Can you comment on small-cap performance in 3Q26 and year-to-date through 9/30/26?

Francis Gannon It was a little disappointing to see small-caps in negative territory for the quarter while large-caps had a small gain: the Russell 2000 Index was down -7.2%, and the Russell 1000 Index was up 1.8% in 3Q26. However, small-cap held on to its leadership for the year-to-date period ended 9/30/26, with the Russell 2000 gaining 13.7% and the Russell 1000 up 12.3%. The Russell 2000 Value Index lost less than the Russell 2000 Growth Index for the quarter, down -4.9% versus -9.4% (the returns were mirror images of each other).

It’s worth keeping in mind that these kinds of mini-corrections are common in a bull market, so the returns were not that much of a surprise. And we’ll talk in more detail about it later in the interview, but the fundamentals for many small-cap companies are still quite strong, so we’re not terribly worried about a short-term pullback. In fact, I think it’s healthy during long bull markets to see a reset. We’ve been describing it as “pause that refreshes.” The first quarter of this year had an even deeper intra-quarter downturn—which was almost immediately forgotten once small-caps rebounded in late March.

Chris Clark I think we should also mention that, while Royce Small-Cap Growth Fund, which Chip manages with Will, also fell back in the third quarter, the Fund only fell -2.9%. It lost less than the Russell 2000, the Russell 2000 Value, and the Russell 2000 Growth. Longer-term absolute and relative performance has been really noteworthy—the Fund beat the Russell Small-Cap Growth for the 1-, 3-, 5-, 10-year and since inception (6/14/01) periods ended 9/30/26 and also outperformed the Russell 2000 for each of those periods except the 5 years ended 9/30/26.

What factors had the biggest impact on overall equity performance in 3Q26?

Chip Skinner It’s always hard to pinpoint exactly what drives the market up or down, but the third quarter felt like a risk off period to me. There are growing concerns about inflation, we’ve had the first Federal Reserve rate hike in a while, possibly putting us in a rising interest rate cycle, and there’s been a lack of progress on resolving the Strait of Hormuz and the conflict with Iran. We’re also beginning to see concerns about the AI investment cycle even as it’s been benefiting several adjacent areas and industries. And small-caps had been performing really well coming into July, so as Frank said, a pause—hopefully brief—wasn’t unexpected.

William Collopy What’s been happening in the semiconductor space has been really interesting. Year-to-date, it’s still the top contributing industry within the Russell 2000, even after a pretty sharp correction in the third quarter—down -22.5%. A lot of analysts are already starting to price in great numbers for 2026 and 2027 within the semi-cap and semi-cap equipment space. We’re now at the point of the cycle where the numbers have really started to flow through. We’re seeing it hit revenues and now can see which companies are the haves and have-nots.

For those companies that were talking about winning a lot of market share, we can now see who’s proving it and who’s being pushed out. There are also questions about the length of the cycle: is it more of a 2027 or all the way to 2028 cycle? And we’re seeing a constant change in the narrative, especially like when we look in the optical space, where everyone is focused on which companies and whose wires are going to be better for the next leg of the buildout. When we look at companies like NVIDIA and the hardware builders, they don't necessarily know the answers. They seem to change their mind every day. So we’re seeing a lot of this uncertainty being priced in, along with peak multiples, and that’s where we began to see a lot of that pullback.

Does the Fed’s tightening cycle mean that the days are numbered for small-cap leadership?

CC I don’t think so. Certainly the idea that rate increases always spell trouble for small-caps is one of the most stubborn myths about the asset class. We can see why: the conventional wisdom is that small-caps are more volatile, less established businesses that also carry debt. And it is true that certain small-caps fit that profile—but many do not. And it’s surprising to us that after almost three decades of small-caps being an institutionally accepted asset class—one that contains thousands of companies—people make the knee-jerk assumption that a rate hike means all or most small-cap stocks will suffer. Frank has discussed in detail why this myth doesn’t hold up. If a company, regardless of market cap, is carrying a lot of debt, then higher rates will create challenges—but not all small-cap companies have a lot of debt, and indebtedness is not the exclusive province of small-cap companies.

CS Equities in general tend to perform better in a falling rate environment because falling risk premiums and borrowing costs tend to be more stimulative to the economy, corporate earnings, and markets—and of course the opposite is often true as well. But it depends on the length of the rising rate cycle as well as the rate of change. Abrupt spikes in rates, or any other monetary policy levers for that matter, can really spook markets, which we haven’t seen yet.

FG I would add that we have found little evidence that higher interest rates translated into poor small-cap performance. In fact, our research showed that earnings were a far more accurate gauge of small-cap performance on both an absolute basis and relative to large-cap stocks. Over time, share prices and earnings consistently converged. Interest rates have occasionally influenced valuations and investor sentiment, but mostly over short-term periods. Long-term returns ultimately followed the path of earnings. And earnings growth continues to accelerate for both small- and large-cap companies.

How have higher energy prices affected your portfolio?

CS The Energy sector has outperformed the overall small-cap index so far this year, and we have been working to move our weighting up there. I am not optimistic that a resolution to the Iranian conflict, and therefore lower oil prices, are in the cards anytime soon. Will and I have also shifted exposure into more traditional core/quality growth at a reasonable price holdings because they’re typically less economically sensitive—and the valuations in many cases have quietly become very attractive.

Data center and other AI anxieties have been front and center over the last several weeks. How has it been affecting your investments?

CS I think this coming to the forefront is a positive because a certain amount of regulation needs to happen. I think a digestion period is likely to occur as projects are delayed and communities keep the data center risk debate in the news. It’s hard to envision how this plays out, but it probably will not follow a straight up and to the right line chart pattern. I am betting we see bumps in the road. There are always unexpected variables. I often reference the Gartner Group Hype Cycle chart, which in a very rudimentary sense reflects the path of numerous technological innovations over time. It moves from the Innovation Trigger stage to a peak of Inflated Expectations, followed by a Trough of Disillusionment, and then a long, rising period of Enlightenment and Productivity Improvement. It has a pretty good record of accuracy, so I expect we’ll see things play out along similar lines.

What effect, if any, do you think the midterm elections will have on small-caps—or the market more generally?

CC We get this question prior to a every election—pretty much every asset manager does. And the truth is that there’s almost always a short-term reaction, sometimes a pretty steep one, whether up or down. But as the weeks roll on, the market almost always settles back into the pattern it was in prior to us all voting. As we always do, we’ll be watching closely to take advantage of any opportunities in the interim.

Where have you been finding investment opportunities over the last few months?

WC We’re seeing a lot of innovation from companies today that are driving unique stock opportunities. We think many of them should be able to weather market cycles. We’ve also attended several really productive investment conferences this year, coming back to the office with a lot of new ideas to work on—which is a positive in and of itself but also because we’ve had a few holdings get acquired, including ACV Auctions, CBIZ (which provides financial, insurance and advisory services), along with several pharma companies last year.

Chip, Will, and Frank—can you each discuss a current holding?

FG We own Saia (Nasdaq: SAIA) in Royce Small-Cap Fund’s portfolio, which a company PM Lauren Romeo has researched. It’s a leading less-than-truckload (LTL) transportation services provider and is one of only a handful of LTL trucking companies that offers national direct service, which makes it somewhat unique. After struggling a bit from its aggressive network expansion to complete its national buildout—Saia’s added roughly 38 terminals in the prior three years—and a long freight recession, management appears to have its hands firmly back on the wheel.

Saia (Nasdaq: SAIA)
12/31/25-9/30/26

Source: FactSet.
Past performance is no guarantee of future results.

We think some of its recent moves can drive organic revenue growth beyond its industry peers, including the network benefits of improved route density and scale efficiencies from its new and existing terminals as Saia grows wallet share with its current customers while adding new ones in its served markets, along with management’s continued focus on price and mix optimization.

We also think that Saia’s operating income growth can outpace sales growth as operating leverage on incremental volumes is likely to drive above average profitability and put SAIA on the road to operating margins that are at least more consistent with its historical 20%+ range—and are more than double current levels. After largely self-funding about $2 billion worth of network expansion investment over the past several years, Saia should start seeing higher returns on that invested capital from improved utilization and rates, as well as increased free cash flow as its CapEx normalizes from elevated levels. Industry consolidation—the top 10 LTL players have 76% of the U.S. market—and permanent capacity reductions (due to bankruptcies, stricter regulatory enforcement, and driver shortages) are setting the stage for a more profitable, prolonged industry recovery once volumes inflect positively.

CS For holdings, there’s one name that we are particularly fond of. Definium Therapeutics (Nasdaq: DFTX) is one of a handful of public pharma companies that are working to bring a new class of drugs to the market —psychedelics. A few of these psychedelic pharma companies that came public five or six years ago. They all sort of followed the typical Gartner Hype Cycle I mentioned earlier where the share prices ran up due to the potential these drugs have, but they were very early stage in terms of getting through clinical trials and getting FDA approval. The stocks all cratered and were kind of left for dead.

Then late last year, we became aware that a number of these companies are not only still going, but they were going to be reporting Phase 3 data this year. We’ve seen a few Phase 3 data reports but pharma holdings. Two have come from Definium that have been just breathtaking in terms of the efficacy. These drugs treat the most severs types of depression: Treatment resistant depression, or TRD, and major depressive disorder, or MDD, along with a treatment for anxiety. This is important because fifty-million Americans suffer from depression, so there is an enormous need for effective treatments.

Definium Therapeutics (Nasdaq: DFTX)
12/31/25-9/30/26

Source: FactSet.
Past performance is no guarantee of future results.

The efficacy of these drugs is two to three times better than anything currently on the market. So, while the patient has to spend six to eight hours in the doctor’s office where they have this psychedelic experience, the patient generally feels better after this first treatment. This differs from other drugs that often take weeks before the patient feels any effect at all. Most depression sufferers end up trying at least three different medications before they find one that works for them. And generally, it’s a cocktail of different treatments or meds. But the results for Definium’s treatment are astounding. Many of these psychedelic drugs are going to come on the market because the FDA has a very favorable bias towards them. I think they’re likely to hit the market next year.

WC I’ll talk about Magnite (Nasdaq: MGNI), an advertising technology company that sits between the publishers and the advertisers. They’re connecting the pipes, running a lot of the auctions, and connecting buyers with sellers. The company started as a merger between a few different companies putting all the necessary pieces together that was needed to be a successful SSP—a supply side platform, which is a technology used by publishers and media owners to sell their advertising inventory programmatically. Every advertising dollar flows from the spender to a DSP, a demand-side platform. The DSP then decides where to route it, then it'll go to the SSP, which is where Magnite sits. Magnite will then connect it with the publisher, who will then run it on their website or more increasingly now, connected television.

Magnite (Nasdaq: MGNI)
12/31/25-9/30/26

Source: FactSet.
Past performance is no guarantee of future results.

It’s a complex system. We’ve had to map it out. Advertising, especially in small-cap, is historically very volatile because companies start doing really well, then the map changes a little bit, and all of a sudden they can be cut out. Over the past five years since I’ve been looking at this name, there have been fears that they can be cut right out of it. The Trade Desk, which is the biggest independent DSP, or Google, might simply cut Magnite out because both are massive companies that can just bypass it and go right to the publisher. But we began to see earlier this year that Trade Desk has been getting a lot of pushback from their customers for overcharging them and not providing any value, just taking about 30% of every dollar right off the bat before doing anything for the customer. Magnite, despite all that fear, has become more and more important within that value chain. The company has been winning a lot more business, especially as dollars are flowing from linear television into streaming or connected television.

Linear television historically has been a direct sale. At the beginning of the year, there were upfronts where the major networks would sell a year's worth of time slots for all their primetime premium shows. But as we’ve moved to connected television, it’s become much more of an automated sale process. This is where a lot of data is being collected. Much of this data is targeted, so a company can get a lot more bang for their buck. They can spend less and really target the customers that they want. Over the past few years, Magnite has built up great relationships and partnerships with streamers like Netflix, Disney, and other streamers, as well the publishers and the DSPs. So as more ad dollars flow from linear television to connected television, Magnite is well positioned to grow. It has two business segments: one is connected television, which has grown 30%--and now accounts for more than 50% of Magnite’s revenue.

Magnite had been low to no growth for the past few years, mostly because it’s in the Google ecosystem. However, last year a court found that that Google was running a monopoly within that segment of its business. Google had a 60% share of this space, and Magnite had about a 5% share. So we’re now waiting a final ruling on the remedies. We saw the stock pop at the very end of last year, and then everything regarding these remedies quieted down. We’ve been hearing “any day now “ for the last nine months as the stock pulled back. But we had conviction in the company as it was pulling back, which allowed us to build our position. Finally, just a couple of weeks ago, the final ruling came down, with the result that there won’t be any structural breakup of the Google business, but Google also needs to run fair auctions and allow everyone to participate equally, so Google does not get the first or last look

What is your outlook?

CS We feel good about our holdings and themes, particularly if we get a continuation of strong earnings. We’ve have added some high quality GARP (“Growth at a Reasonable Price) names and even added to AI beneficiaries that have seen some of the steepest price corrections. We still like our drug development theme, specifically those like Definium that are involved in treating depression. We’re also seeing opportunities emerge in industries and companies that are implementing AI. The call center market is one example. In addition, we like payment solutions companies, domestic power business, rare resource producers (especially lithium and uranium), automation/robotics, medical devices, and diagnostic testing.

FG The underlying fundamentals for small caps are still quite strong from an earnings perspective—even in the face of a raising rate environment—as well as valuations. Small-caps finished September much more attractively valued than large-caps based on EV/EBIT, or enterprise value over earnings before interest & taxes, which is our preferred index valuation metric that we also use when screening companies.

Small-Cap’s Estimated Earnings Growth Is Expected to Be Higher Than Large-Cap’s in 2026 and 2027

Earnings per share (EPS) is calculated as a company’s profit divided by the outstanding shares of its common stock. The EPS Growth Estimates are the pre-calculated mean one-year EPS growth rate estimates by brokerage analysts. Estimates are the average of those provided by analysts working for brokerage firms who provide research coverage on each individual security as reported by FactSet. All non-equity securities, investment companies, and companies without brokerage analyst coverage are excluded. Data was run on October 1, 2026. Source: FactSet.

I think small-caps, especially with active management, are still well positioned for long-term leadership despite the third-quarter correction. And as a last reminder, corrections are common—they happen, and they’re a normal part of every bull cycle. Our job is take advantage of the opportunities that short-term downdrafts create—which is exactly what we’ve all been doing.

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