Royce Smaller-Companies Growth Fund Manager Commentary
article 06-30-2019

Royce Smaller-Companies Growth Fund Manager Commentary

Our GARP (“Growth at a Reasonable Price”) Strategy outperformed its benchmark, the Russell 2000 Index, showcasing the strength small-cap growth stocks saw during 2019’s first half.


Fund Performance 

The strength of small-cap growth stocks in the first half was reflected in strong absolute and relative performance for our GARP (“Growth at a Reasonable Price”) strategy. For the year-to-date period ended June 30, 2019, Royce Smaller-Companies Growth Fund gained 21.1%, outpacing the Russell 2000 Index, its small-cap benchmark, which was up 17.0% for the same period. This impressive result also helped the Fund to outperform the small-cap index for the one-, three-year, and since inception (6/14/01) periods ended June 30, 2019.

What Worked... And What Didn't

Eight of the portfolio’s 10 equity sectors finished the first half of 2019 in the black. The most significant positive contribution by far came from Information Technology, our largest sector and biggest overweight versus the Russell 2000 at the end of June. Health Care and Industrials also made notable positive impacts on performance while Materials and Energy detracted, but only marginally. 

Some of the largest contributions at the industry level came from three groups in Information Technology—software (which led by a wide margin), semiconductors & semiconductor equipment, and electronic equipment, instruments & components. Three groups in Health Care were also sizable contributors—biotechnology, health care equipment & supplies, and life sciences tools & services. They were joined by strong gains from aerospace & defense (Industrials). Only 11 of the Fund’s 44 industries had a negative impact on performance, led by health care technology and pharmaceuticals (both in Health Care), as well as Internet & direct marketing retail (Consumer Discretionary). The remaining eight groups, including electrical equipment (Industrials), insurance (Financials), and personal products (Consumer Staples), detracted at more modest levels.

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The top-contributing position in the first half was Veracyte, a global genomic diagnostics company. In April, the company reported substantial growth in product revenue and genomic volume as well as a positive Medicare coverage decision for its Envisia Genomic Classifier. It was therefore no surprise that its CEO gave a favorable outlook for short- and long-term growth. Paylocity Holding Corporation, another top contributor, makes cloud-based human resources software primarily for smaller businesses’ payroll applications. With its SaaS (software as a service) model and expertise in user-friendly products, the firm continues to take market share in a growing industry primarily by executing more effectively than its larger competitors and newer players. In our view, this gives Paylocity ongoing growth opportunities. It was the portfolio’s top holding at the end of June. KeyW Holding Corporation is an intelligence, cyber and mission IT, and analytics solutions provider that agreed to a buyout offer in April, which led us to begin selling our stake at an attractive gain.

In March, we initiated a position in the portfolio’s biggest first-half detractor, Waitr Holdings. We proceeded to build our stake as its stock price was cut in half. Waitr runs an on-demand food ordering and delivery business that serves smaller markets in the U.S. A former SPAC—special purpose acquisition company—the firm reported terrific revenue growth in May but also faces competition from more established players such as Door Dash and Uber. We think its beachhead in smaller, underserved markets should help it survive, perhaps as a takeover target. Inogen makes portable oxygen concentrators for people suffering from chronic respiratory conditions. After growing robustly for a number of years, its shares fell sharply after the company significantly lowered its expectations for net income growth, which led us to exit our position.

Relative outperformance in the first half came largely from stock selection, though sector allocation also contributed. Stock picks in Information Technology were the biggest drivers, most notably in the semiconductors & semiconductor equipment and electronic equipment, instruments & components groups. Our significant overweight in software also boosted relative results, as did stock picking in the Communication Services sector. Conversely, our cash position was the largest source of underperformance. With equity returns so strong, even our modest 5.1% average weight was enough to drag relative results. Ineffective stock selection in Materials also hurt in the first half.

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

Paylocity Holding Corporation1.15
KEYW Holding Corporation1.09
Quanterix Corporation1.05

1 Includes dividends

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

Waitr Holdings-0.37
Unisys Corporation-0.29
Apyx Medical-0.24

2 Net of dividends

Current Positioning and Outlook

The risks for stocks remain real, and mostly unchanged from the end of 2018: weakness in China and Europe, the extended economic cycle here in the U.S., and slowing growth. We can add to this list the related item of intensified rhetoric around trade wars and tariffs, which we suspect has done as much to erode confidence as the tariffs themselves. One likely outcome of this, which we’ve already seen in some instances, is decelerating earnings growth and/or downward-trending guidance. Still, we’re reasonably confident that the U.S. economy will continue to grow, however slowly, with the consequence that select small-caps can keep running. We are especially confident in the ongoing long-term prospects for other SaaS holdings such as Everbridge, Avalara, and Coupa Software, as well positions involved in genetic diagnostics and drug discovery. In other areas, we continue to find companies that we believe look capable of ongoing earnings growth on a stock-by-stock basis. While some of these names carried high multiples at the end of June, we think their steady growth makes them worth holding.

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

Smaller-Companies Growth 4.5221.08-1.5313.216.5411.097.7910.95 06/14/01

Annual Operating Expenses: Gross 1.52 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: Veracyte was 1.7%, Paylocity Holding Corporation was 2.9%, KEYW Holding Corporation was 0.0%, uniQure was 1.6%, Quanterix Corporation was 2.1%, Waitr Holdings was 0.4%, Inogen was 0.0%, Unisys Corporation was 1.7%, Evolus was 0.7%, Apyx Medical was 0.6%

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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