Royce Smaller-Companies Growth Fund Manager Commentary
article 02-12-2018

Royce Smaller-Companies Growth Fund Manager Commentary

Driven by savvy stock selection, the Fund handily beat its benchmark, the Russell 2000 Index. 


Fund Performance

Savvy stock selection and leadership for growth stocks contributed to a strong absolute and relative showing for the ‘GARP’ (“growth-at-a-reasonable price”) strategy we use in Royce Smaller-Companies Growth Fund. The Fund advanced 17.8% in 2017, ahead of the 14.6% gain for its small-cap benchmark, the Russell 2000 Index, for the same period.

The year offered an interesting mix of varying measures of strength through every small-cap sector except Energy. The highest returns by far came from Health Care, boosted by biotechnology stocks.

What Worked… and What Didn’t

The Fund’s strongest sector in 2017, however, was Information Technology—by a factor of more than two. It joined seven more of the Fund’s 10 equity sectors to finish the year in the black.

Other notable positive contributions came from Health Care, Materials, and Industrials. Of the sectors that detracted, Energy had the greatest negative impact, with only a minor net loss coming from Consumer Staples.

Three groups from the large and diverse Information Technology sector topped the list of contributors at the industry level—electronic equipment, instruments & components, software, and Internet software & services. The sector was also home to the portfolio’s biggest detractor among its industry groups, semiconductors & semiconductor equipment.

Other groups making a negative impact included energy equipment & services (Energy) and specialty retail (Consumer Discretionary).

Relative to the Russell 2000 in 2017, the Fund’s biggest advantage came unsurprisingly from Information Technology. An enormous stock selection edge, most impactfully in the aforementioned electronic equipment, instruments & components group, drove outperformance. Superior stock picking also keyed relative performance in Materials while a combination of effective stock picking and lower exposure to Real Estate provided an additional edge.

Conversely, relative results were hampered by ineffective stock selection in Health Care, especially in biotechnology. Poor stock picking also made a negative impact in the specialty retail and hotels, restaurants & leisure industries within Consumer Discretionary. In addition, our cash position detracted from 
relative performance.

Portfolio holdings involved in technology were helped by the global buildout that’s driving spending and innovation in diverse areas such as process automation, robotics, lasers, and cloud storage. Universal Display, the portfolio’s top-contributing position in 2017, was a beneficiary of these developments. The company and its partners in the United States Display Consortium develop high-resolution, full color, lightweight Organic Light Emitting Diode (OLED) technology, and the growing global demand for this technology drew investors to its shares.

IPG Photonics, which produces high-power fiber lasers and amplifiers, also benefited from robust, expanding demand for its wares. Also helping was the company’s proven ability to rapidly scale production and reduce costs in a way that stymied competition.

We also like the core businesses of two companies with high-demand technology niches that help small businesses. Square offers mobile payment solutions while Shopify provides a cloud-based, omni-channel e-commerce platform. Rising share prices led us to reduce our stake in each of these four companies.

The biggest detractor at the position level was IT consultant Unisys Corporation, which we think has terrific potential. A new CEO came on board two years ago with a proven track record as a turnaround specialist. He continues to work toward better integrating a slate of global businesses in order to boost results.

CyberOptics Corporation makes optical process control sensors and inspection systems used in the manufacture of printed circuit boards and semiconductor wafer transport. The company’s often lumpy earnings pattern led to consecutive quarters of disappointing results that discouraged investors. We think it can benefit from the growing need for process automation, especially with its more recent entry into the wafer transport business.

We sold our shares of western and work gear retailer Boot Barn Holdings, whose business was hurt by both the travails affecting many retailers and declining energy prices, which slowed its previously strong business in oil-rich states.

Top Contributors to Performance 20171 (%)

Universal Display1.78
IPG Photonics1.44
Square Cl. A1.30
Shopify Cl. A1.19

1 Includes dividends

Top Detractors from Performance 20172 (%)

Unisys Corporation-1.02
CyberOptics Corporation-1.01
Boot Barn Holdings-0.66
Unit Corporation-0.46
Financial Engines-0.35

2 Net of dividends

Current Positioning and Outlook

One of the potential benefits of using a GARP approach is the flexibility it provides to tilt the portfolio more toward high growth or more valuation-based factors. As 2017 was drawing to a close, we began to gradually lean more toward price-sensitive attributes as we saw stretched valuations for many high multiple names, mostly in tech and healthcare, as well as a potentially rewarding combination of earnings or other growth drivers with more reasonable stock prices.

Early in 2018, we began investigating these kinds of opportunities in a diverse number of cyclical areas including energy, other natural resources, financials, retailers, restaurants, transportation, and homebuilding as the quickening pace of global economic growth looks likely to reward more cyclical industries in the months ahead.

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

Smaller-Companies Growth 1.4917.8017.808.1511.746.0712.4311.44 06/14/01
Russell 2000 3.3414.6514.659.9614.128.7111.178.52 N/A

Annual Operating Expenses: Gross 1.51 Net 1.49

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.

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: Universal Display was 0.8%, IPG Photonics was 0.7%, Square Cl. A was 0.3%, Shopify Cl. A was 0.7%, Orocobre was 1.3%, Unisys Corporation was 0.8%, CyberOptics Corporation was 0.7%, Boot Barn Holdings was 0.0%, Unit Corporation was 0.0%, Financial Engines 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 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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