Royce Special Equity Fund Manager Commentary
article 06-30-2020

Royce Special Equity Fund Manager Commentary

We were pleased the Fund outperformed both its indexes in 2020’s first half and maintained its longer-term relative advantages against the Russell 2000 Value Index for the year-to-date, one-, three-, five-, 10-, 15-, 20-year, and since inception (5/1/98) periods ended 6/30/20.


Fund Performance

We were pleased that Royce Special Equity Fund maintained its longer-term relative advantages as it outpaced its primary benchmark, the Russell 2000 Value Index, for the year-to-date, one-, three-, five-, 10-, 15-, 20-year, and since inception (5/1/98) periods ended 6/30/20. The Fund was down 10.0% in the first half of 2020, losing far less than the small-cap value index, which fell 23.5% and also outperforming the Russell 2000 Index, which declined 13.0% for the same period.

The Fund’s first-half results were in line with our expectations for any period of high volatility and market extremes, particularly one that saw most stocks finish the semiannual period in the red. During the steep and sudden first-quarter downturn, the Fund was down 24.6%. It held its value better than both the Russell 2000 Value, which slid 35.7%, and the Russell 2000, which lost 30.6%. (The Fund’s first-quarter resilience was even more notable given how historically rare it is for the small-cap value index to underperform in a bearish period.) When stocks stormed back in the second quarter, the Fund was up 19.4%, again outpacing the Russell 2000 Value (+18.9%) while trailing the small-cap index (+25.4%).

What Worked… And What Didn't

For the year-to-date period ended 6/30/20, five of the Fund’s eight equity sectors detracted from performance, with Communication Services, Materials, and Consumer Discretionary detracting most. The positive contributions from Information Technology, Financials, and Consumer Staples were far more modest. The media group (Communication Services) detracted most at the industry level due to disappointing results from two holdings: Media conglomerate Meredith Corporation, which had the biggest negative effect on first-half results on the position level, and children’s publishing, education, and media company Scholastic Corporation. Paper & forest products (Materials) followed as the second-largest detractor at the industry level, led by Verso Corporation, which produces coated freesheet, coated ground wood, and uncoated super calendered papers and pulp, and Mercer International, which makes bleached softwood kraft pulp for use in tissues, hygiene products, and high end printing and writing paper. Standard Motor Products, which manufactures replacement automotive items, detracted most in Consumer Discretionary’s auto components industry, the portfolio’s third-biggest detractor at that level. Rounding out the top five detractors at the position level were Marcus & Millichap, a national brokerage firm that specializes in commercial real estate investment sales and financing, and apparel retailer Children’s Place.

The three industries that made the biggest positive impact on performance in 2020’s first half were leisure products, automobiles, and IT services. The first two are part the Consumer Discretionary sector while the third is in Information Technology. Recreational product manufacturer Johnson Outdoors made the largest positive impact at the position level in the first half, followed at second by RV maker Winnebago Industries and third by Computer Services, which provides banking, payment processing, and related services. Diversified manufacturing company National Presto Industries and manufactured and modular home builder Skyline Champion also made notable positive impacts during the first half of 2020.

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First-half relative outperformance was driven primarily by sector allocation, though stock selection also contributed. The Fund’s substantially lower weighting in Financials, at less than 2% of the portfolio’s total assets, created a sizable advantage over the Russell 2000 Value. A combination of savvy stock selection and a portfolio overweight resulted in a relative advantage in Industrials while the Fund’s cash position also had a measurable positive impact on first-half relative performance. By contrast, the Fund was hurt by its lack of exposure to Health Care, the least bad sector performer in the small-cap value index in the first half. Ineffective stock picking and greater sector exposure combined to give the Fund a relative disadvantage in Communication Services while poor stock selection in Materials also detracted from performance versus the benchmark.

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

Johnson Outdoors Cl. A1.08
Winnebago Industries0.91
Computer Services0.84
National Presto Industries0.41
Skyline Champion0.39

1 Includes dividends

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

Meredith Corporation-3.56
Standard Motor Products-1.21
Marcus & Millichap-1.16
Children's Place-1.05
Scholastic Corporation-1.03

2 Net of dividends

Current Positioning and Outlook

The longer-term outlook remains uncertain. Month-over-month improvements will show advances off their recent severely depressed levels, but the sugar high could end once investors see how difficult it will be to return to pre-coronavirus levels. Valuation would seem not to be an issue currently, with the Fed playing an active role not only in risk-free asset pricing but also in pricing risky assets. There will come a time, likely with no warning, that the Fed’s prop will no longer support lofty valuations, which only bolsters our feeling of being justifiably comforted by our perennial practice of investing in absolute, rather than relative, value. Indeed, valuation is critical in the long run, and I have always held that rate of return is a function of entry level. Moreover, value investing might be particularly double blessed in the currently unsettled climate. If deaths do not accelerate, and physical distancing helps contain the spikes in cases and hospitalizations, a rebound for value seems likely. If not, the surge in new cases increases the odds of ongoing easier monetary policy and a new, larger fiscal package, which would also favor value.

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

Special Equity 19.38-10.01-3.09-0.362.807.836.519.447.91 05/01/98

Annual Operating Expenses: 1.23

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 Operating expenses reflect the Fund's total annual operating expenses for the Investment Class as of the Fund's most current prospectus and include management fees and other expenses.

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: Johnson Outdoors Cl. A was 3.8%, Winnebago Industries was 2.2%, Computer Services was 7.0%, National Presto Industries was 3.7%, Skyline Champion was 0.4%, Meredith Corporation was 2.5%, Standard Motor Products was 4.3%, Marcus & Millichap was 3.9%, Children's Place was 1.2%, Scholastic Corporation was 3.7%, Verso Corporation was 2.2%, Mercer International was 1.4%

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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