Royce Small-Cap Value Fund Manager Commentary
article 06-30-2022

Royce Small-Cap Value Fund Manager Commentary

With the economic outlook unpromising, several small-cap companies with what seems like transitory issues to us have become attractively inexpensive. We have been focusing primarily on those that combine strong fundamentals with effective operations and execution.


Fund Performance

Royce Small-Cap Value Fund fell 19.4% for the year-to-date period ended 6/30/22 versus a 17.3% decline for its primary benchmark, the Russell 2000 Value Index, and a loss of 23.4% for the Russell 2000, its secondary benchmark, for the same period. The portfolio outperformed both small-cap indexes for the one- and 20-year periods ended 6/30/22. In addition, its relative performance improved through the first half of 2022. After substantially trailing the Russell 2000 Value in 1Q22—down 9.3% versus a loss of 2.4%—the Fund fell 11.1% versus a decline of 15.3% for its primary benchmark in 2Q22.

What Worked… And What Didn’t

Seven of the portfolio’s nine equity sectors had a negative impact on year-to-date performance. The sectors making the largest detractions were Consumer Discretionary, Information Technology, and Industrials. Health Care and Consumer Staples (along with a contribution from the Fund’s cash holdings) made the only positive impact while Communication Services had the smallest negative effect. At the industry level, specialty retail, household durables (both in Consumer Discretionary), and electronic equipment, instruments & components (Information Technology) detracted most for the year-to-date period, while pharmaceuticals (Health Care), entertainment (Communication Services), and IT services (Information Technology) were the largest contributors.

The portfolio’s top detractor at the position level in the first half of 2022 was family footwear retailer Shoe Carnival. We believe the company continues to execute well, in particular compared to its competitors, by reducing costs, opening new stores, and renovating older sites. Shoe Carnival also released strong 1Q22 earnings in May and maintained its top-line guidance, but saw its shares fall amidst the inhospitable climate for retailers. We held shares at the end of June. Rent-A-Center operates rent-to-own stores. Investors shied away from its stock after the company said that both the end of Covid relief funds and rising inflation would likely hurt its customers’ ability to buy and/or make payments. We were equally concerned about how the company’s 2021 acquisition of lease-to-own solutions provider Acima Holdings put leverage on Rent-A-Center’s balance sheet while also adding credit losses to recent financial results. We sold the last of our shares in March.

The top contributor at the position level was SIGA Technologies, which sells a treatment for smallpox that has also been approved in some countries to treat monkey pox. Its growth has historically been lumpy, driven by government contracts by which purchases of SIGA’s TPOXX smallpox treatment are made in large amounts to stockpile. More recently, however, the monkey pox outbreak has attracted a fresh round of investor interest in its shares. We trimmed our stake in the first half. BioDelivery Sciences International is a specialty pharmaceutical company that makes pain management and neurology products that treat patients living with serious and complex conditions such as chronic pain and acute migraines. In February, Collegium Pharmaceutical, which we also hold, and which also specializes in pain management medicines, announced it would acquire BioDelivery at a sizable premium, leading us to begin selling our position.

The portfolio’s disadvantage versus the Russell 2000 Value Index (its primary benchmark) came entirely from sector allocation in the year-to-date period; stock selection was additive, though not enough to outweigh the effects of sector positioning. Both our substantially larger exposure and stock picks hurt relative results in Consumer Discretionary. Our low weighting in Energy and lack of exposure to Utilities also made an appreciable negative impact versus the benchmark. Conversely, savvy stock selection boosted relative performance in Health Care. Stock picking and our lower weighting in Communication Services also helped results versus the small-cap value index, as did stock selection in Information Technology.

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

SIGA Technologies0.69
BioDelivery Sciences International0.64
Resources Connection0.28
SciPlay Corporation Cl. A0.14

1 Includes dividends

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

Shoe Carnival-0.94
OneWater Marine Cl. A-0.91
American Eagle Outfitters-0.80

2 Net of dividends

Current Positioning and Outlook

We typically adhere to the wisdom in the adage, “Don’t fight the Fed.” However, as the Fed continues to raise rates—and may do so even more aggressively in its attempts to curb inflation—the yield curve has been flipping back and forth from inversion and ended June nearly flat. In addition, credit spreads keep widening, commodity prices have softened, and the bond market is signaling that the economy may be headed for recession—though we may already be there. Needless to say, this has made for a highly challenging investment environment, made even more difficult by the market’s downward moves, which are casting doubt on many earnings estimates. We will be paying especially close attention to any changes in guidance from last quarter once earnings announcements begin in mid-July. With the economic outlook unpromising, several small-cap companies with what seems like transitory issues to us have become attractively inexpensive. We have been focusing primarily on those that combine strong fundamentals—particularly low-debt balance sheets and positive cash flows—with effective operations and execution as well as tangible evidence of efforts to improve their business through the current uncertain period. During the first half, we increased our exposure to certain areas in Information Technology—most notably semiconductor and component makers and contract manufacturers—and Energy while reducing our weightings in big-ticket consumer areas such as boats and housing.

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

Small-Cap Value -11.05-19.36-15.981.643.125.473.548.247.77

Annual Operating Expenses: Gross 1.59 Net 1.49

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 Gross operating expenses reflect the Fund's gross total annual operating expenses for the Service Class and include management fees, 12b-1 distribution and service fees, and other expenses. Net operating expenses reflect contractual fee waivers and/or expense reimbursements. All expense information is reported as of the Fund's most current prospectus. Royce has contractually agreed, without right of termination, to waive fees and/or reimburse expenses to the extent necessary to maintain the Service Class's net annual operating expenses (excluding brokerage commissions, taxes, interest, litigation expenses, acquired fund fees and expenses, and other expenses not borne in the ordinary course of business) at or below 1.49% through April 30, 2023.

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: SIGA Technologies was 0.4%, BioDelivery Sciences International was 0.0%, Resources Connection was 1.7%, IBEX was 1.1%, SciPlay Corporation Cl. A was 1.1%, Shoe Carnival was 1.2%, Rent-A-Center was 0.0%, OneWater Marine Cl. A was 0.6%, American Eagle Outfitters was 0.8%, ArcBest was 1.5%, Acima Holdings 0.0%, Collegium Pharmaceutical 1.3%.

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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