Royce Smaller-Companies Growth Fund Manager Commentary
article 06-30-2022

Royce Smaller-Companies Growth Fund Manager Commentary

The disappointments of 2022’s first half notwithstanding, we are bullish as valuations for small-cap growth companies are significantly lower compared to their levels a year ago, which has allowed us to purchase several companies at attractively inexpensive prices.

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Fund Performance

Royce Smaller-Companies Growth Fund fell 36.2% for the year-to-date period ended 6/30/22, lagging its primary benchmark, the Russell 2000 Growth Index, which lost 29.5%, and the Russell 2000 Index, its secondary benchmark, which declined 23.4% for the same period. The portfolio outperformed the Russell 2000 Growth Index for the three-, 20-year, and since inception (6/14/01) periods ended 6/30/22.

What Worked… And What Didn’t

Consistent with the dismal first half of the year for growth stocks—the worst in the history of the Russell 2000 Growth—it was not surprising that all of the portfolio’s nine equity sectors detracted from year-to-date performance. The Fund’s three biggest sector weights—Information Technology, Health Care, and Industrials—detracted most while the smallest negative impact came from Real Estate, Consumer Staples, and Communication Services. Software, semiconductors & semiconductor equipment (both in Information Technology), and biotechnology (Health Care) detracted most at the industry level while beverages (Consumer Staples), trading companies & distributors (Industrials), and multiline retail (Consumer Discretionary) were the largest contributors.

Ambarella, which manufactures machine vision sensor and semiconductor modules, was the biggest detractor at the position level. The company struggled with supply-chain challenges—especially those related to China’s Covid-driven shutdowns—and production issues among its major auto manufacturer customers. While valuations have compressed for most semiconductor makers, we believe in Ambarella’s management and in its applications for the Internet of Things. Its new CV3 chip solutions, for example, sell at much higher prices than the current versions due to key improvements that provide the automotive industry’s highest AI processing performance. While growth in the first half and guidance for the second half of 2022 were tepid, management expects its computer vision products to improve fiscal 2023 revenues.

Freshpet, a pioneer and market share leader in the fresh/refrigerated dog and cat food market, also made a sizable detraction. The company has struggled to keep up with robust order volumes over the last few years while incurring higher costs for ingredients, shipping, and labor that resulted in problems meeting demand. While there were signs earlier in 2022 that production efficiencies were improving, the firm later announced a large—and dilutive—equity offering to fund future growth that caught investors by surprise and sent its shares downward immediately after 1Q22 results were reported. While management’s credibility has clearly suffered from the decision to build capacity ahead of supply growth, we believe the company has a long runway for growth—and could, in our view, end up in a global consumer brand’s portfolio at some point.

The Fund’s top contributor was TransMedics Group, which is building an end-to-end donor organ transportation business, starting with an innovative organ perfusion transport system that supplies blood to the organs while in transit. This is a more effective method than a simple ice cooler, providing healthier organs with a lower discard rate. TransMedics has won FDA approval for lung, heart, and liver transport and is investing in a national network of service providers for further adoption. We think the company may have reached a revenue growth inflection point in the first calendar quarter that we hope will continue for the foreseeable future. Celsius Holdings makes caffeinated and other energy beverages that have roots in the sports enthusiast, gym, and health food markets. Following a pullback in its valuation from late 2021 into early 2022, we reinitiated a position in 2022, having enjoyed a profitable experience with the stock in the past. Celsius has continued to expand into new retail areas, including Costco, while also beginning to gain access to the convenience store channel, which represents close to half the overall market for energy drinks. In addition, the company has continued to report impressively high organic revenue growth rates.

The portfolio’s disadvantage versus the Russell 2000 Growth (its primary benchmark) was attributable to stock selection for the year-to-date period, as our sector allocation decisions were modestly additive. Stock picks in Health Care and Information Technology detracted most, followed by our lack of exposure to Energy, which was the top-contributing sector in the small-cap growth index. Conversely, both stock selection and lower weightings in both Consumer Discretionary and Real Estate contributed to relative results during the first half, as did the portfolio’s cash holdings.


Top Contributors to Performance Year-to-Date Through 6/30/221 (%)

TransMedics Group0.57
Celsius Holdings0.38
Lantheus Holdings0.26
AeroVironment0.25
Distribution Solutions Group0.23

1 Includes dividends

Top Detractors from Performance Year-to-Date Through 6/30/222 (%)

Ambarella-2.00
Freshpet-1.41
InMode-1.36
Matterport Cl. A-1.29
Atlas Technical Consultants Cl. A-0.97

2 Net of dividends

Current Positioning and Outlook

The disappointments of 2022’s first half notwithstanding, we are very bullish. First, valuations for small-cap growth companies are significantly lower compared to their levels a year ago, which has allowed us to purchase several companies at what we believe were attractively inexpensive prices. More generally, small-cap market drawdowns of 30% or more have historically been followed by positive absolute returns. We also believe that the Fed has several options at its disposal to control inflation—and has the will to do so. Additionally, economic deceleration was already impacting commodity prices at the end of June. With investor pessimism running high—and assuming no further major Covid outbreaks or other exogenous factors—we anticipate that both sentiment and share prices will have improved a year from now.

Average Annual Total Returns Through 06/30/22 (%)

QTR1 YTD1 1YR 3YR 5YR 10YR 15YR 20YR SINCE INCEPT. DATE
Smaller-Companies Growth -23.44-36.21-42.181.583.828.004.309.149.57 06/14/01

Annual Operating Expenses: Gross 1.51 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 www.royceinvest.com. 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, 2023.

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, 2022, 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, 2022 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 6/30/22, the percentage of Fund assets was as follows: TransMedics Group was 2.3%, Celsius Holdings was 2.0%, Lantheus Holdings was 1.9%, AeroVironment was 1.1%, Distribution Solutions Group was 4.7%, Ambarella was 1.8%, Freshpet was 1.9%, InMode was 1.2%, Matterport Cl. A was 0.0%, Atlas Technical Consultants Cl. A was 1.1%, Costco 0.0%.


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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