Quarterly Small-Cap Equity Factor Review—Royce
article 01-31-2024

Quarterly Small-Cap Equity Factor Review—4Q23

QTD and YTD Factor Performance

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Growth Swings Ahead

In the fourth quarter of 2023, high growth took center stage as the top performing factor among those examined by Royce within the Russell 2000 as set forth below in the following chart, surging by an impressive 17.5%, while low leverage had a more modest increase, up 11.6%. Rate hikes were paused for the second and third time in the beginning of November and mid-December, leaving investors with the perception that the Fed may reverse course and lower rates next year. Consequently, Deep Value factors, which have historically tended to perform relatively better in a falling interest rate environment, exhibited strong performance from late October through December.

Small-Cap Factor Performance in 4Q23 and 2023
Average Annual Total Returns for QTD and 1-Year Periods for the Deep Value, Quality Value, and Dividend Value Factors Within the Russell 2000 Index

Subsequent Average Annualized Three-Year Return for the Russell 2000 Starting in Monthly Rolling VIX Return Ranges

Past performance is no guarantee of future results. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.

In 2023, banks’ investment portfolios were impacted by higher rates, raising concerns about the potential impact on credit conditions and prompting increased lending standards. The standout factor in the small-cap market was low leverage, which posted an impressive gain of 19.3%. Following slightly behind, high value, as measured by earnings yield, also showed robust performance, with an increase of 19.0%, while high profitability gained 17.7%. Each of these individual factor returns outpaced the overall returns for the Russell 2000 Index for the year. The overall U.S. equity market displayed unusually low breadth, with the top seven companies by market cap contributing more than half of the Russell 3000’s performance for the year (14.0% out of 26.0%). Unsurprisingly, a size factor, tracking the smallest quintile of companies by market-cap within the Russell 2000, gained only 3.3%. In the small-cap bear market that commenced on 11/8/21 through 12/31/23, typical safe-haven factors such as dividend payers and low volatility stocks outperformed the overall small-cap market. In contrast, lower market-cap companies in the Russell 2000 faced significant challenges, posting particularly poor performance during the bearish period.

Royce Small-Cap Deep Value Takes Lead from Dividend Value Among the Royce Multi-Factor Indexes

In the fourth quarter of 2023, a notable turnaround unfolded. The Russell 2000 surged by 14.0%, while Royce’s multi-factor-based indexes reflected even better gains: Quality Value was up 15.0%, and Dividend Value advanced 16.6%. Additionally, Deep Value outpaced the overall small-cap index with an impressive rise of 17.0%. The strength of the Deep Value Index in November and December allowed it to surpass the overall performance of the Dividend Value Index for the quarter.

Royce Multi-Factor Index Performance
Average Annual Total Returns for 4Q23, 2023 and Since the Russell 2000 Peak on 11/8/2021

Subsequent Average Annualized Three-Year Return for the Russell 2000 Starting in Monthly Rolling VIX Return Ranges

Past performance is no guarantee of future results. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.

In 2023, a Quality Value theme at the single factor level carried over into the multi-factor Royce indexes. The Russell 2000 rose 16.9%. Notably, the Royce indexes demonstrated even more robust returns, with the Quality Value Index up 21.7%, the Dividend Value Index up 25.1%, and the Deep Value Index leading with an impressive increase of 25.3%. The Deep Value Index managed to edge out the Dividend Value Index for the year due to its strong performance in the final two months of 2023.

From the Russell 2000 peak on 11/8/21 through the fourth quarter of 2023, the Royce Small-Cap Dividend Value Index demonstrated exceptional resilience, posting an increase of 13.2%. In contrast, the broader market, represented by the Russell 2000, declined -14.3% over the same period. We believe these results underscore the defensive characteristics that factors such as paying dividends often possess during challenging markets.

Outlook

In 2023, the market revealed a trend where the single factors of quality and value emerged as outperformers. However, the final two months of the year witnessed a remarkable surge in Deep Value factors, which posted impressive performance. Looking ahead, it's worth noting that historically Deep Value has tended to shine in more speculative market environments, often spurred by declining interest rates. We may have seen investors attempting to get ahead of the anticipated rate cuts in the form of strong performance in the Royce Small-Cap Deep Value Index in the final two months of 2023.

Important Disclosure Information

The thoughts concerning recent market movements and future prospects for small-company stocks are solely those of Royce Investment Partners, and, of course, there can be no assurances with respect to future small-cap market performance. Past performance is no guarantee of future results. Historical market trends are not necessarily indicative of future market movements. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.

1High Growth Small-Caps are the top quintile of securities within each Russell 2000 FactSet sector, sorted by each company’s asset growth over the past five years. High Momentum Small-Caps are the top quintile of securities within each Russell 2000 FactSet sector, sorted by each company’s total return over the past year, excluding the most recent month. Small Size Small-Caps are the bottom quintile of securities within each Russell 2000 FactSet sector, sorted by each company’s market-cap. High Value Book-to-Price Small-Caps are the top quintile of securities within each Russell 2000 FactSet sector, sorted by the inverse of each company’s P/B (share price divided by book value per share).

2High Value Earnings Yield Small-Caps are the top quintile of securities within each Russell 2000 FactSet sector, sorted by the inverse of each company’s P/E, i.e. its earning yield (share price divided by trailing 12-month earnings per share). High Profitability Small-Caps are the top quintile of securities within each Russell 2000 FactSet sector, sorted by each company’s ROA (trailing 12-month net income divided by the two fiscal period average total assets).

3Dividend Payer Small-Caps are securities within the Russell 2000 that paid a dividend within the last 12-months. Low Volatility Small-Caps are the top quintile of securities within each Russell 2000 FactSet sector, sorted ascending by each company’s 90-Day Price Standard Deviation. Standard deviation is a statistical measure within which a company’s stock price has varied over time. The greater the standard deviation, the greater the volatility. Low Leverage Small-Caps are the top quintile of securities within each Russell 2000 FactSet sector, sorted ascending by each company’s Net Debt-to-LTM EBITDA (earnings before interest, taxes, depreciation and amortization).

All factors are equal weighted, rebalanced quarterly, and performance is calculated monthly.

The Royce Small-Cap Quality Value Index is a proprietary index composed of small-cap stocks trading in the United States with relatively low valuations, high profitability and high debt coverage compared with the average of stocks in the investment universe. The Royce Small-Cap Deep Value Index is a proprietary index composed of small-cap stocks trading in the United States with relatively low valuations and high debt coverage compared with the average of stocks in the investment universe. The Royce Small-Cap Dividend Value Index is a proprietary index composed of small-cap dividend paying stocks trading in the United States with relatively low valuations, high profitability and high debt coverage compared with the average of stocks in the investment universe. Royce has retained Solactive AG, an unaffiliated third party, to calculate the Underlying Indexes. Solactive AG publishes information regarding the market value of the Underlying Indexes. The full Index rulebooks are available upon request. Past performance is no guarantee of future results. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.

Frank 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. All indexes referenced are unmanaged and capitalization weighted. The Russell 2000 Index is an index of domestic small-cap stocks that measures the performance of the 2,000 smallest publicly traded U.S. companies in the Russell 3000 Index.

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