Royce Opportunity Fund Manager Commentary
article 02-12-2018

Royce Opportunity Fund Manager Commentary

A second stellar year of absolute and relative performance helped the Fund extend its relative advantages over the Russell 2000.


Fund Performance

A second consecutive year of stellar absolute and relative performance helped Royce Opportunity Fund to extend its relative advantages over its small-cap benchmark, the Russell 2000 Index, for the one-, three-, five-, 10-, 15-, 20-year, and since inception (11/19/96) periods ended December 31, 2017. The Fund gained 21.9% in 2017, well ahead of the Russell 2000, which was up 14.6% for the same period.

Although 2017 was not as favorable for many cyclicals and value stocks as 2016 was, breadth was solid, with cyclical sectors such as Industrials, Information Technology, and Materials doing well even as they trailed Health Care, the strongest performer in the small-cap index largely due to lofty returns from resurgent biotechnology companies.

What Worked… and What Didn’t

Information Technology and Industrials made by far the biggest positive impact on the Fund’s calendar-year performance, part of a group of seven equity sectors that finished the year in the black. Along with Materials, these two were also the strongest sectors versus the Russell 2000.

Those portfolio sectors that detracted on an absolute basis—Telecommunication Services, Consumer Staples, Energy, and Real Estate—made only a slight negative impact. The portfolio’s significant underweight in Health Care was the biggest relative detractor in 2017, due to our lack of exposure to biotechnology.

The Fund’s cash position also hurt relative results, as did modest stock-picking disadvantages in Telecommunication Services and Consumer Staples.

At the industry level, semiconductors & semiconductor equipment (Information Technology), machinery (Industrials), and electronic equipment, instruments & components (Information Technology) led while detractors were comparably modest, led by energy equipment & services (Energy), IT services (Information Technology), and multiline retail (Consumer Discretionary).

The global technology buildout that has been driving widespread innovation and development rolled on through the second half of the year. This led us to sell or trim several technology holdings, many clustered in the previously mentioned semiconductors & semiconductor equipment and electronic equipment, instruments & components groups.

While we think demand is likely to remain robust, many holdings reached or exceeded our sell targets in 2017. We continue to watch these companies carefully, with especially close attention to product and valuation cycles.

Top contributor KEMET Corporation, a solid tantalum and multilayer ceramic capacitor manufacturer in the electronic equipment, instruments & components groups, is a great example of both the strength and consistency of this run for certain small-cap tech companies. In addition to its disproportionately strong performance in 2017, KEMET was one of the portfolio’s top contributor in 2016’s fourth quarter. We reduced our stake slowly and steadily into the fall.

The list of the Fund’s top-five contributors also included three companies in the semiconductors & semiconductor equipment industry, one of which—IXYS Corporation—was a takeover target (as was TRC Companies, an engineering, environmental consulting, and construction management firm in the Industrials sector). Both Brooks Automation, which offers automation-oriented software and hardware for semiconductors, and capital equipment subsystem provider Ultra Clean Holdings benefited from the ongoing high demand for semiconductor equipment.

Of the five positions that detracted most from results, each was a “turnaround in waiting” in which we built our stake in 2017. IT consultant Unisys Corporation had underwhelming results that discouraged investors, though we think its large book of business, much of it government related, can allow it to ultimately address its weaknesses.

We also believe the new management team at Wesco Aircraft Holdings is well positioned to address the firm’s operational issues and eventually improve results. Telecommunications services provider Windstream Holdings has consolidated operations to improve efficiency, but investors disconnected when expectations for increased sales were not met.

Top Contributors to Performance 20171 (%)

KEMET Corporation1.34
IXYS Corporation0.76
Brooks Automation0.74
Ultra Clean Holdings0.71
TRC Companies0.67

1 Includes dividends

Top Detractors from Performance 20172 (%)

Unisys Corporation-0.54
Wesco Aircraft Holdings-0.49
Windstream Holdings-0.48
J.C. Penney Company-0.33

2 Net of dividends

Current Positioning and Outlook

With the global economy accelerating and U.S. GDP rising, it’s possible that positive developments can keep lifting the market in the months ahead. However, there are also risks of inflation and rapidly rising deficits in addition to high equity valuations, rising rates, and a Fed that has already begun to taper. This last development could have the largest impact on stocks, as contracting liquidity crimps the funds available for investment. We are therefore measured in our optimism.

While reducing our exposure to technology stocks, we put proceeds to work via investments in industrial and commodity-based businesses in the expectation that global growth will continue to stoke demand. With the recovery of energy prices, nearly all industrial end markets were doing well by year-end. In addition, we hold many companies in cyclical areas where turnarounds were just getting underway or did not occur in 2017, which enhances our cautious optimism for select small-cap stocks.

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

Opportunity 3.5121.8821.8811.0114.339.3912.7912.1212.71 11/19/96

Annual Operating Expenses: 1.18

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. 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 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: KEMET Corporation was 0.7%, IXYS Corporation was 0.0%, Brooks Automation was 0.1%, Ultra Clean Holdings was 0.1%, TRC Companies was 0.0%, Unisys Corporation was 0.5%, Wesco Aircraft Holdings was 0.5%, Windstream Holdings was 0.2%, J.C. Penney Company was 0.2%, Team was 0.4%.

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 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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