How did the Small-Cap Premier Quality Strategy perform in 4Q21?

Chuck Royce Royce Premier Fund, the mutual fund that we manage in this Strategy, advanced 8.9% for the quarter and beat its benchmark, Russell 2000 Index, which was up 2.1%. For 2021, the Fund gained 16.4%, outpacing the benchmark’s gain of 14.8%. We were also pleased that the portfolio outperformed the Russell 2000 for the 3-, 5-, 15-, 20-, 25-, 30-year, and since inception (12/31/91) periods ended 12/31/21.

Which areas of the portfolio made the biggest positive impact on performance?

Lauren Romeo Seven of the portfolio's eight equity sectors made a positive impact. Industrials and Information Technology, our two largest holdings, as well as Consumer Discretionary, made the largest positive contributions. The only negative impact came from Health Care, where we have a fairly low weighting. On a relative basis, our Health Care underweight was a positive given that the sector declined almost 10% within the Russell 2000 versus around a 3% loss for the Fund’s holdings. In fact, Health Care was the biggest detractor for the Russell 2000 in the quarter. Materials and Real Estate made modest positive contributions.

Which industries and companies did well in 4Q21?

Steven McBoyle At the industry level, we saw strong contributions from semiconductors & semiconductor equipment and electronic equipment, instruments & components, both in Information Technology. Machinery in Industrials was also a strong performer.

LR The portfolio’s top-contributing position for the quarter was CMC Materials, which is a supplier of critical materials to semiconductor manufacturers. The stock reported a strong quarter in November than jumped again in December when it was announced that semiconductor materials company Entegris was acquiring CMC Materials for a 35% premium in a $6.5 billion deal. Rogers Corporation was another notable contributor—DuPont announced it was acquiring the company in November. Rogers works with specialty engineered materials that enable high performance and high reliability in EV/HEV, wireless infrastructure, automotive safety and portable electronics.

Conversely, which areas hurt 4Q21 performance?

CR Software in Information Technology, health care equipment & supplies in Health Care, and IT services in Information Technology were the largest detractors. Upland Software detracted most at the position level. Upland provides cloud-based enterprise work management software, and it offers software applications that enable organizations to plan, manage, and execute projects and work. Muted sales growth and an underwhelming outlook disappointed investors when 3Q21 results were announced in November. We exited our position in December.

LR Blood and plasma supplies and services provider Haemonetics Corporation also detracted. The company reported healthy revenues in November but also lowered guidance for the second half of fiscal 2022 due to ongoing plasma collection volatility due to the pandemic.

How did the Fund perform vis-à-vis the Russell 2000 in the fourth quarter?

SM The portfolio’s advantage over its benchmark came mostly from sector allocation in the quarter, with Health Care, Industrials, and Consumer Discretionary making the most sizable positive impacts. Our respective under- and overweighting in the first two sectors drove relative quarterly performance, while our savvy stock selection in the third was additive.

LR On the other hand, Utilities and Real Estate were the only two detractors because we were underweight in these index outperformers. Materials made a very modest relative contribution to quarterly results. Lagging stock selection helped mitigate our overweighting this strong sector.

In 2021, which sectors had the greatest impact on the portfolio?

CR All of the portfolio's eight sectors made a positive impact on year-to-date period performance. The sectors making the largest positive contributions were Industrials, our highest weighting, Information Technology, our second highest weighting, and Consumer Discretionary. The smallest positive impacts came from Health Care, Materials, and Real Estate.

How did industries and companies fare during the year?

CR Contributing most was machinery in Industrials, electronic, instruments & components in Information Technology, and capital markets in Financials. Position wise, the aforementioned Rogers Corporation made the largest positive impact.

SM Conversely, health care equipment & supplies in Health Care, software in Information Technology, and commercial services & supplies in Industrials were the largest detractors. The portfolio’s top detractor was Haemonetics Corporation.

What sectors helped or hurt the Fund versus its benchmark in 2021?

LR The portfolio’s advantage over its benchmark came mainly from sector allocation for the year-to-date period. Health Care, Industrials, and Consumer Staples made the most significant positive impact versus the benchmark. In the first two sectors, our respective underweight and overweight were the primary positive factors, while good stock selection drove relative results in the third. Conversely, Financials, Materials, and Energy detracted most. In Financials, the Fund’s lack of bank stocks was the primary negative factor as in the Russell 2000, banks rose 36%. Our chemicals stocks lagged in Materials, but for what we believe are temporary rather than structural issues. Our lack of exposure in Energy detracted from relative returns as the sector rose 67% for the Russell 2000.

What is your outlook?

CR We were very encouraged by the second-half performance of the Fund. After lagging by more than 700 basis points in the first half, Premier outperformed the Russell 2000 by more than 850 basis points in the second half, beating its benchmark for the year. We appreciate all of the investors who stuck with us. We also believe that what we define as high-quality is just beginning an extended period of outperformance. Our rationale is based on high-quality's still relatively cheap valuation within small-cap. Historically, the Fund has enjoyed its best excess return experiences starting from periods of low high-yield spreads, similar to where we finished 2021, a dynamic that also favors Premier. We believe that small caps will see moderate returns that are lower than what we saw in 2021. As we mentioned, Premier benefited from two takeovers in the quarter: CMC Materials and Rogers Corporation. Strategic buyers recognized the same attractive attributes that we had identified with these companies, and they were willing to pay significant premiums to acquire these companies. With M&A transactions expected to remain at high levels, we anticipate the Fund may continue to benefit from acquisitions.

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