Royce Small-Cap Value Fund Manager Commentary
article 06-30-2019

Royce Small-Cap Value Fund Manager Commentary

Despite relative performance challenges, we are comfortable with how we have positioned the portfolio going forward amid economic and market uncertainty.


Fund Performance

Royce Small-Cap Value Fund increased 8.9% for the year-to-date period ended June 30, 2019, trailing respective gains of 17.0% and 13.5% for its small-cap benchmarks, the Russell 2000 and Russell 2000 Value Indexes, 
for the same period.

What Worked… And What Didn’t

Five of the portfolio’s 11 equity sectors finished the year-to-date period in the black. Industrials, Information Technology, and Financials were the strongest contributors, while Materials and Health Care were more muted. Five sectors finished in the red, with Consumer Discretionary making the biggest detraction, followed by much smaller negative impacts from Energy, Communication Services, Consumer Staples, and Real Estate. (Utilities was essentially flat.)

At the industry level, electronic equipment, instruments & components (Information Technology) was the strongest positive contributor in 2019’s first half. The rising shares of Insight Enterprises, which provides information technology hardware and software for large and small enterprises, helped both this industry and the portfolio as a whole. Investors seemed drawn to its improved margins and earnings, along with its solid outlook for the rest of the year. We took some gains as its stock rose. Machinery (Industrials) was the second-biggest industry contributor, boosted by Meritor, which supplies drivetrain, braking, and other aftermarket solutions for commercial and industrial vehicles. Improved revenues and better-than-expected earnings were driven largely by higher North American truck production. It was the portfolio’s second-largest holding at the end of June.

Specialty retail (Consumer Discretionary) detracted most at the industry level, due in part to poor performance from Caleres and top-10 holding, Shoe Carnival. Several factors hurt Caleres, such as reduced traffic and same-store sales growth at the firm’s Famous Footwear retailer (which accounts for about half of its profits); near-term margin pressure from having to clear excess inventory at hefty discounts in advance of new, much improved back-to-school styles from Famous Footwear’s largest vendor; and the negative impact that the threatened next round of U.S. tariffs on China-made goods would have on consumer prices and demand. Few retailers were immune from these anxieties, but it seemed to us that the shares of apparel and footwear companies, which also included Shoe Carnival, were among the hardest hit. Ever contrarian and always thinking about the long run, we began to build our stake in Caleres in late June.

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G-III Apparel Group lost most in the textiles, apparel & luxury goods group, the second-biggest industry detractor. Its stock suffered from the same tariff worries that helped hurt Caleres and Shoe Carnival, as well as from poor results in its retail arm. We like that G-III is preparing to move some production out of China. It also maintains a strong wholesale business, powered by popular brands such as DKNY, Donna Karan, and Tommy Hilfiger. ArcBest is a freight and logistics solutions specialist that saw its business stall in the first quarter. Believing in its long-term prospects and thinking that its shares were punished disproportionately by recession fears, we held our position at the end of June.

Relative to the Russell 2000, poor stock picking was the main source of first-half underperformance. Stock selection in Consumer Discretionary hurt most, particularly in specialty retail. Stock selection also hurt in Information Technology, primarily in electronic equipment, instruments & components, and in Industrials, where professional services and road & rail detracted most. Materials was the sole source of first-half outperformance, thanks mostly to savvy stock selection in metals & mining—the only industry in this sector where we had exposure.

Top Contributors to Performance Year-to-Date Through 6/30/191 (%)

Insight Enterprises0.91
Advanced Energy Industries0.51
Camden National0.51
Apogee Enterprises0.50

1 Includes dividends

Top Detractors from Performance Year-to-Date Through 6/30/192 (%)

G-III Apparel Group-0.62
Tower International-0.33
Shoe Carnival-0.32

2 Net of dividends

Current Positioning and Outlook

There’s been an ongoing slugfest among investors: in one corner, large-cap indexes have been routinely reaching new highs, the labor market is strong, and the economy is growing; on the opposite side of the ring, small-caps have been lagging large-caps—which seldom happens in a vibrant economy—the yield curve was flat or inverted through much of the first half, and economies outside the U.S. are slowing more quickly and appreciably than our own. So optimism, including the more cautious variety, is facing off against a pessimism that sees recession as imminent. Needless to say, only one of these combatants will be able to claim victory. For our part, we are squarely in the guarded optimism camp. The first half saw widespread concerns over trade tensions, the extended economic cycle, and slowing growth. There was also talk that the Fed would continue to lower rates—possibly later this year—which the market seemed to price in immediately. And while the Fed has historically reduced rates when the economy is slowing, we see growth slowing at a marginal pace—and certainly not contracting, which is the key distinction. Many of our holdings finished June at prices that looked to us like a recession had already been priced in. We have therefore been adding to positions in select cyclical areas such as trucking, trucks and automobile components, and footwear manufactures and retailers. We have not found many new opportunities, however, due to the otherwise mostly elevated state of many small-cap valuations. Recent relative performance challenges notwithstanding, we are comfortable with how we’ve positioned the portfolio in the face of ongoing uncertainty.

Average Annual Total Returns Through 06/30/19 (%)

Small-Cap Value -0.668.88-5.647.621.968.767.308.82 06/14/01

Annual Operating Expenses: Gross 1.53 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 & Associates 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, 2020.

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, 2019, 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, 2019 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 6/30/19, the percentage of Fund assets was as follows: Insight Enterprises was 2.5%, Meritor was 2.5%, Advanced Energy Industries was 1.1%, Camden National was 2.0%, Apogee Enterprises was 1.1%, G-III Apparel Group was 1.8%, ArcBest was 1.6%, Caleres was 1.0%, Tower International was 1.5%, Shoe Carnival was 2.1%

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 1000 Index is an index of domestic large-cap stocks. It measures the performance of the 1,000 largest publicly traded U.S. companies in the Russell 3000 Index. 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 Midcap Index measures the performance of the mid-cap segment of the U.S. equity universe. It includes approximately 800 of the smallest securities in the Russell 1000 Index. 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 ex USA Small Cap Index is an index of global small-cap stocks, excluding the United States. Index returns include net reinvested dividends and/or interest income. 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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