Royce Smaller-Companies Growth Fund Manager Commentary
article 06-30-2018

Royce Smaller-Companies Growth Fund Manager Commentary

The Fund benefited from a hospitable climate for its growth-at-a-reasonable price strategy, as small-cap growth stocks once again outperformed their value counterparts.


Fund Performance

As was the case in 2017, Royce Smaller-Companies Growth Fund benefited from a hospitable climate for its ‘GARP’ (growth-at-a-reasonable price) strategy in the first half of 2018, as small-cap growth stocks once again outperformed their value counterparts. The Fund advanced 10.4% for the year-to-date period ended June 30, 2018, ahead of its benchmark, the Russell 2000 Index, which was up 7.7% for the same period. Improved market breadth in the second quarter helped the Fund to solidify its first-half advantage over the small-cap index, as six of its nine equity sectors exceeded quarterly returns for those sectors in the Russell 2000.

What Worked… And What Didn’t

Given the recent strength of growth stocks, the ongoing advantages for Information Technology and Health Care holdings in the portfolio came as no surprise. These two sectors dominated first-half results, with respectable gains also coming from Industrials and Consumer Discretionary. Materials and Telecommunication Services were the only two sectors that detracted, and only the first had a meaningful negative impact. Two groups led at the industry level by wide margins, paralleling sector results. Positive contributions in the Internet software & services group came from a number of holdings, including top-10 position LivePerson, which develops products and applications for online messaging, marketing, and analytics. Health care equipment & supplies was also home to several holdings that made notable contributions, including ABIOMED, which is quickly gaining market share with Impella, a minimally invasive heart pump that reroutes blood through a catheter then back into the patient’s heart. We took some gains as its shares climbed.

Elsewhere in Health Care, we had success with companies involved in gene therapy. REGENXBIO has 25 therapeutic programs in its pipeline that treat retinal, metabolic, and neurodegenerative diseases, with 12 of these at the clinical trial stage. As its stock rose well past our initial targets, we reduced our stake. uniQure is developing new disease modifying therapies for patients with serious genetic diseases and also offers ongoing clinical programs in hemophilia B and a pre-clinical proof-of-concept treatment for Huntington’s disease. We took some gains in the first half as its shares moved up. Both of these companies began as small portfolio positions given the higher-risk, higher-reward nature of biotech companies. We remain very interested in the potential of gene therapy and the prospects for the companies that specialize in it, even as many valuations for this group looked stretched to us at the end of June. Given the radical effect it is having on the drug discovery front, we believe gene therapy looks likely to remain a critical area of innovation and growth in the years ahead, and we will be investigating opportunities carefully. Outside of Health Care, and coming from the electrical equipment group in Industrials, Enphase Energy is an energy technology company and the world’s leading supplier of solar microinverters, a key solar panel component. The company’s shares rose on news of increasing sales volumes and management’s optimism about future margin growth.

As for holdings that disappointed, vTv Therapeutics saw a late stage treatment for Alzheimer’s disease stall, which led many investors, including us, to sell their shares. We felt more confident in the long-term prospects for top-20 holding Cobalt 27 Capital, a leading electric metals investment vehicle that gives investors access to those integral to the electric vehicle and battery energy storage markets. Based in Toronto, the company’s stock tends to track closely with cobalt commodity prices. We anticipate that as electric vehicles gain more popularity, its shares should see a benefit.

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Relative to the Russell 2000, the Fund drew performance advantages from superior stock selection, as well as our overweights, in three sectors—Information Technology, where the Internet software & services group again stood out, Industrials, thanks to strong results in several groups, and Health Care, where health care equipment & supplies did best versus the small-cap index. The only significant detractor was Materials, where our position in Cobalt 27 Capital did most to dampen relative results. Much more modest detractions came from our underweight in Energy and ineffective stock selection in Financials.

Top Contributors to Performance Year-to-Date Through 6/30/181 (%)

Enphase Energy0.78
Unisys Corporation0.65

1 Includes dividends

Top Detractors from Performance Year-to-Date Through 6/30/182 (%)

vTv Therapeutics Cl. A-0.61
Cobalt 27 Capital-0.58
Universal Display-0.48
Axsome Therapeutics-0.46
Orocobre 1-0.41

2 Net of dividends

Current Positioning and Outlook

We continue to see potential in discrete special situations where the potential for high growth looks promising and valuations still appear reasonable. Otherwise, valuations appear high to us through much of the small-cap market, particularly the fastest growing companies. So while the last few years of strong returns have been welcome, we are increasingly concerned that the small-cap market has not seen any significant readjustment of valuations since early 2016. That long an absence is historically atypical, which is causing us to proceed with caution. So far in 2018, we have reduced weightings in holdings where the valuations looked most vulnerable to correction and have sold or trimmed other positions that exceeded our price targets. However, we are guardedly optimistic about the strength of the U.S. economy and suspect that many fast-growing companies will remain well-positioned to keep accelerating along with improved GDP growth.

Average Annual Total Returns Through 06/30/18 (%)

Smaller-Companies Growth 9.9710.3816.878.6311.348.0011.0511.73 06/14/01

Annual Operating Expenses: 1.49

1 Not annualized.

Important Performance, Expense 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 June 30, 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 June 30, 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 6/30/18, the percentage of Fund assets was as follows: REGENXBIO was 0.8%, Enphase Energy was 1.2%, ABIOMED was 0.2%, uniQure was 1.0%, Unisys Corporation was 1.7%, vTv Therapeutics Cl. A was 0.0%, Cobalt 27 Capital was 1.0%, Universal Display was 1.0%, Axsome Therapeutics was 0.5%, Orocobre 1 was 0.0%, LivePerson was 1.5%

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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