Outdoors (ASO), the nation’s second largest sporting goods retailer. As a value leader, it skews more closely to middle and lower income buyers. Unsurprisingly, then, its core business has been under pressure for the last few years, largely due to the pressure on its core customers. The decline in its shares was largely related to tariff announcements and their potential impact on Academy’s customers, and thus the company’s fundamentals. Academy sources some product from China, while most of its suppliers source from China, Vietnam, and other countries in Southeast Asia. However, as a value-oriented retailer, management believes its business is also benefiting from trade downs into its stores from higher end consumers. Academy also has a host of self-help levers it is pulling to improve same store sales, including the recent launch of the popular Jordan brand across many locations, with more to come in the future.

Our fourth top detractor was Franklin Covey, which provides consulting, seminars, educational materials, publications, and products designed to make organizations and educational institutions more effective through collective behavioral change. The company has been adversely affected by DOGE-related cancellations of government projects and tariff uncertainty, forcing enterprises to dial back on leadership training investments, yet demand in its education segment is robust. While the current economic uncertainty is an unwelcome headwind, we expect Franklin Covey’s new go-to-market strategy to result in greater penetration of its customer base and near-term margin expansion. In the meantime, its net cash balance sheet and cost controls should serve the company well as it executes on this strategy.

First-half underperformance for semiconductor assembly specialist Kulicke and Soffa was largely driven by overall weakness within the broader semiconductor capital equipment industry rather than any idiosyncratic issues facing the company. There was significant bifurcation within the industry’s stock performance in 2025’s first half, with anything exposed to AI enjoying a strong year so far, while most of the remaining companies have seen a continuation of the extended cyclical bottom that has been present for several quarters now. Within the Russell 2000 Value, for example, the semiconductors & semiconductor equipment industry, the best performing stock was up 83.5% year-to-date through 6/30/25 due to its technology partnership with Nvidia, while the overall industry was down -14.5%. We have always felt that it is a fool’s errand to try calling the bottom of a cycle within the semiconductor industry given that the bounce off the bottom can be extremely rapid and strong. Thus, if you miss the first part of the move, then you have likely missed a significant part of the next cycle’s returns. So, while it has been frustrating that growth for semiconductor equipment within the past couple of years has been exclusively focused in the AI space, we still view the larger industry as having strong secular growth characteristics over the long term. We also view KLIC as a phenomenal place to wait out the cyclical bottom due to its net cash balance sheet, which provides downside protection, and very strong through-cycle returns on capital, which signals high quality.

The Fund’s top contributor at the position level was Healthcare Services Group, which provides housekeeping and dining services predominantly to skilled nursing facilities (post-acute care) in the U.S. In April, management reported the company’s best quarterly revenue and cash flow performance in five years, and, most importantly, saw significant growth within the housekeeping segment. While cross-selling dining services into existing housekeeping clients provides tremendous growth opportunities, a growing housekeeping segment is the first strong indicator that the company is growing net new client count again for the first time in many years.

The Fund’s second top contributor was Kyndryl Holdings, the world’s largest IT infrastructure services provider, which involves keeping the mission-critical IT systems, data centers, and IT networks of large enterprises such as banks, airlines, and retailers, up and running in a secure manner on a 24x7 basis. Throughout most of its history, Kyndryl was operated as a loss-making cost center that existed to sell IBM hardware and/or software. Since being spun off from IBM in November 2021, however, Kyndryl has adroitly balanced its legacy IBM business while offering customers more advanced technology through partnerships with Google, Amazon Web Services, and Microsoft. Kyndryl had 1.3% constant currency revenue growth during the latest quarter, in line with management’s projections and offering evidence of the recession-resistant and non-discretionary nature of its services. Signings rose by a whopping 55%, led by a 37% increase in consulting signings. These contracts had 9% pretax margins versus the 5.5% achieved in 2024’s fourth quarter. Kyndryl is a financially-strong business with recurring revenue, sticky customers, and ample operational momentum to deliver on its conservative full year 2026 guidance.

As a futures commission merchant, Marex Group benefited from heightened volatility in many of the world’s capital markets and economies as uncertainty creates a greater need for clients to keep hedging and trading volumes high. This uncertainty has mainly been driven by U.S. tariffs, which resulted in the VIX (volatility index) reaching 5-year highs earlier this year. Marex is also a big inorganic grower, and the more favorable M&A environment has created opportunities for the company to do highly accretive deals. In addition, the company has benefited from elevated interest rates, as Marex invests a large amount of client cash in U.S. Treasuries and other fixed income assets. Finally, an oversubscribed April follow-on offering heavily increased the free float of the shares while private equity investors continue to exit the name, which ultimately removes another overhang.

Advance Auto Parts provides aftermarket parts provider and serves both professional installers and do-it-yourself customers with 4,285 stores in the U.S. and Canada. In 1Q25, AAP reported same store sales that were significantly better than feared, and its operating metrics, especially in the important professional channel, began to inflect positively. Importantly, management also signaled that they expected to benefit from tariffs/inflation, enabling investors to gain confidence in Advance’s ability to meet their full year 2025 guidance. We see Advance as a financially strong business with several self-help levers, led by operationally savvy managers and operating in an industry with favorable tailwinds, excellent economics, rational competition, and supportive vendors.

Air Lease is one of the world’s largest global lessors of commercial aircraft to commercial airlines. A rebound in airline passenger miles back from Covid-lows combined with ongoing production woes at both major aircraft suppliers has led to a multi-year imbalance of available supply of new planes versus demand. This is putting upward pressure on lease rates as well as leading to higher used aircraft resale values for planes that a come off lease. Both trends are starting to flow through in Air Lease’s recent earnings. Given the size of its order book and its focus on new, fuel-efficient models, Air Lease has good visibility of future revenue streams, with over almost 60% of its deliveries through early in the next decade already under lease (including almost 100% of the next two year’s deliveries). Insurance recoveries on planes seized by Russia are also providing more financial flexibility, including the potential for Air Lease to begin buying back stock—despite strong performance, the shares remain below understated, tangible book value.

The Fund’s narrow disadvantage vis-à-vis the Russell 2000 Value was attributable to stock selection in 2025’s first half. At the sector level, stock selection in Consumer Discretionary, a lack of exposure to Utilities, and stock selection in Industrials hurt relative results most while lower exposure to Health Care (with an assist from stock selection), an underweight in Energy, and higher exposure to Financials were additive versus the Russell 2000 Value.

Current Positioning and Outlook

The second quarter regained much of the lost ground from the first quarter, as investors seemed to gain comfort despite continued U.S. policy and tariff uncertainty. However, underneath the surface there was a significant dispersion of returns across the market, with low-quality and high-beta driving much of the returns in the small-cap universe. Within the Russell 2000 Value, Information Technology led by a wide margin, with Materials following in a distant second place in the quarter. While the Fund has an overweight position within the IT sector, the strength of the sector within the small-cap value index came mostly from massive share price swings in more speculative growth-type companies with negative earnings. Given our focus on high-quality companies with strong financial characteristics, we would not expect to outperform in such a big risk-on market. (For reference, the Russell 2000 Value rallied 20.2% from the 4/8/25 bottom through the end of June.) We continue to hold a somewhat cautious view entering the third quarter. As we have previously discussed, the un-inverting of the yield curve near the end of last year may not have been a positive development. Not only has it historically signaled the presence or imminent arrival of recessions going back to 1980, but it is also another data point in a current environment that has so a plethora of mixed signals, making the subsequent direction of the economy and capital markets even tougher to gauge than usual. Furthermore, while 1Q25 earnings were not nearly as bad as many had feared following the tariff announcements on 4/2/25 and the concurrent market swoon, we think that risks remain elevated from U.S. trade policy and overall geopolitical tensions. We continue to build the portfolio using our robust and repeatable research process and feel that our bottom-up focus on constructing the portfolio with high-quality companies that trade at undemanding valuations can drive solid returns regardless of the macro environment. We think that our overweight within insurance offers a perfect example of this view, particularly within the lens of second quarter performance. The overweight was a detractor in the quarter, predominantly because the industry’s defensive characteristics worked against it in a low-quality rally. That being said, we don’t own this group of companies predominantly for their defensive characteristics, but rather because each holding company operates within a unique niche and has a strong management team, which we think will lead to idiosyncratic opportunities in the long run.

Average Annual Total Returns Through 06/30/25 (%)

Annual Operating Expenses: 1.21

¹ Not annualized.

Important Performance, Expense and Disclosure Information