Royce Smaller-Companies Growth Fund Manager Commentary
article 02-14-2019

Royce Smaller-Companies Growth Fund Manager Commentary

The Fund outperformed its benchmark, the Russell 2000 Index, showcasing how our GARP (“Growth at a Reasonable Price”) strategy can hold its value effectively even during a challenging year for small-cap stocks.


Fund Performance

Royce Smaller-Companies Growth Fund was down 10.2% in 2018, losing less than the Russell 2000 Index, its small-cap benchmark, which declined 11.0% for the same period. We were pleased that the Fund’s GARP (“Growth at a Reasonable Price”) strategy held its value more effectively in what was a very challenging year for small-cap stocks, especially during the downturn that persisted throughout the fourth quarter and was particularly tough in December, when both the Fund (-10.5%) and its benchmark (-11.9%) saw their steepest losses for the year.

What Worked… And What Didn’t

Eight of the Fund’s 10 equity sectors detracted from performance in 2018. Materials made the biggest negative impact, hurt most by holdings in the metals & mining group, followed by sizable net losses for Industrials and Financials. Information Technology and Consumer Staples were the only sectors that made positive contributions. Information Technology saw an interesting contrast between industries with significant detractions—the electronic equipment, instruments and components and semiconductors & semiconductor equipment groups—and those that made large positive contributions—software and IT services. This was a testament to the breadth and diversity of the sector, which features both cyclical and secular businesses as well as asset-heavy and asset-light companies.

The lion’s share of the net losses in metals & mining came from two positions that produce metals integral to the battery energy storage markets, especially electric vehicles. Adoption of these vehicles was slower than many had been anticipating in 2018, which was a factor in both stocks’ performance. Cobalt 27 Capital is a Toronto-based investment vehicle that gives investors access to cobalt and nickel production. Its stock often tracks closely with cobalt commodity prices, which fell in 2018 as short- and intermediate-term supply outstripped demand, and production in certain of Cobalt 27’s key mines was delayed. We began to reduce our position in June, though our long-term outlook for its business remains constructive given the necessity of nickel and cobalt to electric vehicle batteries as well as our bullish outlook on that industry. With operations in Argentina, Australia’s Orocobre is one of the world’s largest and lowest-cost lithium producers. Its stock first began to tumble on news of short-term production issues, which was compounded by news of potentially increased lithium production in Chile. The company then announced in December that it received lower prices for its lithium output than it had earlier in the year—and that it expected little price improvement in the short run. Again focused on the long run, we were encouraged by its strategic partnerships, which include an arrangement with Toyota, and strong market position.

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USA Technologies makes e-Port, a credit card payment system used at vending machines, convenience stores, gas pumps, etc. Its stock began to slide in September when the company reported a delay in its annual report filing for fiscal 2018. An internal investigation and audit led the firm to implement new measures to strengthen its governance and improve oversight. Believing from the outset that the firm would be able to right itself in relatively short order, we added shares. We built an even bigger stake in Iteris as its stock price was slipping. A leader in applied informatics for transportation and agriculture, Iteris makes sensors and systems to optimize traffic flows and enhance agricultural yields, among other applications. The company endured the loss of a large customer and faced headwinds from another, but we see its partnership with Cisco and growing demand in its smart transportation and digital agriculture markets as potential growth drivers going forward.

Turning to positive contributors, we enjoyed the most success with Materialise, a Belgian software business that specializes in 3D printing with applications used in industrial production and medicine. Its shares rose in December, perhaps in part due to better-than-expected earnings announced late in October—the firm made no major news in December. We like its growing business in what looks to us like a highly correlated long-run growth trajectory for 3D printing.

Relative to the Russell 2000 in 2018, the Fund benefited from sector allocation—stock selection in aggregate was slightly negative for the year. The most pronounced edge came from our overweight in Information Technology’s software group, while both our underweight and stock picking helped in Energy. Conversely, ineffective stock picking hurt in Materials and, to a lesser extent, in Financials.

Top Contributors to Performance 20181 (%)

Materialise ADR1.07
Apyx Medical0.63
Enphase Energy0.55
RingCentral Cl. A0.55

1 Includes dividends

Top Detractors from Performance 20182 (%)

Cobalt 27 Capital-0.92
USA Technologies-0.76
Restoration Robotics-0.69

2 Net of dividends

Current Positioning and Outlook

Few events inspire a bullish outlook more than a significant decline for the Russell 2000, and in 2018, the correction generated a number of long-term buying opportunities. So while the risks are real, including weakness in China and Europe, we see the greater impact coming from a still growing U.S. economy and the likelihood of a global trade deal some time in 2019. In this admittedly uncertain environment, we are emphasizing companies that look capable of ongoing earnings growth or, in more select cases, what we see as the potential for strong recovery. Although it remained by far the portfolio’s largest sector at year-end, we reduced our exposure to Information Technology somewhat and increased our weight in Industrials in 2018.

Average Annual Total Returns Through 12/31/18 (%)

Smaller-Companies Growth -22.79-10.22-10.224.973.3610.637.3410.07 06/14/01

Annual Operating Expenses: Gross 1.52 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, 12b-1 distribution and service 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, 2018, 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, 2018 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 12/31/18, the percentage of Fund assets was as follows: Materialise ADR was 3.1%, Apyx Medical was 1.8%, ABIOMED was 0.0%, Enphase Energy was 0.0%, RingCentral Cl. A was 1.0%, Cobalt 27 Capital was 0.2%, USA Technologies was 1.1%, Iteris was 2.1%, Restoration Robotics was 0.1%, Orocobre was 0.6%

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 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. 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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