How did Royce Small-Cap Total Return Fund in 1Q23 and over longer-term periods?
Chuck Royce (Trades, Portfolio): The Fund, which is part of Royce’s Quality Value Strategy, advance 2.3% in 1Q23, beating its small-cap benchmark, the Russell 2000 Value Index, for the same period. The Fund also outperformed both the Russell 2000 Value and the Russell 2000 Index for the 1-, 5-, 10-, 15-, 25-year, and since inception periods ended 3/31/23.
How did performance shake out at the sector and industry level in 1Q23?
Miles Lewis: It was another challenging quarter given that small-cap returns were positive into early February and then declined through most of February and March. However, we were pleased that six of the portfolio’s 10 equity sectors had a positive effect on quarterly performance, led by Information Technology, Industrials, and Consumer Discretionary. Financials made the biggest detraction by far, mostly due to our holdings in banks declining precipitously, while Energy and Health Care also hurt quarterly returns, though to a much lower degree.
What about for the Fund’s industry groups?
Joe Hintz: At the industry level, trading companies & distributors, which are in Industrials, made the biggest positive impact, followed by two industries in Information Technology: electronic equipment, instruments & components and software. Banks—which is part of the Financials sector—were the biggest detractor at the industry level, followed by capital markets, which are also in Financials, and energy equipment & services. After doing very well in 2022, Energy stocks fell hard in the first quarter.
Which holdings contributed and detracted most in 1Q23?
ML: FTAI Aviation (FTAI, Financial) was our top contributor. FTAI operates through two segments, Aviation Leasing and Aerospace Products. Aviation Leasing owns and manages aviation assets, including aircraft and aircraft engines, which it leases and sells to customers. Aerospace Products develops, manufactures, repairs, and sells aircraft engines and aftermarket components for aircraft engines. The top detractor was the Tel Aviv Stock Exchange (XTAE:TASE, Financial), which operates a stock exchange in Israel. The company offers markets for the listing and trading of a range of securities and derivative instruments and engages in the clearing and settlement of securities. Each was one of our 20 largest holdings at the end of March.
At the sector level, how did the Fund perform versus its benchmark?
JH: The portfolio’s advantage versus its benchmark came primarily from stock selection in the quarter, although our sector allocation decisions were also additive. Our larger weighting in Information Technology, along with an assist from stock selection. Helped most. Both stock picking and our higher weight in Industrials also helped. With so much difficulty in the Financials sector, we were pleased that our stock selection was a relative strength in 1Q23. Conversely, a combination of stock selection and somewhat lower exposure to Consumer Discretionary detracted, as did stock selection in Energy. Our lack of exposure to Consumer Stapes also hurt, though it did so much less impactfully.
What is your outlook for the Fund?
ML: The quarter was made much wilder when the failures of Silicon Valley (SIVBQ, Financial) and Signature Banks (SBNY, Financial) catalyzed a sharp sell-off into a broader sell-off in regional and community bank stocks, which accounted for approximately 16% of the Russell 2000 Value. We entered 2023 slightly underweight, though we had been bullish on banks since the spring of 2020. This stance served us well. Recent drawdowns notwithstanding, banks have been among the Fund’s top contributing industries since May of 2020—and substantially outperformed on a relative basis. Recent events, however, have, appropriately in our view, led us to revise our longstanding positive bias. We still believe credit and capital are not the issues for the banks we hold. We also do not believe that the unique circumstances that took down Silicon Valley and Signature can be extrapolated to the industry at large, that is, we do not believe there is broader systemic risk. Nonetheless, we believe the perception of the group has taken a significant blow that likely limits the multiple re-rating opportunity we once viewed as our base case, which calls into question our bull thesis for the group, though we still believe opportunity is being created in specific banks. We are therefore actively looking to capitalize on what we see as dislocations in the industry, both in- and outside our portfolio. Beyond banks, we have high conviction in our portfolio of what we think are high quality, attractively valued businesses. Recent tumult throughout the market has given us opportunities to add to a variety of names across the portfolio at what we think are more attractive valuations while also surfacing new ideas that we expect to investigate using our rigorous investment process. As always, we welcome the opportunities created by market volatility, regardless of the root cause.
Mr. Lewis’s, Mr. Royce’s, and Mr. Hintz’s thoughts and opinions concerning the stock market are solely their own and, of course, there can be no assurance with regard to future market movements. No assurance can be given that the past performance trends as outlined above will continue in the future.
The performance data and trends outlined in this presentation are presented for illustrative purposes only. Past performance is no guarantee of future results. Historical market trends are not necessarily indicative of future market movements.
