Royce Smaller-Companies Growth Fund Manager Commentary
article 06-30-2023

Royce Smaller-Companies Growth Fund Manager Commentary

Royce Smaller Companies Growth Fund outperformed the Russell 2000 Growth for the 1-, 3-, 5-, 20-year, and since inception (6/14/01) periods ended 6/30/23 and outpaced the Russell 2000 for each of these periods except the 3-year span.


Fund Performance

Royce Smaller-Companies Growth Fund advanced 15.3% for the year-to-date period ended 6/30/23, beating both its primary benchmark, the Russell 2000 Growth Index, which was up 13.6%, and its secondary benchmark, the Russell 2000 Index, which was up 8.1% for the same period. The Fund also outperformed the Russell 2000 Growth for the 1-, 3-, 5-, 20-year, and since inception (6/14/01) periods ended 6/30/23 and outpaced the Russell 2000 for each of these periods, except the 3-year span.

What Worked… And What Didn’t

Nine of the portfolio’s 10 equity sectors made a positive impact on 2023’s first half performance, led by Industrials, Information Technology, and Health Care. Financials made the only negative impact, while the smallest contributions came from Real Estate and Energy. At the industry level, health care equipment & supplies (Health Care), machinery (Industrials), and commercial services & supplies (Industrials) contributed most while banks (Financials), biotechnology (Health Care), and communications equipment (Information Technology) were the largest detractors.

The Fund’s top contributing position was Aehr Test Systems, a semiconductor capital equipment company that focuses on emerging and fast-growing compound semiconductor materials. Aehr’s current product addresses a rapidly growing market for silicon carbide, which is used in higher end, mission critical applications in electric vehicles, clean energy, and power semiconductors. The company is also involved in other emerging end markets for gallium nitride semiconductors and silicon photonics solutions aimed at 5-G communications and data centers. Several large, key customers wins so far in 2023 have proved the importance of its system and drove rapid revenue growth. ACV Auctions, the technology leader in digital/online wholesale used car auctions, has invested heavily over the last few years to gain a nearly national presence in the U.S., as the industry shifts from physical/live auctions to online. ACV is gaining share, though the entire industry was hit in 2022 with soaring used car prices and low transaction volumes due to the lack of new cars available (which drives trade-ins that a dealer would then need to auction). Despite this, ACV has demonstrated it can take market share and outperform its industry. We have also seen signs of improved industry conditions in the past 3-4 months.

ViewRay, the Fund’s top detractor for 2023’s first half, markets a medical system that combines real-time MRI imaging and cancer radiation treatment, resulting in superior patient outcomes, fewer treatment sessions, and fewer side effects. Unfortunately, despite improved sales results in 2022, the sales cycles lengthened recently, stretching cash flow deficits further, which led to concerns over its financial viability. ViewRay has announced it is exploring alternatives that will likely result in the business being sold. Halozyme Therapeutics has a biotechnology licensing platform that enables large pharmaceutical companies to convert IV therapeutics to subcutaneous injections via its ENHANZE technology. Following success with its lead product, revenues have fallen below expectations in 2023, as investors await new product approvals and launches. Concerns have also emerged regarding generic competition and approaching formulation technology patent expiration, which has led to valuation compression. We finished exiting our position in May.

The Fund’s advantage relative to its primary benchmark came mostly from sector allocation decisions. At the sector level, the Fund benefited most from stock selection in Industrials. Our lack of exposure to Energy and stock selection in Consumer Staples were also additive versus the Russell 2000 Growth. Conversely, stock picks detracted in Information Technology, Financials, and Health Care.

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

Aehr Test Systems1.91
ACV Auctions Cl. A1.55
Atlas Technical Consultants Cl. A1.48
TransMedics Group1.35
Distribution Solutions Group1.19

1 Includes dividends

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

Halozyme Therapeutics-0.95
Western Alliance Bancorp-0.58

2 Net of dividends

Current Positioning and Outlook

U.S. mega-cap tech stocks continued to lead the market into the second quarter, with the Nasdaq up 32.3% for the year-to-date period ended 6/30/23. The robust performance of Nvidia—the maker of powerful graphics processing unit chips that power data centers—spurred further market excitement over the potential (and pitfalls) of Artificial Intelligence applications and contributed to the recovery in tech stocks following an abysmal 2022. The Federal Reserve continued to promise additional interest rate increases despite pausing in June, suggesting continued concerns over inflation and a tight labor market. Further signs of a potential recession, regional bank jitters, and geopolitical worries, however, were not enough to prevent the broader market’s nearly 15% return in the first half of 2023. Anticipating the market’s moves over the next 12 months is particularly difficult, especially with further delays in peak interest rates and the impact on corporate earnings that a potential recession would bring. We are still of a mind that markets will rally ahead of a Fed pause or reversal of rate hikes and that we are due for a reversion to the mean after 2022’s negative returns, but it is not certain whether a recession will occur and/or what its depth and duration will be. We believe there are positives regarding federal, state, and local infrastructure spending as well as continued innovation, despite funding risk for early stage companies. At the end of June, the Fund remained overweight in Information Technology and Health Care while being underweight in Financials, Energy, and Real Estate.

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

Smaller-Companies Growth 5.3315.3322.287.104.768.006.919.4510.11

Annual Operating Expenses: Gross 1.57 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, 2024.

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: Aehr Test Systems was 2.9%, ACV Auctions Cl. A was 2.8%, Atlas Technical Consultants Cl. A was 0.0%, TransMedics Group was 3.4%, Distribution Solutions Group was 3.9%, ViewRay was 0.2%, Halozyme Therapeutics was 0.0%, Clearfield was 0.0%, Western Alliance Bancorp was 0.0%, Impinj was 2.5%.

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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