Royce Pennsylvania Mutual Fund Performance Discussion

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

We were pleased with the performance of our flagship, Royce Pennsylvania Mutual Fund (PMF) through the first six months of 2011. This was especially true considering the somewhat schizoid nature of the stock market during the year's first half, with mostly rising share prices through the first four months followed by six weeks of greater volatility than equities had seen since the previous spring and summer. PMF was up 7.1% for the year-to-date period ended June 30, 2011, ahead of its small-cap benchmark index, the Russell 2000 Index, which climbed 6.2% for the same period. The Fund's admittedly narrow advantage was a mix of stronger results in the year's more placid first four months (+11.6% versus +10.8% for the benchmark) and a slightly better showing in the more topsy-turvy market following the interim small-cap high on April 29, 2011 through the end of June (-4.0% versus -4.1%).

On a quarterly basis, the pattern was only slightly different. PMF was up 9.1% in the first quarter, compared to a gain of 7.9% for the Russell 2000, while in the more volatile second quarter, the Fund was down 1.8% versus a loss of 1.6% for the small-cap index. Turning to recent longer-term market cycle periods, PMF's results were competitive with its benchmark. The Fund outperformed the small-cap index from the small-cap market peak on July 13, 2007 through the end of 2011's first half, gaining 7.1% versus 2.2%.

From the market low on March 9, 2009 through June 30, 2011, PMF was ahead of the Russell 2000, up 149.0% versus 148.6%. The Fund trailed from the small-cap trough on July 6, 2010 through the end of June 2011, climbing 39.3% while its benchmark rose 41.9%. (More on the Fund's results over recent market cycles.)

PMF's long-term advantage over the Russell 2000 remained in place, helped in large part by its strong longerterm market cycle returns. The Fund outpaced the small-cap index for the five-, 10-, 15-, 20-, 25- and 30-year periods ended June 30, 2011. The Fund was also up 14.1% for the 35-year period ended June 30, 2011, a long-term record that makes us quite proud.

Three sectors—Industrials, Energy and Information Technology—made notable contributions to first-half performance even as each suffered net losses in the more challenging second quarter. Net gains in the Industrials sector were spread across a number of industry groups, including machinery, commercial services & supplies, and aerospace & defense. The same pattern held for stocks in that sector, with solid but unspectacular contributions from HEICO Corporation, Nordson Corporation, KBR and Kirby Corporation.

Net gains in Energy were a bit more concentrated, with three of PMF's top contributors (each of them a top-10 position at June 30) coming from that sector. CARBO Ceramics is an old Royce favorite that we have owned continuously in the portfolio since 2006 but first purchased in 1996. The company manufactures ceramic proppants, a specialized component in the hydraulic fracturing process. High demand and better-than-expected earnings helped its stock price to rise, prompting us to take some gains in April. Oil and gas contract driller Helmerich & Payne is another long-time holding that we re-purchased in 2006. The company's stock was a bit volatile in the second quarter, but ended the semiannual period strongly, as demand for the company's newer, safer rigs helped draw investors to what we regard as a fundamentally sound and well-managed business.

Continuing with the theme of successful portfolio veterans in the energy services business, Unit Corporation, which we first purchased in PMF in 2002, participated in the good times for its industry and also benefited from effective utilization of its drilling fleet and some interesting exploration and production plays. We have long liked its unique standing as both a contract driller and an exploration and production company, which helped it to stay off the radar of many analysts.

Elsewhere in portfolio, the 'urge to merge' affected technology consulting business SRA International when its acquisition at an attractive premium was announced in April, which led us to continue selling our shares. Women's apparel retailer Ascena Retail Group, known to us for many years as The Dress Barn, has been successfully managing its way through highly challenging times for retailers, with recent earnings stronger than most analysts were anticipating. It was a top-ten holding at the end of June.

At the individual stock level, portfolio losses were mostly modest. A steadily falling stock price allowed us to add shares of RV (recreational vehicle) maker Winnebago Industries in June. Demand has declined in the difficult economy and was not helped when gas prices were spiking earlier in the year. An earnings miss, brought on by lowered demand, detoured investors. Hecla Mining boasts a strong balance sheet, robust earnings, attractively low production costs and positive cash flow from its operations, which include mines in Alaska and Idaho. It has recently met with more than its share of difficulties, including a sharp second-quarter pull-back in precious metals prices, especially silver, the settlement of a decades-old lawsuit and a mine collapse (since repaired and operating again). We sold some shares in May but were otherwise content to hold a decent-sized position.

The sum of all contributions to and detractions from performance for all securities would approximate the Fund's year-to-date performance for the period ended June 30, 2011.

See our June 30, 2011 Semiannual Review and Report to Shareholders for a complete list of holdings for Royce Pennsylvania Mutual Fund as of June 30, 2011.
View the complete list of holdings for Royce Pennsylvania Mutual Fund as of the most recent quarter end.

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