Our Small-Cap Opportunistic Value Strategy dates back to the 1990s with Royce Small-Cap Opportunity Fund. In this piece, Lead Portfolio Manager Brendan Hartman, Portfolio Managers Jim Stoeffel and Jim Harvey, and Assistant Portfolio Manager Kavitha Venkatraman talk about the unique, theme-driven approach that we use in our Small-Cap Opportunistic Value Strategy.

What Is the Small-Cap Opportunistic Value Strategy?

Our Small-Cap Opportunistic Strategy takes a unique and distinctive approach to constructing a small-cap value portfolio.

Like all value-oriented approaches, the Strategy focuses on trying to find good companies trading at attractively low prices. In this case, we look for a catalyst for change at the company or industry level, one that we think is likely to eventually reverse the firm’s fortunes and drive its stock price upward.

At the same time, these purchase candidates must be statistically valid for a value portfolio. The primary metrics we use to determine this are price-to-book and price-to-sales ratios, as the team believes that an examination of each together provides the best estimate of a company’s potential to rebound. We prefer companies with low debt but are willing to look past a less-than-pristine balance sheet if we think that the company is otherwise well-positioned to have positive or improved earnings.

Perhaps the most unique element is the strategy’s theme-driven approach. Once our exhaustive research and analysis process is complete, we slot holdings into one of four investment themes.

The Four Portfolio Themes

Unrecognized Asset Values | Generally 15%-25% of portfolio

• Market value is less than the probable liquidating value of the assets
• Physical assets in the form of land and/or equipment or intangible such as high brand value
• Sum of the parts discount with potential corporate action

Turnarounds | Generally 20%-35% of portfolio

• Profits recovering from depressed operating margins due to company or industry specific factors
• Management is critical—monitor changes and track talented executives in the small- and micro-cap space

Undervalued Growth | Generally 35%-45% of portfolio

• Potential growth rate > 12% that is unrecognized by investors
• May be due to operating in a depressed industry or disappointing investors previously
• Seek to identify situations where recent revenue growth has been below potential growth

Interrupted Earnings | Generally 10%-20% of portfolio

• Identify 20% potential annual growth rate or preeminent market position
• Past strong growth interrupted, e.g. broken IPO’s and/or companies in a product or service transition
• Seek to identify situations where historic high revenue growth rate has decelerated and has the potential to reaccelerate

We also begin building positions slowly over time, usually beginning at the first signs of corporate distress. New positions typically account for anywhere from 0.25% to 0.50% of net assets. If the company’s stock price rises and it reaches or comes close to 1.00% of net assets, we usually begin to pare it back or sell it off entirely.

The Fund's Investment Philosophy

• Uses a value oriented approach to buy statistically cheap stocks facing transitory/fixable issues and that possess a catalyst to close the valuation gap
• Buys stocks with low valuations, seeking to increase margin of safety
• Recognizes that volatility is not synonymous with risk and seeks to take advantage of volatility to maximize returns
• Looks for opportunities where we can gain an advantage in areas such as micro-caps, turnarounds, and distressed businesses

The Fund's Investment Process

Selection Universe

• Small-Caps: Market caps less than the largest stock in the Russell 2000 Index
• Statistically cheap stocks—low P/S or P/B relative to history/peer group
• Adequate trading liquidity

How Ideas Are Generated

• Royce’s deep domain knowledge as a Small-Cap Specialist
• Proprietary research
• Screens
• Industry Sources
• Conferences

Due Diligence

• Identify the Investment Theme
• Identify why the stock is cheap
• Analyze normalized earnings and valuation multiples
• Identify conditions or actions that may improve valuation
• Assess ESG risks, if any

How Investment Decisions Are Made

• The team debates the investment merits and risk-reward characteristics
• Position sizes are based on collective conviction

Portfolio Maintenance

• The team holds a daily meeting to review portfolio positions, to share news, and make trading decisions

Portfolio Construction: Risk Management Through Diversification

• Generally target a 200-260 stock portfolio in an effort to reduce stock-specific fundamental and liquidity risk
• Generally target a stock weighting of 25-50 basis points
• Build positions slowly and exit slowly to reduce liquidity risk and stock price impact
• Generally begin to reduce position when weightings reach 1.0% of portfolio assets
• Seek to ensure ideas Royce believes have the best risk/reward characteristics stay in the portfolio

Sell Discipline

• The stock returns to a reasonable valuation on normalized earnings
• Better risk/reward potential exists in another investment
• The investment thesis is incorrect or macroeconomic or industry environment changes
• The company is acquired

As the chart below shows, the Strategy’s distinctive approach to small-cap value results in a highly differentiated portfolio vis-à-vis its small-cap benchmark, the Russell 2000 Value Index.

Highly Differentiated Portfolio Based On Sector Breakdown
Sector Weights vs. Russell 2000 Value as of 9/30/26 (%)

Past performance is no guarantee of future results.

We think that the best example of how the Strategy’s unique characteristics work is its impressive long-term performance record—on both an absolute and relative basis. The chart below shows the growth of $10,000 for Royce Small-Cap Opportunity Fund, the Russell 2000, and the Russell 2000 Value from the Fund’s inception in 1996—the Fund marks its 30th anniversary next month.

Growth of Investment Value of $10,000 Invested on 11/19/96 as of 9/30/26 ($)
Sector Weights vs. Russell 2000 Value as of 9/30/26 (%)

Past performance is no guarantee of future results.

On a monthly basis, the Fund also outperformed the Russell 2000 Value in 99% of all 10-Year periods; 80% of all 5-Year periods; and 56% of all 1-Year periods. In addition, for 98% of the periods, 10-year average annual total returns were greater than 5%.

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