Small-Cap Market Review

FOR FINANCIAL PROFESSIONALS ONLY Small-Cap Market Review 3Q20 Interview Although the next few months may be volatile, Portfolio Manager Chuck Royce and Co-CIO Francis Gannon are optimistic for small-caps over the next few years. Chart Book A comprehensive overview of our asset class including long-term market cycles and performance patterns for large-cap vs small-cap and cyclicals vs. defensives. Fund Performance A look at how Royce’s featured value and core strategies have fared. Small-cap specialist with unparalleled knowledge and experience, offering distinct investment approaches to meet a variety of investors’ goals. Unparalleled Knowledge + Experience Founded 1972 Pioneers in small-cap investing, with 40+ years of experience, depth of knowledge, and focus. Independent Thinking 30+ The confidence to go against consensus, the insight Years Average PM Industry to uncover opportunities others might miss, and the Experience tenacity to stay the course through market cycles. Specialized Approaches $11.5B US, international, and global investment strategies AUM that pursue approaches with different risk profiles. Unwavering Commitment $114M Employee Our team of 18 portfolio managers have significant Investments1 personal investments in the strategies they manage. As of 9/30/20 Source: Morningstar 1 Our officers, employees, and their families have approximately $114 million invested in The Royce Funds and similarly managed strategies and vehicles as of 08/31/20. 3Q20 Interview Although the next few months may be volatile, Portfolio Manager Chuck Royce and Co-CIO Francis Gannon are optimistic for small-caps over the next few years. Do you think the market’s strength is sustainable? CR Over at least the next few years, yes. Based on what I see in small cap’s fundamentals, current valuations, and market behavior, I’m cautiously optimistic. September was a volatile month, as well as the first month with negative returns for most of the indexes around the globe since the recovery began in March. The losses, however, weren’t significant. This sort of more benign correction is common over the if by fits and starts. Equally if not more horizon. Because the coronavirus is an course of recoveries and gives me more important, the world is making progress exogenous event, I think it makes the confidence in the market’s underlying toward a coronavirus vaccine that’s likely prospect of a sustained recovery more strength. Yet with a vaccine still to come, to be available by the early to middle part likely. The global economy was in solid a contentious election in November, of next year. I’m also pleased with the shape going back to the early part of ample economic uncertainty, and way that so many companies are moving 2020. Indeed, some of our holdings, the recent positive diagnoses for the forward and effectively managing their such as those with exposure to housing president and certain members of his way through an extraordinary period— and certain niche consumer areas, are staff, I don’t have a firm conviction about one that’s been unprecedented for most doing quite well. In addition, many of the short run. Although I also don’t see of them. The markets are behaving the management teams we’ve spoken to the likelihood of a major correction, I mostly as we’d anticipate in a typical in industries such as chemicals, electrical do think stocks could experience more recovery from a recession. In fact, with equipment, and machinery are preparing of the corrective volatility we saw in so much of the world feeling upside for continued economic recovery. down, it’s interesting how “normal” the September over the next few months. How is your view of the investment environment has been. What positive signs do you recovery affecting how you’re see that support your long- With the economy showing looking at companies? term conviction? mixed signals, what’s your FG What stands out most is the sense of its condition? CR I’m encouraged by the number of sizable gap between perception and welcome developments. The market’s CR I think the economy is in pretty fundamentals. Even as the market strength coming off the mid-March good shape—and getting better. The rises, much of the world seems lows has been a pleasant surprise, and road ahead looks promising to me, with apprehensive about the overall state of the economy is growing stronger, even no recession or financial crisis on the corporate health, especially in small- Royce Investment Partners 3Q20 Small-Cap Market Review | Page 1 caps, where the companies are often The Surprising Strength of non-U.S. Small-Caps seen as being less financially sound. Recent performance of non-U.S. small-caps versus U.S. small-caps as of 9/30/20 Yet we see a large number of small- Russell 2000 MSCI ACWI xUS SC 3Q20¹ YTD¹ 1-Year cap businesses that have solid free 10.5% cash flows, strong balance sheets, and 7.0% 4.9% capable, innovative management teams that have been executing at a high level 0.4% throughout 2020. Those are the kinds -3.6% of characteristics that we think will help companies to emerge stronger. -8.7% 1Not annualized. Past performance is no guarantee of future results. Is there anything happening in the market that you think beating the Russell 2000 in all three fiscal stimulus to revitalize the economy. investors may be missing? months. It’s equally notable that non- Are there any themes U.S. small-caps (as measured by the FG I think a lot of investors aren’t emerging in areas you find MSCI ACWI ex-USA Small Cap Index) aware of how much risk there is in attractive? have outperformed their U.S. small-cap passive equity products where mega-cap peers in three of the past four quarters FG There are two related factors we look names predominate. Apple, Microsoft, and are now ahead on a one-year basis for, regardless of industry or sector. The and Amazon—along with Google after trailing for several years. first is companies that are profitably and Facebook, part of the “FAAMG” This could be the beginning of an using their technology and/or intellectual group—each made up more than extended period of attractive returns for property to help other businesses 10% of the Nasdaq 100 Index at the non-U.S. small caps. Yet many other innovate or execute more effectively. end of September—more than 30% investors aren’t allocating or even looking The second would be companies that of the index’s total market cap. This at what we see as very fertile ground that are effectively absorbing technology high degree of concentration creates can provide terrific opportunities for and other innovations for their own considerable risk. Given that investors active managers. uses. I don’t know if other investors are often turn to passive vehicles in an scrutinizing the advantages that these effort to reduce risk, we think they may What are the implications for attributes can create, but we see them as be particularly disappointed when risk small-cap investors of the absolutely critical to a company’s long- shows up where it’s least expected—and Fed’s decision to keep very term success. We also like companies that there’s more concentration risk in large- low rates longer, allow higher help businesses make smarter decisions cap passive investments right now than I inflation, and welcome strong about technology—which is a specialty can ever recall seeing. labor markets? of Forrester Research. What else have you observed FG We can’t be certain yet about the full Which sectors and industries that other investors may not extent of the effects. However, the Fed’s do you think look most likely be aware of? decision to keep rates lower for longer to emerge stronger? certainly suggests tailwinds that can help CR I think one of the more interesting equity prices to continue drifting higher. CR We own two machinery companies, stories in the third quarter was the The Fed has also become what I’d call Valmont Industries and Lindsay strength of non-U.S. small-caps. a fiscal policy advocate. By essentially Corporation, that are good examples Along with their non-U.S. large-cap saying that the deficit is not something of what Frank just referred to. They’re counterparts, they outpaced domestic we currently need to worry about, the involved in precision engineering for small-cap stocks in the third quarter, central bank is encouraging additional agriculture, which is another area that Page 2 | Royce Investment Partners 3Q20 Small-Cap Market Review we like. These companies are leveraging What conditions need to be such as strong balance sheets, industry intellectual property and technological present for small-caps to leadership, and innovation. These are skill to enhance crop yields, which outperform large-caps? the qualities that have historically helped benefits their customers, most of companies to make it through difficult FG I think the case is pretty whom are farmers. Another area would markets and recover successfully. When straightforward: We agree with the be companies that have an edge in the market is hit with volatility, those consensus that’s expecting the economic supply chain logistics and inventory attributes go on sale, as it were, because recovery to continue broadening and management, such as Manhattan so many investors begin to sell without deepening. A consistently strengthening Associates, a holding we’ve discussed taking fundamentals or long-term success economy should be highly supportive before. The company has the number into account. That short-term mindset for small-cap stocks, as it has been one share in warehouse management is something that any effective active historically, especially the economically systems software.

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