Royce Smaller-Companies Growth Fund Manager Commentary
article 06-30-2020

Royce Smaller-Companies Growth Fund Manager Commentary

The Fund significantly outpaced its small-cap index for the quarter, and it held its advantage for the one-, three-, five-, 15-year, and since inception (6/14/01) periods ended 6/30/20.


Fund Performance

A positive first half of 2020 helped Royce Smaller-Companies Growth Fund to gain longer-term relative advantages over its small-cap benchmark. The Fund advanced 2.1% for the year-to-date period ended 6/30/20, significantly ahead of the 13.0% decline for the Russell 2000 Index for the same period. We were especially pleased that the portfolio beat the benchmark during both the bearish first quarter (-23.8% versus -30.6%) and the bullish second quarter (+34.0% versus +25.4%). The Fund also outpaced the small-cap index for the one-, three-, five-, 15-year, and since inception (6/14/01) periods ended 6/30/20.

What Worked… And What Didn't

While only four of the Fund’s nine equity sectors finished the first half in the black, the positive contributions from two—Information Technology and Communication Services—were particularly strong. The largest detractors from performance on the sector level were Industrials and Financials. At the industry level, two areas from tech made outsized positive impacts: software and semiconductors & semiconductor equipment while banks (Financials) and professional services (Industrials) detracted most, as each was hurt by the recessionary environment.

At the position level, the Fund’s two top contributors were Sea and Lovesac Company, which each benefited from rising e-commerce penetration during the current work- and stay-at-home period. Sea is a U.S.-listed stock headquartered in Singapore that operates two business segments: a mobile gaming site, Garena, and a burgeoning e-commerce site, Shopee, which some have compared to Amazon and Alibaba. Both businesses target Taiwan and ASEAN (Association of Southeast Asian Nations) locales such as Indonesia, Vietnam, Thailand, Singapore, Malaysia, and the Philippines. Each segment has been growing rapidly, with the profitable gaming segment funding a portion of the currently loss-making e-commerce site. Interestingly, Asian e-commerce sites often offer free gaming to draw customers to their site. Lovesac is a sofa and beanbag furniture retailer with a strong online presence. Following its successful IPO in 2018, its shares fell steeply in late 2019-early 2020. Lovesac then reported positive overall sales growth rooted in the strength of its e-commerce business and despite having closed all of its retail showrooms during the early stage of the pandemic.

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GP Strategies, an online and classroom-based corporate training services provider, detracted most at the position level. GP has struggled to turn its business around after several years of acquisitions, though the company recently appointed a new CEO. We held shares at the end of June after trimming our position. We also reduced our stake in Paylocity, a cloud-based payroll processor and service provider that has been a long-term success in the portfolio since its IPO. However, its concentration on smaller businesses, which are seen as most vulnerable to the pandemic, hurt its stock. Paylocity’s business model is also based on a company’s number of employees, making it likely that layoffs or business failures will crimp its organic growth rate.

Both sector allocation and stock selection contributed to the Fund’s relative outperformance, with the latter having a marginally larger impact. On a sector basis, the portfolio benefited the most by far from an almost equal combination of stock picking and an overweight in Information Technology while stock selection hindered relative performance in Health Care.

Top Contributors to Performance Year-to-Date Through 6/30/201 (%)

Sea Cl. A ADR1.70
Lovesac Company (The)1.70
RingCentral Cl. A1.12
Bandwidth Cl. A0.95

1 Includes dividends

Top Detractors from Performance Year-to-Date Through 6/30/202 (%)

GP Strategies-1.47
Paylocity Holding Corporation-1.10
Lawson Products-0.84
Apyx Medical-0.83
TriState Capital Holdings-0.72

2 Net of dividends

Current Positioning and Outlook

It is becoming increasingly clear that the U.S. economy will not experience a V-shaped economic recovery, as some states see sharp growth in the number of COVID-19 cases, we have no firm timeline for vaccination approval and rollout, and we face the risk that winter will bring a second wave of infections. While the pandemic will almost certainly recede by some point in early 2021, we may not see a meaningful economic recovery until later next year. In this context, the market’s own V-shaped bounce-back may result in equities marking time until there is more evidence supporting a recovery. We suspect that public health concerns will continue to hit retail and restaurant establishments hard—and many have already permanently closed their doors. Demand for commercial office space is also almost certain to suffer, as more companies will encourage remote work now that we have reliable technologies such as Zoom and faster home internet speeds. Our view is that we will continue to see a slow, steady climb back to some type of normalcy in 2021, and the equity markets will march higher over the next few years due to improved earnings outlooks and near zero interest rates, which have forced investors out of fixed income and into equities for any semblance of positive returns. The markets may actually view a change in presidential leadership as a net positive, notwithstanding the fact that this is also likely to bring higher taxes. While inflation does not seem to be a concern in the intermediate term, the unprecedented fiscal and monetary stimulus rolled out to keep the economy and financial market afloat will undoubtedly have longer-lasting negative consequences for the U.S., as we seldom seem to be motivated to pay down the federal debt during economic expansions.

Average Annual Total Returns Through 06/30/20 (%)

Smaller-Companies Growth 33.992.134.316.285.669.747.6310.60 06/14/01

Annual Operating Expenses: Gross 1.54 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, 2021.

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, 2020, 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, 2020 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 6/30/20, the percentage of Fund assets was as follows: Sea Cl. A ADR was 1.3%, Lovesac Company (The) was 1.3%, CryoPort was 2.9%, RingCentral Cl. A was 1.1%, Bandwidth Cl. A was 1.1%, GP Strategies was 0.8%, Paylocity Holding Corporation was 0.8%, Lawson Products was 2.2%, Apyx Medical was 0.0%, TriState Capital Holdings was 0.8%

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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