Royce Small-Cap Total Return Fund Manager Commentary
article 06-30-2022

Royce Small-Cap Total Return Fund Manager Commentary

The Fund outperformed the Russell 2000 Value Index, for the one-, three, five-, 10-, 15-, 20-, 25-year, and since inception (12/15/93) periods ended 6/30/22 while also beating the Russell 2000 Index for each of these spans except the 10-, 15-, and 20-year periods.


Fund Performance

Royce Small-Cap Total Return Fund outperformed its primary benchmark, the Russell 2000 Value Index, for the one-, three, five-, 10-, 15-, 20-, 25-year, and since inception (12/15/93) periods ended 6/30/22 while also beating the Russell 2000 Index, its secondary benchmark, for each of these spans except the 10-, 15-, and 20-year periods. As has historically been the case, a better down-market performance helped the Fund, which was down 13.6% for the year-to-date period ended 6/30/22, to outpace both the Russell 2000 Value, which fell 17.3%, and the Russell 2000, which declined 23.4% for the same period.

What Worked… And What Didn’t

Unsurprisingly in light of the widespread bearish environment, seven of the portfolio’s 10 sectors made a negative impact on year-to-date performance, with the largest detractions coming from Financials, Industrials, and Consumer Discretionary. Energy, Materials, and Health Care were the only sectors to finish the first half in the black. At the industry level, banks, insurance (both in Financials), and machinery (Industrials) detracted most for the year-to-date period, while containers & packaging (Materials), energy equipment & services (Energy), and entertainment (Communication Services) were the largest contributors.

The Fund’s top-detracting position was GrafTech International, which makes natural and synthetic graphite and carbon-based electrodes and other products. Although the company, in our view, delivered a solid fiscal first quarter that showed ongoing improvements in pricing and volumes for graphite electrodes, the market was disappointed with a lack of commentary on expected pricing. Investors also seemed to fear that GrafTech’s steel-producer customers will experience reduced utilization, thus hurting demand. We believe, however, that pricing will improve because input costs are rising, which will force producers to raise prices. At the end of June, the company looked attractively valued, to us, at roughly four times earnings, suggesting to us that a lot of bad news had already been priced in. Franchise Group owns four consumer businesses: The Vitamin Shoppe, Pet Supplies Plus, and two discount furniture retailers. Its shares suffered after its plans to acquire retailer Kohl’s—a deal that would likely have been highly accretive for Franchise Group—fell through. Its stock has also experienced the same weakness that recessionary concerns have inflicted on most retailers. Our view is that its core assets are uncommonly resilient and therefore likely to see limited impact from a recession, specifically the Vitamin Shoppe and Pet Supplies Plus, which account for the majority of the firm’s earnings.

The Fund’s top two contributors were both acquisition targets. Industrial packaging company Intertape Polymer Group makes Water Activated Tape, the black tape on Amazon boxes. When we first invested, we saw an industrial packaging company that was an effective backdoor play on e-commerce trading at a deeply discounted multiple. Our research and due diligence were validated in early March when Intertape agreed to be taken private by a private equity buyer at an 82% premium to its prior close. CDK Global provides technology and software as a service (SaaS) solutions that help dealers and auto manufacturers run their businesses more effectively. In April, CDK agreed to be acquired by a private equity firm, Brookfield Business Partners, at a sizable premium.

The portfolio’s advantage over the Russell 2000 Value (its primary benchmark) was attributable entirely to stock selection in the year-to-date period, with stock picks helping most in Materials and Communication Services. The Fund’s significantly lower exposure to Health Care also boosted results versus the benchmark. Conversely, our low weighting in Energy, lack of exposure to Utilities, and stock picks in Consumer Staples detracted most from relative year-to-date results.

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

Intertape Polymer Group1.35
CDK Global0.45
Pason Systems0.35
Cactus Cl. A0.27
World Wrestling Entertainment Cl. A0.27

1 Includes dividends

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

GrafTech International-0.80
Franchise Group Cl. A-0.67
Vontier Corporation-0.58
Element Solutions-0.56
Denny's Corporation-0.54

2 Net of dividends

Current Positioning and Outlook

We are highly constructive on the outlook for small-cap value stocks in general—and our holdings in particular. We believe the market’s steep, swift decline set the stage for potentially strong returns, particularly given what we see as attractive valuations through much of our asset class. We believe that forward estimates, at least for companies with pricing power, will prove more resilient than the market seems to think. We suspect this will be true even in the event of a recession, as corporate revenues and earnings are calculated in nominal, not real, terms, so that companies with pricing power should see more earnings stability, if not perhaps growth, during a contraction. Our screens, watchlists, and other sources of idea generation are turning up far more candidates than usual, resulting in the addition of seven new names in 2Q22 alone. We have been adding to companies that appear poised to disproportionately capitalize on the current environment—those with the balance sheet health and cash flows that enable them to be opportunistic. This opportunism may manifest itself in the form of acquisitions and can also mean that companies can use their financial clout to take market share when competitors are struggling. The portfolio finished June with its highest average returns on invested capital (ROIC) in more than five years and cheapest valuations in more than 10. We think that is a potent combination that positions Small-Cap Total Return well for the years ahead, regardless of the economic backdrop.

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

Small-Cap Total Return -11.41-13.63-9.326.496.

Annual Operating Expenses: 1.26

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, other expenses, and acquired fund fees and expenses. Acquired fund fees and expenses reflect the estimated amount of the fees and expenses incurred indirectly by the Fund through its investments in mutual funds, hedge funds, private equity funds, and other investment companies.

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: Intertape Polymer Group was 0.0%, CDK Global was 0.0%, Pason Systems was 1.7%, Cactus Cl. A was 0.9%, World Wrestling Entertainment Cl. A was 0.3%, GrafTech International was 1.6%, Franchise Group Cl. A was 2.7%, Vontier Corporation was 2.4%, Element Solutions was 1.8%, Denny's Corporation was 0.4%, The Vitamin Shoppe 0.0%, Pet Supplies Plus 0.0%, Kohl’s 0.0%, Brookfield Business Partners 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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