Royce Opportunity Select Fund Performance Discussion

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

The first half of 2011 was reminiscent of the comparable period in 2010 when solid-to strong corporate results helped to generate gains for equities that threatened to be, if only partially, undone by renewed risk aversion related to macroeconomic issues. Growth stocks maintained the market leadership they had established in the second half of 2010, as investors continued to place a premium on companies with above average growth in a world generally devoid of it.

Royce Opportunity Select Fund (ROS), our newest offering for qualified investors, was down 1.2% for the year-todate period ended June 30, 2011, versus a 6.2% gain for its small-cap benchmark, the Russell 2000 Index, for the same period.

The Fund debuted in August 2010, shortly after the market shook off the effects of a sharp correction in early July. Commencing operations in the midst of a rapidly rising market was a mixed blessing. Starting out with a portfolio entirely made up of cash, the Fund was not fully invested during the month of September and thus trailed the market's rapid advance in 2010's last four months.

In addition, the portfolio was seeded with long-term opportunities; that is, we chose companies with a multi-year investment horizon. It was not surprising, then, to find that many of these stocks had not yet reversed course by the end of the first half of 2011. Many positions that we see as attractively value-priced stocks saw their prices sink even lower during the spring correction and then lag during the late-June rebound. Those areas that felt the full effect included several turnaround candidates, many of our micro-cap holdings, and companies in the Financials, Consumer Discretionary and Information Technology sectors.

We were therefore only somewhat disappointed that the Fund failed to keep pace with its benchmark in an environment that was both increasingly turbulent and clearly favored the growth segment of the market. ROS was up 6.2% in the less volatile and more bullish first quarter, compared to a gain of 7.9% for the Russell 2000. The Fund then lost more ground when the market became more tumultuous in the second quarter, losing 6.9% versus a decline of 1.6% for its small-cap benchmark. The Fund's cumulative total return since inception (8/31/10) was 28.4%, a very strong result on an absolute basis.

ROS uses the opportunistic value approach that we employ in Royce Opportunity Fund with the added flexibility to invest in both long and short equity positions and to use a modest amount of leverage. Its singular opportunistic value approach to stock selection for the long portion of the portfolio emphasizes four investment themes—turnarounds, companies with unrecognized assets, undervalued growth stocks and companies with interrupted earnings patterns. In that sense, the Fund differs to a degree from more traditional small-cap value portfolios.

In addition to net losses from the three sectors mentioned above, there was also encouraging news at the sector level. Energy led all areas with a strong contribution to first-half results, followed by solid net gains from Materials and Health Care. Net gains and losses at the industry level reflected the portfolio's respective strengths and weaknesses in its sectors, with one notable exception. The Fund's best-performing industry was the semiconductors & semiconductor equipment group, which hails from the otherwise disappointing Information Technology sector.

Other industries with solid contributions included energy equipment & services companies and the metals & mining group, while net losses came from software stocks, thrifts & mortgage finance stocks and household durables companies.

At the individual stock level, Smith Micro Software, which develops ecommerce and communications software primarily for telecommunications applications, was the largest detractor by a wide margin. Its stock price cratered in early February when the company suspended its full-year 2011 guidance because a large customer pulled back orders and created a glut of inventory for a key product. We more than tripled our stake in the first half, with the bulk of those shares purchased between March and the end of June. Telecommunications vendors frequently must deal with customer-concentration issues, so we view its recent struggles as a manageable, short-term problem. We also think very highly of its core products,

which helped to build our confidence in the company's long-term prospects. Radian Group and MGIC Investment are also long-term plays, and ongoing softness in the mortgage market hurt the price of both stocks. Radian Group provides credit-related insurance coverage and financial services, as well as mortgage insurance, while MGIC Investment primarily provides mortgage insurance.

The Fund benefited from the continued pick-up in M&A (mergers and acquisitions) activity as Varian Semiconductor Equipment Associates agreed to be acquired in an all cash deal early in May. We sold the position shortly after the announcement of the transaction. Union Drilling's share price fluctuated roughly in parallel with the price of oil, but ended the first half on the rise. Better utilization helped the stock of this contract land driller to finish strong.

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