Fund Performance

Royce Smaller-Companies Growth Fund gained 6.1% for the year-to-date period ended 6/30/24, beating its primary benchmark, the Russell 2000 Growth Index, which was up 4.4%, and the Russell 2000 Index, which gained 3.3% for the same period.

What Worked... and What Didn’t

Six of the portfolio’s 10 equity sectors made a positive impact on performance in the first half of 2024. The sectors making the biggest positive contributions were Information Technology, Industrials, and Consumer Staples while Financials, Materials, and Health Care had the largest negative effects. At the industry level, technology hardware, storage & peripherals (Information Technology), trading companies & distributors (Industrials), and semiconductors & semiconductor equipment (Information Technology) contributed most, while health care equipment & supplies (Health Care), banks (Financials), and professional services (Industrials) were the largest detractors for the year-to-date period.

At the position level, the top contributor was FTAI Aviation, an aircraft engine lessor that also offers a cost-effective engine maintenance, repair, and exchange program that is eagerly sought by smaller airlines. Its business has benefited from new aircraft delivery delays, as well as Boeing’s overall safety problems. As operators have sought to refurbish and operate aircraft and engines longer, the shift has benefited FTAI. In addition, the market value of its leased engine portfolio continues to rise. It was the Fund’s second largest position at the end of June, reflecting our confidence in FTAI’s long-term prospects. Few stocks of any capitalization size have seen more growth from Artificial Intelligence (“AI”) datacenter spending than Super Micro Computer, which manufactures the chassis, subassemblies, and components for data center servers, as well as the box and systems that house graphics processing units, including Nvidia’s high demand chips. We sold the position based on our concerns about Super Micro Computer’s declining gross margins and price reductions, which suggest that competition is on the horizon, as well as the fact that data center spending will normalize again.

Impinj manufactures radio-frequency identification chips that are used for location and authentication, which go into readers and a variety of retail items and which help companies manage, track, and secure their inventories. Starting in the apparel industry, Impinj has won customers in the larger categories of general merchandise and package logistics, thereby extending its growth runway. Its share rebounded following excess channel inventory overhang and slower retail apparel spending just as many companies have been affected by similar supply chain issues. Given its valuation expansion in recent months, we trimmed our position but still like its longer-term prospects. VSE Corporation, which distributes aerospace parts and components, has experienced a dramatic business transformation under its current management and is a rare example of a business that’s been able to simultaneously divest slower growth/lower margin businesses while accelerating the revenue and margin growth of its core business. VSE was the Fund’s largest position at the end of June. TransMedics develops and markets organ transplant systems and services that are displacing antiquated and less efficient modes of transportation, which also have lower organ transplant success rates. It does this with medical technology that provides circulatory support for the organs during transport. Management is on track to double the volume of transplants in the U.S., in part by extending organ transplant windows. Its shares were weak in 2023, when the company invested in a private jet fleet, but so far the bet has paid off by providing a turnkey solution to transplant surgery centers.

CVRx develops and manufactures implantable neuromodulation devices that treat heart failure. This small company experienced the unexpected retirement of its CEO, an unsuccessful sales and marketing strategy (which they have since corrected) that led to a slow down in system sales early in 2024. With a view that it may take the new CEO, who came from Medtronic, several quarters to reinvigorate its direct selling effort, we sold the position but still believe in the technology, which improves the quality of life and reduces the number of serious cardiac events. Sprout Social is one of the larger software as a service (“SaaS”) platforms that help companies manage the social media element of brand marketing and increases in digital media spend. After a year or more of predicting a return to +30% revenue growth, Sprout reported a weak 1Q24, announced a CEO change, and lowered growth expectations to +20% organic revenue growth. Like many “nice to have” SaaS software vendors, Sprout bore the brunt of weakening corporate spending patterns. When new management indicated they would be reporting fewer business metrics on a quarterly basis, we decided to exit the position until management has rebuilt investor confidence.

SiBone is an innovative medical device manufacturer targeting lower spine/pelvic (Sacro-iliac) repair and deformities, which represent about 20% of spinal surgeries. After an acceleration in its business post-COVID lockdowns and solid share price performance, SiBone (like Alphatec below) was among a number of medical device companies that underperformed, in part due to concerns over the impact of “wonder-drug” Glucagon-like peptide-1 (“GLP-1”) pharmaceutical product launches and how certain of them may reduce or delay the number of spine surgeries. For the most part, its business has remained solid, albeit at a slightly slower normalized pace of growth. Another factor driving underperformance may be that, while SiBone has high gross margins, its net margins are negative as it has decided to spend in order to grow top line and gain market share. And while there has been a shift away from these types of companies in the current ‘higher for longer’ interest rate environment, we continue to have confidence in management and hold a position.

Alphatec’s innovative medical devices target spinal implants, and the company also offers related systems and software. Current management has executed a dramatic turnaround, stepping up both R&D and sales and marketing while broadening its product offerings, all of which have reaccelerated growth. Following robust business and solid share price performance in the early post-COVID period, Alphatec underperformed, in part due to concerns over the impact of GLP-1 product launches and how they may reduce or delay the number of spine surgery procedures, though its business has been solid. Also like SiBone, Alphatec has been unprofitable, but has prioritized attaining profitability or break even in recent quarters. We held our stake based in large part on our faith in current management. DoubleVerify is a dominant SaaS software provider of third party digital advertising verification for corporate advertisers, helping businesses insure the suitability of various digital channels and prevent fraudulent impressions results. While an important service—similar to an A.C. Nielsen in the digital, social media, cable, streaming, and mobile realms—the company experienced decelerating growth beginning in late 2023 and worsening in 1Q24. Seeing it as another instance of constrained enterprise spending, we took our lumps and sold the position.

The portfolio’s advantage over the Russell 2000 Growth in the first half of 2024 was attributable to both stock selection and sector allocation decisions, with the former having the larger positive impact. At the sector level, stock selection in Industrials and Consumer Discretionary, as well as a higher weight in Information Technology, made the most significant positive impact versus the benchmark. Conversely, stock selection in Financials, Health Care, and Materials detracted most from relative results.

Current Positioning and Outlook

As the timing of anticipated Federal Reserve rate cuts this year is pushed further towards year end, the market has favored the safety of large-cap equities, as well as the fear of missing out around large-cap technology names, though July saw some encouraging shifts in favor of small-cap. In any event, a see-saw dynamic has gripped the markets around pockets of continued inflation and fiscal spending programs versus early signs of economic deceleration and reduced consumer spending. The Fund continues to target multi-year themes during this period of uncertainty—including aerospace supply constraints, AI spending beneficiaries, SaaS security companies, infrastructure spending beneficiaries, and pharma/biotech spending recovery—while trimming some of the portfolio’s more richly valued companies. As we head into a softer economic and corporate spending environment, we continue to believe that, once we begin to see rate cut momentum, small-cap growth stocks should experience a period of outperformance after five years of lagging the larger-cap indexes.

Average Annual Total Returns Through 06/30/24 (%)

Annual Operating Expenses: Gross 1.55 Net 1.49

¹ Not annualized.

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