Portfolio Manager Bill Hench discusses the benefits of the global technology buildout on Royce Opportunity Fund/his portfolios.

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You and Buzz Zaino typically have a large weighting in technology companies. What's been attracting your attention in technology most recently?

We're currently seeing one of the largest technology buildouts that we've experienced since the early days of the Internet, one that's benefiting U.S. small-cap tech companies in several industries.

Technology Stock Picks
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This buildout consists of a number of different developments and innovations, including the move from 4G to 5G, artificial intelligence, autonomous driving, public and private cloud storage, and the expansion of the semiconductor industry in China.

Is this activity mostly happening among small-cap tech firms?

It's really across the board. The largest companies, such as Google, Facebook, Amazon, and others are spending on items such as data mining and transmission, technology enabled goods delivery, and cloud storage applications, while the large telecomm carriers are spending on data and the upgrade to 5G.

All of this work involves chips, semiconductors, and other components, which is where smaller companies get involved.

Which industries within technology are seeing the most benefit?

Many of our holdings that are being rewarded are clustered in two industries— the semiconductors and semiconductor equipment group and electronic equipment, instruments & components companies.

These developments are creating robust demand for chips and components that are used in nearly every stage of the buildout—and at each stage there is need for a lot of product.

And U.S. small-cap companies are really the only businesses that can meet the capital equipment demand and effectively deliver products to the large-cap producers and/or to the larger device makers themselves.

So we think it's a fantastic time to be invested in small-cap technology companies. Our thought is that this cycle is just getting started, especially when you look at developing countries and see the potential for growth and expansion.

We're focusing on the small-cap companies that we think will best benefit. We also see ample potential in micro-cap tech stocks that have not yet fully participated in this strong run despite a similarly healthy outlook for many of these businesses.

Can you talk about a few holdings that you see as having strong participation in the buildout?

The first would be Alpha & Omega Semiconductor (Nasdaq, AOSL), which is a semiconductor device company that makes analog switches, power integrated circuits, and transient voltage suppressors.

It looked very cheap to us when we first bought it, especially in light of the company's ambitious R&D plans and related efforts to expand its product offerings. As it has introduced more specialized devices, its reputation has grown globally, particularly in China. So far in 2017, we added shares in Royce Opportunity Fund.

Next would be FormFactor (Nasdaq, FORM), which is a leading provider of the probe cards used to test semiconductor chips and wafers. It first drew our attention about six years ago as a potential turnaround.

When the small-cap market was nearing a low point in February 2016, FormFactor combined with Cascade Microtech, which gave the new company complementary market leadership positions in semiconductor test, measurement, and characterization applications. Along with buildout-driven demand, the increased addressable market has keyed earnings improvement. We began to sell shares in 2017's first quarter.

Cypress Semiconductor (Nasdaq, CY) manufactures digital and mixed-signal integrated circuits mostly for data center and cloud storage applications.

We saw it as an undervalued growth stock because of its potential business growth and capacity for margin expansion. These possibilities looked even brighter as the buildout was first getting under way. Although its shares have begun to recover, we built our stake in the Fund during the first quarter of 2017.

Article by Bill Hench, The Royce Funds