Royce Small/Mid-Cap Premier Fund Manager Commentary
article 02-12-2018

Royce Small/Mid-Cap Premier Fund Manager Commentary

Beating both its small- and mid-cap benchmark, the Fund had a strong absolute and relative showing this year.

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Fund Performance

A strong absolute and relative showing in 2017 allowed Royce Small/Mid-Cap Premier Fund to gain relative advantages for the one-, three-, 20-year, and since inception (12/27/95) periods ended December 31, 2017. The Fund advanced 21.2% in 2017, beating both its small- and mid-cap benchmark, the Russell 2500 Index, which was up 16.8%, and the small-cap Russell 2000 Index, which rose 14.6%, for the same period.

(We shifted the Fund’s benchmark from the Russell 2000 to the Russell 2500 during 2017 to better reflect the portfolio’s small- and mid-cap selection universe, which Royce defines as those with market capitalizations up to $15 billion. The Fund’s investment approach, however, remained unchanged—we continue to seek companies that we consider “premier”—those that we believe have sustainable, moat-like franchises, discernible competitive advantages, a history of prudent capital allocation, and opportunities to profitably reinvest excess cash flow.)

Breadth was solid in cyclical sectors during 2017, with Industrials, Information Technology, and Materials all doing well. Health Care was the strongest performer in the Russell 2500 largely due to lofty returns from resurgent biotechnology companies.

What Worked… and What Didn’t

Nine of the portfolio’s 10 equity sectors made positive contributions to calendar-year performance. Industrials led by a significant margin while notable net gains also came from Information Technology, and Consumer Discretionary. Energy made a very modest detraction. Along with Telecommunication Services (where the portfolio had no exposure), Energy was the only sector in the Russell 2500 to finish 2017 in the red.

Relative to the Russell 2500, the portfolio drew its largest advantages from superior stock selection in the Industrials and Information Technology sectors. Our very low exposure to Energy, where we had no holdings at year-end, also proved advantageous. Conversely, our significant underweight in Health Care was a source of underperformance, as was the portfolio’s cash position.

Driven by the ongoing global technology buildout, the Fund’s top-contributing industry group was electronic equipment, instruments & components, home of its second-largest contributor, IPG Photonics. IPG is the dominant provider of fiber lasers, which continue to take share from traditional industrial lasers in cutting, marking, and welding.

Renewed demand in China fueled further growth in 2017 while Europe’s expanding economy bodes well for 2018. IPG also continually drove down costs while increasing the power of its core fiber lasers. Moreover, three smaller technology acquisitions in 2017 expanded its addressable markets. We reduced our position as its shares rose.

Westlake Chemical, the portfolio’s biggest holding at year-end, was its top contributor at the position level. The company produces basic chemicals, vinyls, polymers, and fabricated products for a range of consumer and industrial markets. North America’s largest polyethylene producer, Westlake also became the region’s most vertically integrated vinyls manufacturer in 2016 after acquiring Axiall. The company benefited from other synergies related to the acquisition, as well as from a much-improved vinyls cycle.

Also making a large positive contribution was Copart, the largest online salvage auction provider in the U.S. Strong sales growth in 2017 was driven by the expansion of sites, favorable price dynamics, share gains among the insurance carriers that are its target customers, and its expansion into Europe.

Led by insurance (Financials), only four industry groups had a negative impact on performance, each of them very minor, while two specialty retailers topped the portfolio’s list of detractors. The growing popularity of e-commerce is ushering in greater price transparency and algorithmic-based pricing strategies that are threatening profits across many industries resulting in an even more regular reexamination of our retail holdings.

We exited our position in Dicks Sporting Goods in July. The company, which has been cutting costs and streamlining operations, nonetheless continued to report disappointing earnings due to poor sales. Earlier in the year we opted to sell our position in Signet Jewelers, which operates Zales, Jared, and Kay Jewelers, due to our discomfort with the company’s reliance on in-house financing to spur sales and sluggish earnings.


Top Contributors to Performance 20171 (%)

Westlake Chemical2.23
IPG Photonics1.90
Copart1.53
NVR1.26
Thor Industries1.20

1 Includes dividends

Top Detractors from Performance 20172 (%)

Dicks Sporting Goods-0.69
Signet Jewelers-0.61
Standard Motor Products-0.30
Minerals Technologies-0.27
Alleghany Corporation-0.13

2 Net of dividends

Current Positioning and Outlook

We believe that high-ROIC small-cap companies can continue to outperform. Many of these companies are in cyclical areas, that we think have relatively more attractive valuations even after the strong run of the last two years.

So while we are cautious about the prospects for small- and mid-cap returns as a whole, we are also optimistic about our portfolio’s return potential as it leans towards three factors we believe will be well-rewarded going forward—high-quality business models that we think will be able to take advantage of cyclical strength or stress in the economy.

During 2017, we reduced our exposure to the technology area while we invested in what we deemed were high-quality cyclical companies in a number of industries that appeared well-positioned to benefit from accelerating global growth.

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

QTR1 YTD1 1YR 3YR 5YR 10YR 15YR 20YR SINCE INCEPT. DATE
Small/Mid-Cap Premier 8.1021.2121.2110.1110.707.8410.9811.5012.73 12/27/95
Russell 2000 3.3414.6514.659.9614.128.7111.177.898.92 N/A
Russell 2500 5.2416.8116.8110.0714.339.2211.759.1210.24 N/A

Annual Operating Expenses: 1.30

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 www.roycefunds.com. 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.

All performance and risk information presented in this material prior to the commencement date of Investment Class shares on 3/15/07 reflects Service Class results. Shares of the Fund's Service Class bear an annual distribution expense that is not borne by the Investment Class.

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: Westlake Chemical was 3.8%, Copart was 3.4%, Thor Industries was 3.2%, Alleghany Corporation was 2.8%, Minerals Technologies was 2.4%, NVR was 1.9%, IPG Photonics was 0.4%, Axiall Corporation was 0.0%, Dicks Sporting Goods was 0.0%, Signet Jewelers was 0.0%, Standard Motor Products was 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 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 Russell 2500 is an unmanaged, capitalization-weighted index of the 2,500 smallest publicly traded U.S. companies in the Russell 3000 index. 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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