Royce Small-Cap Total Return Fund Manager Commentary
article 06-30-2023

Royce Small-Cap Total Return Fund Manager Commentary

Royce Small-Cap Total Return Fund outperformed the Russell 2000 Value for the year-to-date, 1-, 5-, 20-, 25-year, and since inception (12/31/91) periods ended 6/30/23 while also beating the Russell 2000 for the year-to-date, 3-, 5-, 25-year, and since inception periods through the end of June.


Fund Performance

Royce Small-Cap Total Return Fund gained 8.9% for the year-to-date period ended 6/30/23, beating its primary benchmark, the Russell 2000 Value Index, which was up 2.5%, and its secondary benchmark, the Russell 2000 Index, which was up 8.1% for the same period. The Fund also outperformed the Russell 2000 Value for the 1-, 5-, 10-, 15-, 20-, 25-year, and since inception (12/15/93) periods ended 6/30/23 while also beating the Russell 2000 for the 3-, 5-, 25-year, and since inception periods through the end of June.

What Worked… And What Didn’t

Five of the portfolio’s nine equity sectors made positive impacts on 2023’s first half performance, led by Information Technology, Industrials, and Consumer Discretionary. The largest negative impacts came from Financials, Energy, and Communication Services. At the industry level, electronic equipment, instruments & components (Information Technology), software (Information Technology), and trading companies & distributors (Industrials) contributed most, while the largest detractors were banks (Financials), energy equipment & services (Energy), and interactive media & services (Communication Services).

First Citizens BancShares was the top contributor at the position level and also the winning bidder for Silicon Valley Bank, a deal that was considerably accretive to the company’s tangible book value. Silicon Valley’s travails notwithstanding, the purchase also enhanced First Citizens’ earnings, helping spur a sharp rise in its stock. We are confident in its ability to merge the acquired company given its long and successful track record of acquiring failed banks. Aircraft leasing company FTAI Aviation focuses mostly on engine leasing and aircraft engine maintenance. FTAI is competitively advantaged due to several key strategic decisions that allow it to provide engine maintenance with much faster turnaround and lower cost than its competitors. Previously, the company had been combined with another unrelated infrastructure asset, but the two businesses were separated in 2022, when the aviation business looked attractively undervalued to us. Its stock rose in 2023’s first half as its value began to be realized. Vontier Corporation has a mixture of businesses with a focus on technical equipment for gas pumps’ and convenience stores’ support infrastructure, such as the software used at the pump, in the store, and in any attached car wash systems. Its shares suffered in 2022 as investors focused on revenue declines tied to increased spending on gas pump payment terminals. As the payment terminal issue receded from investor attention, the stock responded well as Vontier’s fundamental strength became clear.

As for the detractors, Independent Bank Group, BankUnited, and Valley National Bancorp are each located in an attractive geography with a growing economy, have solid management teams and strong credit underwriting skills, and invest in differentiated service areas. We remain confident that the integral role these banks play in the communities they serve—relationships that drive the majority of their respective businesses—will not be replaced outside the regional banking system. Pason Systems has a dominant market share in Electronic Drilling Recorders, a network of sensors, software, and displays that are integrated into the workflow on oil rigs and are low-cost, mission critical features for drillers. Although Pason reported strong financial results in March and May, its shares were caught up in the broad downturn for energy stocks.

The Fund’s relative advantage in 2023’s first half came mostly from stock selection. At the sector level, both our markedly higher weighting and stock picks boosted relative performance in Information Technology. Stock selection was also additive in Financials, as were our higher weighting and, to a lesser extent, stock selection in Industrials. Conversely, stock picks detracted from relative results in Energy, Materials, and Communication Services.

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

First Citizens BancShares Cl. A1.65
FTAI Aviation1.49
Vontier Corporation1.36
Teradata Corporation1.06
Sapiens International0.92

1 Includes dividends

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

Independent Bank Group-0.94
Pason Systems-0.53
Valley National Bancorp-0.49

2 Net of dividends

Current Positioning and Outlook

The first half of 2023 saw continued volatility in regional bank stocks, particularly in May, and we used this volatility to establish new positions, each of which presented us with an opportunity to purchase what we see as strong franchises at or near record low valuations. From a top-down perspective, we were pleased with the ongoing fundamental strength in our holdings. Despite these strong fundamentals, however, the portfolio in aggregate continues to trade at historically low multiples. Of course, storm clouds remain visible on the horizon, and it seems probable that the economy will succumb to the impact of higher interest rates in the future. Though that may sound ominous, it excites us as owners of quality businesses, some of which also may be acquired. We hold several cash generative businesses with strong balance sheets and, most important, capital allocation prowess that we believe will enable these companies to act opportunistically in a difficult environment. These opportunities range from hiring teams of lenders amid the market disruption caused by failed banks (i.e., market share gains) to acquiring competitors and other assets at discounted valuations across a variety of industries. We believe that capital allocation skill is key to the ability to drive superior, risk-adjusted returns for our investors.

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

Small-Cap Total Return 6.508.959.4214.295.817.767.738.408.379.97

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 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, 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: First Citizens BancShares Cl. A was 0.4%, FTAI Aviation was 2.4%, Vontier Corporation was 2.8%, Teradata Corporation was 2.1%, Sapiens International was 2.0%, Independent Bank Group was 1.1%, BankUnited was 1.9%, Pason Systems was 1.2%, Valley National Bancorp was 1.3%, Dril-Quip was 1.2%.

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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