Royce Capital Fund-Micro-Cap Portfolio Manager Commentary
article 02-13-2018

Royce Capital Fund–Micro-Cap Portfolio Manager Commentary

The strength of growth stocks in 2017 was a surprise that also created obstacles for the Fund’s valuation-sensitive approach.

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Fund Performance

In 2017, large-caps beat small-caps, small-cap growth beat value, and small-caps beat micro-caps. This created obstacles for our valuation-sensitive approach in Royce Capital Fund–Micro-Cap Portfolio. For the full year, the Fund gained 5.2%, trailing both its benchmark, the Russell Microcap Index, which rose 13.2%, and the Russell 2000 Index, which was up 14.6% for the same period. The strength of growth stocks was surprising in light of both the rebound for cyclical industries and value stocks in 2016 and the growing global economy, one in which we would typically expect these areas to lead.

What Worked… and What Didn’t

Seven of the portfolio’s 10 equity sectors made positive contributions to performance in 2017, with Industrials leading by a sizable measure, followed by Financials, Information Technology, and Health Care. Of the three sectors that detracted, only Consumer Discretionary had a meaningful negative effect—net losses for Energy and Consumer Staples were far lower. At the industry level, machinery (Industrials) and capital markets (Financials) led decisively while specialty retail (Consumer Discretionary) and electrical equipment (Industrials) headed the list of detractors.

Relative to the Russell Microcap, the Fund suffered most in 2017 from ineffective stock picks in two sectors. In Consumer Discretionary, the problem areas were leisure products, textiles, apparel & luxury goods, and specialty retail, while in Information Technology, the electronic equipment, instruments & components group fared worst versus the benchmark.

Our lower exposure to Health Care also hurt, mostly due to an underweight in high-flying biotechnology companies, ineffective stock selection in the sector was an additional factor. Helping relative results, on the other hand, was a balanced combination in Financials, where the Fund had lower exposure to lagging banks and a higher weighting in strong performers within capital markets, such as top-10 positions Canaccord Genuity Group and Silvercrest Asset Management Group. Savvy stock selection in Energy and Real Estate was also a positive in 2017.

Capital equipment subsystem provider Ultra Clean Holdings was the Fund’s top contributor at the position level in 2017. The company gained market share through most of the year with critical OEM customers in a generally strong environment for semiconductor capital equipment spending. We were pleased to see earnings growth drive much of the rise for its stock price.

Corium International manufactures transdermal patches across a wide range of applications from drug delivery to consumer products. After many years as a contract manufacturer, Corium has been developing generic drugs of its own over the past several years to leverage its delivery expertise.

Results in early clinical trials were promising, which helped to send its shares higher. Internet vertical marketing and media specialist QuinStreet benefited from its management’s efforts to expand its reach beyond for-profit education into other industry verticals, including insurance and mortgages. We continued to hold a position as we believe that the firm has just begun to improve its business model.

As for those positions that detracted from calendar-year results, we sold our position in value-priced department store operator Stein Mart, the Fund’s largest detractor at the position level, in the wake of ongoing earnings and operational disappointments. Cherokee has a global business marketing and licensing numerous lifestyle brand products. Recent results were hurt by integration issues stemming from a large, transformative acquisition. We trimmed our position pending better visibility into management’s efforts to work through and resolve these challenges.

We moved on from BioAmber, an industrial biotechnology company that specializes in renewable feedstocks, because of our concerns with start-up issues in a first-of-its-kind fermentation plant and the company’s tight capital structure. CUI Global offers a unique solution for measuring pipeline gas quality that’s quicker, cheaper, and more accurate than other existing technologies.

A longer-than-expected delivery schedule put pressure on its shares, outweighing a respectable number of orders and a solid sales pipeline. However, we believe its technology can ultimately be monetized successfully, which led to our decision to add shares.


Top Contributors to Performance 20171 (%)

Ultra Clean Holdings0.80
Corium International0.76
QuinStreet0.72
Novanta0.61
Rogers Corporation0.52

1 Includes dividends

Top Detractors from Performance 20172 (%)

Stein Mart-0.55
Cherokee-0.53
BioAmber-0.50
CUI Global-0.47
Neonode-0.42

2 Net of dividends

Current Positioning and Outlook

During the second half of the year we continued to build positions in financial companies, particularly in banks, where we believe that micro-cap names, given their domestic focus, can benefit from a more relaxed regulatory environment as well as lower corporate tax rates. Despite the repositioning, Financials remained among our largest sector underweights at the end of December.

We also maintained our lower exposure to Health Care, although we have been selectively adding to positions in later-stage medical device and biotech companies that we believe have created defensible competitive positions. Our largest weightings at the end of December remained Industrials and Information Technology, with the first of these also reflecting our largest overweight.

Average Annual Total Returns Through 12/31/17 (%)

QTR1 YTD1 1YR 3YR 5YR 10YR 15YR 20YR SINCE INCEPT. DATE
Capital Micro-Cap -1.305.185.183.305.163.558.469.419.95 12/27/96
Russell Microcap 1.8013.1713.178.9114.297.6810.34N/AN/A N/A

Annual Operating Expenses: Gross 1.47 Net 1.42

1 Not annualized.

Important Performance 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. Current month-end performance may be higher or lower than performance quoted and may be obtained at www.roycefunds.com. The Fund's total returns do not reflect any deduction for charges or expenses of the variable contracts investing in the Fund. 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, other expenses, and aquired fund fees and expenses. Acquired fund fees and expenses reflect the estimated amount of the fees and expenses incurred indirectly by the Fund through its investments in mutual funds, hedge funds, private equity funds, and other investment companies.

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 December 31, 2017, 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 December 31, 2017 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 12/31/17, the percentage of Fund assets was as follows: Ultra Clean Holdings was 0.7%, Corium International was 0.6%, QuinStreet was 0.7%, Novanta was 0.7%, Rogers Corporation was 0.8%, Stein Mart was 0.0%, Cherokee was 0.1%, BioAmber was 0.0%, CUI Global was 0.4%, Neonode was 0.2%.


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 Investment Group is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. Russell® is a trademark of Russell Investment Group. 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 1000 Index is an index of domestic large-cap stocks. It measures the performance of the 1,000 largest publicly traded U.S. companies in the Russell 3000 Index. 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 Midcap Index measures the performance of the mid-cap segment of the U.S. equity universe. It includes approximately 800 of the smallest securities in the Russell 1000 Index. The Russell Global ex-U.S. Small Cap Index is an index of global small-cap stocks, excluding the United States. The Russell Global ex-U.S. Large Cap Index is an index of global large-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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