Commentary

Lauren Romeo and Chuck Royce

100 by Ones

Although each of our portfolios is distinctive, all use some variation on a disciplined value approach, giving each of our Funds certain significant resemblances to one another. We work in the vast and diverse universe of smaller companies, primarily those with market caps up to $2.5 billion—7,100 companies as of 12/31/07 according to FactSet. This sizeable universe (approximately $2.3 trillion in total market cap), along with our broadening efforts in international investing, afford us the opportunity to manage several portfolios with time-tested methods for finding what we believe are undervalued stocks.

The significant changes that we have been watching in the small-cap market over the last 15 years have also had a critical impact on our thinking about the construction of the portfolios that we manage. We first responded to these changes by choosing to more broadly diversify our holdings in micro-cap companies—those with market caps less than $500 million—while holding larger positions in a more limited number of small-cap companies, those with market caps between $500 million and $2.5 billion.

Royce 100 Fund: Kindred to Premier

Over the course of the current decade, we began to be more flexible with this model. When we introduced Royce 100 Fund in June 2003, its strategy represented an evolution of the idea that we first implemented in Royce Premier Fund (currently closed to new investors). Premier was the first Royce portfolio explicitly constructed to hold a limited number of positions; it has generally held no more than 60 positions since its inception in December 1991.

With Royce 100 Fund, we somewhat expanded the idea of a limited portfolio while also allowing for a broader selection universe. Our confidence bolstered by more than a decade’s worth of strong returns, we thought by 2003 that a portfolio similar to Premier could work with both small- and micro-cap stocks, provided that it held more than the 50-60 positions that we typically hold in Premier.

At the time of Royce 100 Fund’s inception, our experience with micro-caps in Pennsylvania Mutual Fund, Royce Micro-Cap Fund and other Funds showed us that the kind of pristine financial characteristics that we seek—strong balance sheets, high internal rates of return and excellent prospects for growth—could be found among micro-caps, even if those companies’ diminutive size often makes them more inherently volatile than investments in companies with similarly attractive profiles in other capitalization ranges. We continue to believe that the relatively more established businesses drawn from the upper tier of the small-cap universe can help to mitigate the risks of adding a limited number of micro-cap companies, particularly if those micro-caps have also passed our most rigorous tests for company quality.

Expanding its Market-Cap Range

In 2006, we began to make room in Royce 100 Fund’s portfolio for those mid-cap companies with market caps between $2.5 billion and $5 billion. We also increased the Fund’s ability to invest in foreign securities from 10% to 25% in 2007. So while the Fund’s selection parameters have evolved, its preference for what we judge to be high-quality stocks has remained the same. We believe that its performance in long-term periods and volatility scores over the three-year period, as shown below, bear this out, making the Fund a solid choice for an investor looking for access to a large portion of the smaller-stock universe with an approach that places a premium on company quality.

Royce 100 Fund vs Russell 2000: Performance* and Volatility** Comparison as of December 31, 2007