How did Royce Pennsylvania Mutual Fund perform in 4Q23?

Chuck Royce: The Fund had a very strong fourth quarter, though it lagged its small-cap benchmark, the Russell 2000 Index. Penn advanced 12.9% in 4Q23 while the Russell 2000 was up 14.0%.

How was performance for 2023 and over longer-term periods?

Jay Kaplan: The Fund’s long-term results were excellent. Penn beat the Russell 2000 soundly in 2023, up 26.7% versus 16.9% (and the Fund also narrowly outpaced the large-cap Russell 1000 Index, which was up 26.5% in 2023). Penn also beat the Russell 2000 for the 3-, 5-, 10- 15-, 20-, 25-, 30, 35-, and 40-year periods ended 12/31/23. In addition, the Fund’s average annualized total return for the 50-year period ended 12/31/23 was 13.2%.

Which portfolio sectors made the biggest impact on 4Q23’s performance?

Andrew Palen: All 10 of Penn’s equity sectors had a positive impact on quarterly performance, with the biggest contributions coming from Industrials, Financials, and Information Technology, while the smallest contributions came from Energy, Consumer Staples, and Real Estate.

What happened at the industry level in 4Q23?

Lauren Romeo: The machinery group, which is part of Industrials, contributed most, followed by semiconductors & semiconductor equipment in Information Technology, and resurgent banks from Financials. The three industries that detracted most in 4Q23 were oil, gas & consumable fuels from the Energy sector, electrical equipment in Industrials, and entertainment in Communication Services.

At the sector level, what factors made the biggest impact relative to the benchmark in 4Q23?

Miles Lewis: Our somewhat narrow disadvantage over the Russell 2000 came solely from stock selection in the quarter—our sector allocation decisions were additive. Altogether, eight of 11 sectors underperformed the benchmark in 4Q23. Stock selection hurt most in Financials, Health Care (where our lower weighting also detracted), and Industrials. Conversely, our lower weighting in Energy was additive, as were stock selection in Materials and lack of exposure to Utilities. (Energy was down within the Russell 2000 while Utilities had the lowest positive return in 4Q23.)

Turning to the calendar year, how did the Fund perform in 2023?

Steven McBoyle: All 10 equity sectors in which the Fund held investments finished 2023 in the black, with the largest contributions coming from Industrials, Information Technology, and Financials. Communication Services, Energy, and Health Care made the smallest positive contributions.

What about at the industry level?

ML: Two of Penn’s largest industry weights—semiconductors & semiconductor equipment in Information Technology and machinery in Industrials—were the top contributors, followed by another good-sized weighting—building products in Industrials. The top detractors were communications equipment from Information Technology, air freight & logistics in Industrials, and interactive media & services in Communication Services.

How did the Fund’s results compare with those of the Russell 2000?

LR: Our relative advantage came mostly from stock selection in 2023, though sector allocation was highly additive. Altogether, 10 of 11 equity sectors contributed to the Fund’s outperformance. Both stock selection and our higher weighting helped in Industrials, stock selection in Financials, and stock selection and a higher weighting in Information Technology, drove relative outperformance most. Conversely, stock selection detracted in Communication Services while the smallest contributions to outperformance came from our lower weightings in Consumer Staples and Energy.

What’s your long-term outlook for the Fund?

CR: Our outlook is constructive. First, we suspect that returns are likely to skew more widely over the next few years and that the reign of the Magnificent 7—the mega-cap cohort of Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla—may be coming to an end, especially if 2023’s fourth quarter and early January 2024 are any indication. The backdrop of moderating inflation, normalized interest rates, and a still growing U.S. economy, also bolsters our belief that small-cap’s lengthy stretch in the relative performance wilderness has run its course. Moderate economic growth and the more normalized rate environment should support a broadening of equity market returns where small-caps could be clear beneficiaries, especially those businesses that have largely sat out the mega-cap performance regime. Even more important is what we’ve been hearing from management teams—most of whom remain cautiously optimistic about 2024. It appears increasingly likely, for example, that the U.S. economy will achieve the much-desired soft landing—which is encouraging for many reasons. The next few years will see even more tangible benefits of reshoring, the CHIPS Act, and numerous infrastructure projects, and many of our holdings are poised to benefit from these developments. So, we’re looking forward to what we think should be a favorable cycle for small-cap stocks.

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