Royce Global Select Fund Performance Discussion

This discussion comes from our June 30, 2011 Semiannual Review and Report to Shareholders.

The first-half results for Royce Global Select Fund (RGS) were somewhat disappointing on both an absolute and relative basis. The Fund was up 2.1% for the year-to-date period ended June 30, 2011 versus gains of 5.6% for the MSCI WORLD Small Core Index and 2.5% for its new small-cap global benchmark, the Russell Global Small Cap Index, for the same period. (We chose the Fund's new benchmark because it better reflects the Fund's security selection universe.) The Fund lost the most ground to the MSCI WORLD Small Core Index during the first quarter, a mostly uneventful bull period in which RGS rose 4.1% versus respective gains of 6.2% and 3.2% for the MSCI and Russell Indexes.

Relative results were not much closer during the second quarter. While the overseas markets were less volatile than their domestic counterparts, results were still negative for the major global and international indexes. RGS fell 1.9% for the second quarter, compared to a decline of 0.6% for the MSCI WORLD Small Core Index and 0.7% for the Russell Global Small Cap Index. These quarterly results were in large part a reflection of the Fund's struggles through the domestic market downturn. From the interim domestic small-cap high on April 29 through the ensuing domestic low on June 13, 2011, RGS lost 5.1% versus respective declines of 7.2% for the Russell Global Small Cap Index and 7.9% for the MSCI WORLD Small Core Index.

Recent market cycle performance was considerably stronger on an absolute basis, though mixed on a relative standard. From the domestic small-cap market peak on July 13, 2007 through June 30, 2011, the Fund rose 33.0% versus declines of 1.2% and 5.0%, respectively for the MSCI WORLD Small Core Index and the Russell Global Small Cap Index.

In the more bullish period from the market bottom on March 9, 2009 through the end of June 2011, RGS rose 143.3% compared to the MSCI WORLD Small Core Index's return of 155.6% and the Russell Global Small Cap Index's gain of 146.0%. These strong market cycle results were a major factor in RGS's ability to outpace both small-cap global benchmarks for the three-year, five-year and since inception (6/30/05) periods ended June 30, 2011. (The Fund also beat the Russell Global Small Cap Index for the one-year period.) RGS's average annual total return since inception was 15.0%.

Energy led the Fund's 10 equity sectors, followed by notable gains from Health Care and Information Technology. Three sectors finished the period with net losses—Materials, Industrials and Consumer Discretionary. The last of these, however, detracted only modestly from first-half results.

At the industry level, two areas dominated. Both the energy equipment & services group and pharmaceuticals stocks contributed in a most healthy way. Of those industries that posted net losses through the end of June, only the metals & mining group made a notable negative impact. While holdings with net gains could be found in each sector, positive results came primarily from RGS's three top-performing sectors.

Lamprell, the Fund's top contributor, provides construction and engineering services for oil and gas rigs and is the leading contractor in the Arabian Gulf, where it has operated for more than three decades. We like its business model, which is driven in large part by demand for younger jack-up rigs. We also looked favorably on its accretive acquisition of MIS because we think it makes a compelling strategic fit—MIS brings onshore capabilities and enhances Lamprell's in-house engineering capabilities. We added to our stake through April.

Robust M&A (mergers and acquisitions) activity carried over from 2010, ramping up in the first half of 2011. In a market often short on organic growth but flush with credit availability and excess liquidity, companies are increasingly looking to grow their businesses through acquisitions. RGS benefitted from this trend as a top holding, Varian Semiconductor Equipment Associates, agreed to be acquired in an all cash deal early in May by its larger rival, Applied Materials. We sold our shares shortly after the announcement was made.

Solar power is widely derided by the short-selling community—SMA Solar Technology and one of its peers had approximately 35-40% short interest—so SMA had become very cheap, particularly for a business with its rate of cash generation. Its stock price was an indirect beneficiary of rising oil prices in the first half. We made additional purchases in January and April.

As for those positions that detracted most from performance, Moshi Moshi Hotline is a Japanese business that offers call centers, back office services, consulting and other services. Its stock fell sharply in the aftermath of the March earthquake and has not yet recovered. Liking its core businesses, dividend yield and attractive valuation, we more than doubled our position in the first half.

We also increased our stake in Raubex Group, a South African road construction and infrastructure development specialist. Its share price was hurt as the company faced delays in major road construction projects, dealt with lower-priced competition from imported Chinese crews and tried waiting out unrest in the ranks of South Africa's national highway administration.

Current month-end performance may be obtained from our Prices and Performance page.