Brendan Hartman: As we did during prior periods of market stress in Royce Small-Cap Opportunity Fund, we’re currently finding opportunities to own higher-quality businesses that were previously too expensive or were too large to fit the Fund’s investment and market cap criteria. The selloff is bringing many stocks with competitive moats around their businesses, strong balance sheets, and capable management teams into the small-cap universe at attractive prices. Most recently, we’ve been focusing on companies and sectors that have historically enjoyed robust recoveries when the markets eventually recovered from the initial rounds of indiscriminate selling caused by whatever was spooking investors, causing them to liquidate what they can, not necessarily what they want to. While uncertainty remains the most often quoted word by both market commentators and company managements, we think we can find attractive prices in durable business models in industries that are critical to the U.S. economy.

We’re constructive on the long-term prospects for portfolio holdings, particularly technology and industrial companies. We’ve also added to the Fund’s domestic energy exposure, especially as it relates to natural gas and power generation. In addition, we've been increasing exposure to healthcare companies given the attractive opportunities we’ve uncovered after several years of underperformance in that sector. This has led us to a number of new ideas with company-specific catalysts in the value-based care sector, where technology enabled process improvements are driving better outcomes at lower cost, a trend we suspect has a multi-year tailwind.

There have also been sure signs of slowing growth in certain consumer discretionary and leisure and business travel companies. Due to the considerable uncertainty tariffs are creating, many consumer discretionary stocks have come down in price by 50% or more year-to-date, and we are looking at selective opportunities to take advantage of these lower prices. Corporate deal activity has also cooled off as businesses and consumers await greater clarity. We still believe that less regulatory interference should ultimately lift deal-making activity and expect an increase to benefit the portfolio, which has often held M&A takeover targets. We also hold companies that are benefiting from increased spending by both the government and private sector, driven by the ongoing need to maintain and grow U.S. infrastructure, boost chip-making capabilities, and re-shore manufacturing across several industries. In summary, the bear market is providing attractive prices in our small-cap universe, and we continue to add new positions and increase existing holdings where appropriate.

Chip Skinner: I think that the longer these tariff negotiations (a self-inflicted policy error) persist, the greater the chance that things can go wrong for the economy, the markets, and international relations—to say nothing of the unintended consequences. For example, I worry about a jump in inflation. The cost of some Chinese components, for example, have already risen more than 60%. I also have concerns about inventory and supply chain disruptions, recession, and government spending cuts—where spending is roughly 23% of U.S. GDP. Cuts at the FDA are another worry because the reductions will probably slow drug approvals following several years of the FDA modernizing their approach regarding biologics, gene therapies, and the like.

During previous periods when small-caps fell around -25.0% in just two or three months, I learned that it is better not to make any wholesale changes to Royce Smaller-Companies Growth Fund but instead add to my highest conviction, long-term, top-quality holdings, put any extra cash to work on big down days, and think about letting go of higher beta names that haven’t been delivering on their vision. Some of my biggest positions have steadily growing, recurring revenue business models and a little less correlation with the economy, such as Guardian Pharmacy Services, which provides institutional pharmacy services to assisted living facilities and their patients; ACV Auctions, which conducts online used car auctions for dealerships; and specialty pharmaceutical companies like Corcept Therapeutics and Palvella Therapeutics that target small patient populations/orphan drug categories and thus have little or no competition. Other themes that I expect should hold up relatively well include transaction processing solutions providers, which I discussed recently, and enterprise security software providers that help companies calculate local and other taxes across numerous markets.

Jay Kaplan: The massive uncertainty we’re facing from the federal government is affecting the economy and the markets to the point where not only recession but also stagflation are possible. Needless to say, both would be significant negative developments for stocks. If tariffs are not negotiated down, higher inflation will likely be the result. Trade wars typically have no winners, and reciprocal tariffs would only exacerbate already challenging conditions for the economy and markets. All of this puts the Fed in a difficult position with regard to interest rates—monetary policy can only do so much if the economy is slowing, particularly if above target inflation remains stubborn. In any case, rough sledding is ahead.

Overall, the qualities I look for in Royce Small-Cap Value Fund and Royce Capital Fund–Small-Cap Fund—strong balance sheets with modest levels of debt, consistent cash flow generation, and above average profitability—are not yet selling at bargain prices. Yet I’m confident that the companies we hold should be able to weather what look like stormy days ahead. One interesting example is Adeia, which is an intellectual property—or IP—licensing company that focuses mostly on entertainment media. It’s an asset light business, with very little CapEx. Roughly 15% of the business is in semiconductor manufacturing IP, where they have patents on hybrid bonding, a specific chip-stacking technology. The remaining 85% is, in my view, highly unlikely to be impacted by tariffs because it’s a recurring revenue model where they own licenses for the IP that aids in streaming navigation and giving users choices based on their favorites shows or internet browsing habits—basically everything that interfaces between the viewer and the streaming service, website, or TV network. Amazon and Facebook are among their better known customers. So if that smaller 15% share runs into trouble because of tariffs.

Jim Stoeffel: Periods of market volatility have historically proven to be exceptional entry points for equities in general and micro-cap stocks in particular. After a strong performance in 2024, micro-caps have borne a disproportionate share of the current correction, which has officially become a bear market for the asset class. This is somewhat to be expected as smaller company equity performance is meaningfully tied to economic activity, and concerns over the magnitude of tariffs has raised legitimate concerns about the sustainability of economic growth. While we believe the outlook for the economy remains murky given the unprecedented nature of proposed tariffs, we also see equities in our market cap range as meaningfully discounting the inherent uncertainty. 

As Andrew Palen and I typically do in such situations, we’re attempting to use the volatility to our advantage in our portfolios— Royce Micro-Cap Fund, Royce Capital Fund–Micro-Cap Portfolio, and Royce Micro-Cap Trust—we see a generally constructive outlook over the intermediate term. We see many longer-term trends that should benefit our domestically focused micro-cap stocks. These include reindustrialization associated with onshoring and near-shoring of manufacturing capacity, and the ongoing need for increased power consumption associated with the buildout of next generation computing infrastructure. While the current government policy uncertainty has created significant volatility, we see most of the policy prescriptions as generally supportive of our viewpoint over the intermediate term.

As is typical in such volatile periods, we tend to focus first on our existing portfolio, or the things we know best, to make hard decisions on both the buy and the sell side. However, we have seen increased opportunities in both the medical technology and financial services areas. These are two areas where we gave been underweight, however the sell-off has brought many equities in these segments to more palatable discounts to our estimate of their intrinsic value. There is little question that many of these businesses will be impacted to the extent policy uncertainty creates economic head winds. Yet, given that the demand characteristics of many of these businesses are domestic in nature, on the margin we expect them to be less exposed to tariff dynamics.

In terms of names in our highly diversified micro-cap portfolios, we have been finding opportunities in several different areas. Montrose Environmental Group provides a wide range of environmental services across a broad spectrum of use cases. While there are concerns that the current administration is potentially hostile to environmental issues, this was not the case in the first Trump administration. Equally if not more important, much of the demand for environmental services comes from the states as opposed to federal mandates. Harrow is a specialty compounding pharmacy that has transitioned to a branded ophthalmic drug company with an idiosyncratic growth outlook uncorrelated to overall economic concerns. Finally, Titan Machinery provides agricultural equipment and is at the forefront of concerns about retaliatory tariffs. However, the U.S. agriculture industry entered 2025 period already in a recessionary environment, and we see low levels of industry wide inventories as ultimately supportive of fundamentals through a period of elevated geopolitical volatility.

Francis Gannon: Ongoing high volatility is resulting in a reset throughout the markets—and it’s happening on a global scale. To be sure, the end of 1Q25 feels like a long time ago because the first three weeks of April have been so difficult and dramatic. As challenging as the markets are right now, in Royce Small-Cap Fund, we’re seeing many chances to buy shares of companies where we think the long-term investment thesis remains favorable.

AAON is one example. They develop heating, ventilation, and air conditioning (HVAC) solutions for industrial and commercial customers. In commercial rooftop units, AAON has carved out a dominant position in the semi-custom market through consistent innovation, flexible manufacturing that enables customer-specific configurations to be produced at scale, and excellent distributor relationships. Semi-custom is a growing piece of the overall HVAC pie as more mainstream customers adapt to energy efficiency regulations and place a greater focus on indoor air quality and decarbonized delivery approaches. Through its 2021 acquisition of BasX, AAON gained a foothold in the high performance cooling solutions market for hyperscale data centers and semiconductor clean rooms. BasX’s systems are highly customized and, similar to AAON’s legacy business, manufactured with software-based automation that enables BasX to configure products to meet owners’ unique total cost of ownership and operational efficiency parameters. BasX continues to expand its technology of cooling modalities (i.e., air and liquid) to meet the requirements of new AI data centers which has resulted in several announced wins and orders, putting the segment on a path to achieve $1 billion in revenue over time, up from $225 million in fiscal 2024. In March, AAON’s stock plunged after management provided a muted outlook for 2025 due to a slowdown in rooftop unit sales driven by an ongoing legislated refrigerant transition and weaker non-residential construction, while BasX is managing through production inefficiencies as it races to bring on capacity to fulfill data center orders and backlog. While it will likely take several quarters to work through these headwinds, we believe these problems are temporary and fixable. We bought an initial position in the company as the stock’s roughly 40% pullback since the start of the year created what appears to be a attractive risk/reward profile given AAON’s competitive advantages in end markets with favorable, secular growth drivers.

Walker & Dunlop (WD) offers another compelling opportunity as a high-quality, asset-light commercial real estate services company with premier positioning in multifamily finance and expanding exposure to adjacent markets. WD is the #1 Fannie Mae and #2 Freddie Mac multifamily originator, with a roughly 13% share but still operates in a fragmented market where even top players have single-digit share, leaving ample runway for growth. Unlike traditional real estate brokers, WD’s roots in debt placement give it a differentiated advantage in underwriting properties while providing valuable servicing fee income. Its servicing portfolio generates recurring revenues that represent roughly one-third of total sales and has grown at a 13% compound annualized growth rate since 2014.

These stable, long-duration cash flows smooth earnings through cycles, which helped WD outperform peers during the recent commercial real estate (CRE) slowdown. The CEO’s recent purchase of a meaningful amount of WD stock on the decline reinforces our confidence in the business and signals alignment with shareholders at a key inflection point. The company is entering a new growth cycle that we think is akin to post-Great Financial Crisis 2010, with falling rates and massive refinancing needs providing a tailwind for transaction volumes. WD’s integrated platform—combining property sales, debt placement, and investment management—enables it to win mandates from institutional clients seeking holistic execution. WD is also expanding beyond multifamily units into non-agency lending, small balance loans, and investment management. Its asset management segment—which has assets under management of approximately $16 billion—is set to grow meaningfully, leveraging proprietary data, strong distribution, and client trust. With secular tailwinds in rental housing, bank retrenchment from CRE, and differentiated capabilities, we think WD is poised for significant earnings recovery and multiple expansion. Finally, it shares offer a compelling entry point—a 7.5% cap rate on depressed earnings—just as the flywheel appears ready to turn again.

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