Fund Performance

Royce Smaller-Companies Growth Fund advanced 21.8% in 2024, outpacing both the Russell 2000 Growth Index, which was up 15.2%, and the Russell 2000 Index, which was up 11.5%, for the same period. The Fund also outperformed both indexes for the 5-, 10-year, and since inception (6/14/01) periods ended 12/31/24.

What Worked… and What Didn’t

Seven of the portfolio’s 10 equity sectors made a positive impact on calendar-year performance, with Information Technology, Industrials, and Health Care making the largest positive contributions while the three detractors were Financials, Materials, and Real Estate. At the industry level, trading companies & distributors (Industrials), semiconductors & semiconductor equipment (Information Technology), and pharmaceuticals (Health Care) contributed most in 2024, while health care equipment & supplies (Health Care), chemicals (Materials), and machinery (Industrials) were the largest detractors.

At the position level, the top contributor was FTAI Aviation, an aircraft engine lessor that also offers a cost-effective engine maintenance, repair, and exchange program that is eagerly sought by smaller airlines. Its business has benefited from new aircraft delivery delays, as well as Boeing’s overall safety problems. As operators have sought to refurbish and operate aircraft and engines longer, the shift has benefited FTAI. In addition, the market value of its leased engine portfolio continues to rise.

Few stocks of any capitalization size have seen more growth from Artificial Intelligence (“AI”) datacenter spending than Super Micro Computer, which manufactures the chassis, subassemblies, and components for data center servers, as well as the box and systems that house graphics processing units, including Nvidia’s high demand chips. We sold the position based on our concerns about Super Micro Computer’s declining gross margins and price reductions, which suggest that competition is on the horizon, as well as the fact that data center spending will normalize again.

Harrow is a pharmaceutical company that focuses on eyecare and has transitioned to branded proprietary products through savvy M&A activity and product development. It’s been benefiting from an early ramp-up in a surgical anesthetic and a dry eye treatment. Trying to take advantage of its somewhat volatile stock price, we built our position in 2023 on share price weakness due to some startup product launch delays. We then trimmed the position in 4Q24 after management demonstrated the ability to grow its platform.

Reddit is a popular social media site with a loyal user base that allows people to provide useful answers to everyday questions and problems, with pages organized around key topics and interest groups. While clearly useful for getting answers, the community of users also derives entertainment from sharing and reading commentaries. Reddit has generated so much useful content that Google and others have licensed its data in order to train their machine learning models.

NextNAV acquires low band wireless spectrum that can be used for positioning navigation and timing or PNT use cases. The company has terrestrial-based solutions versus satellite communication, which is the principal source of GPS solutions. It is seeking FCC approval to reconfigure this Spectrum in order to complement and back up GPS systems given that we are seeing more satellite jamming efforts globally, which puts GPS reliance at risk.

CVRx develops and manufactures implantable neuromodulation devices that treat heart failure. This small company experienced the unexpected retirement of its CEO, an unsuccessful sales and marketing strategy (which they have since corrected) that led to a slowdown in system sales early in 2024. With a view that it may take the new CEO, who came from Medtronic, several quarters to reinvigorate its direct selling effort, we sold the position but still believe in the technology, which improves the quality of life and reduces the number of serious cardiac events.

Sprout Social provides enterprise software that helps corporations, brands, and ad agencies manage their social media efforts in addition to helping monitor social media messaging. It can make sure that customers’ digital ad placements don’t sit alongside inappropriate content or sites, while also generating ad placement metrics and views. Despite suggesting late in 2023 that its business would accelerate, Sprout then surprised the market by announcing a major management change at the beginning of 2024 while lowering guidance and growth expectations. On top of all this, the company then decided to cut or reduce the number of business metrics that it was willing to disclose to investors, which led us to sell our position.

Coveo Solutions offers an AI-powered search and customer support software solution that can meaningfully reduce the manual labor of customer support costs while improving search results. Activity around customer interest and beta testing has been generating high revenues, though deal signings have been slow to materialize. Not surprisingly, large corporations want the assurance of accurate responses and eliminate “AI hallucinations” before rolling out a new product to their customers. We have chosen to hold our shares in expectation of revenues accelerating in 2025.

Alphatec Holdings is a medical device and implant developer and marketer that targets the spine surgery market. A long-term holding, it has delivered above-average growth in a category where surgical outcomes have been unacceptably low for many years, driven by broad product offerings and innovative solutions, including lateral spine procedures, imaging, and robotics, along with investment in salesforce growth. Fundamentals improved in 2024, but concerns over cash burn weighed heavily on the shares. In addition, the spinal implant group underperformed to the point of being oversold. We stuck with the shares, and a bounce back appeared to get underway in 4Q24.

Bowman Consulting Group is an engineering services company focused on infrastructure and professional services, including planning, engineering and technical services. Almost two-thirds of its revenues are related to multifamily and residential development projects. Despite seeing growth and acquisitions in less cyclical markets, Bowman endured project delays at the beginning of 2024, was unable to hit its projected guidance, and then lost the head of sales—all of which led us to sell our position.

The portfolio’s advantage over the Russell 2000 Growth was primarily attributable to stock selection in 2024. At the sector level, stock selection helped most in Health Care and Communication Services—our lower exposure to each sector also helped—and Information Technology, where our larger weighting was additive. Conversely, stock selection detracted from relative results in Financials and Materials as did our slightly lower weighting in Consumer Staples.

Current Outlook and Positioning

While one year does not make a trend, the strength of small-cap growth stocks in 2024 represents an overdue broadening of the U.S. equity market after several years of strength in a small handful of mega-cap Tech stocks. Other reasons to be optimistic include the more favorable interest rate backdrop, solid underlying GDP and employment figures with inflation growth holding at more acceptable levels, and the belief that the pendulum swings in the small-cap segment can extend beyond a single year. In support of the latter point, one only has to look at the 3- and 5-year average annualized returns for the Russell 2000 Growth and Russell 2000, which at 12/31/24 were appreciably lower than each index’s average monthly rolling returns for the 3- and 5-year periods since each index’s inception on 12/31/78. In terms of portfolio positioning, we made no major changes in 2024 beyond trimming and adding to positions based on fundamentals, outlook, and valuation. We reduced a few of our larger positions in aerospace & defense, an opportunity that has been predicated on Boeing’s inability to supply new commercial aircraft, which made companies that supply used and replacement parts more important in extending the lives of existing fleets. Boeing has a new CEO and has re-acquired some of its previous internal production capabilities, thereby at least steadying their ship. These actions can clearly impact the out-sized growth that our holdings have been experiencing. Similarly, as highlighted in my quarterly interview on our website, positions related to the payment processing theme have been increased, largely because of strong underlying fundamentals and long runways of growth. Finally, three themes you may hear us speak more about in the future include Non-Bank Financials, Consumer Leisure Spending, and Nuclear Power/Nuclear Medicine.

Average Annual Total Returns Through 12/31/24 (%)

Annual Operating Expenses: Gross 1.57 Net 1.49

¹ Not annualized.

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