Royce Value Fund Performance Discussion

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

Royce Value Fund (RVV) managed to effectively roll with the punches as the equity markets grew more volatile later in the first half of 2011, making us satisfied with its results through the year's first six months. RVV gained 6.2% for the year-to-date period ended June 30, 2011, essentially even with its small-cap benchmark, the Russell 2000 Index, which was up 6.2% for the same period. The Fund did especially well when share prices were mostly rising into the last days of April.

During the first quarter, RVV rose 10.0% versus 7.9% for the small-cap index. The second quarter was a less comfortable time, with a host of factors, including calamities in Japan, devastating floods and tornadoes here in the U.S., discouraging economic data and the renewed possibility of a European debt crisis all working together to keep the stock market falling through all of May and the first two weeks of June.

After hitting an interim high on April 29, small-caps plummeted before the mid-June rally helped stocks to recover some gains. The Fund fell 3.5% in the second quarter, behind the 1.6% decline for the Russell 2000 Index.

Recent market cycle results were strong on an absolute basis, though more mixed when compared to the benchmark. In the more bearish peak-to-current period from the smallcap peak on July 13, 2007 through June 30, 2011, RVV was up 11.4% versus a 2.2% gain for the Russell 2000. From the small-cap trough on March 9, 2009 through June 30, 2011, the Fund rose 143.0% compared to a gain of 148.6% for its benchmark.

Finally, RVV gained 40.3% from the interim small-cap low on July 6, 2010 through the end of June 2011 versus a 41.9% return for the small-cap index. (More on the Fund's results over recent market cycles.) We were very pleased with the Fund's longer-term average annual total returns. RVV outperformed the Russell 2000 for the one-, five-, 10-year and since inception (6/14/01) periods ended June 30, 2011. The Fund's average annual total return since inception was 12.6%.

Three sectors dominated results in the first half—Energy, Information Technology and Consumer Discretionary, while the only notable loss at the sector level was in Materials stocks, home to the industry that detracted most from performance in the semiannual period, metals & mining companies.

Top-20 position Pan American Silver suffered from the twin effects of tarnished silver prices in the second quarter and its exposure to Peru, whose president-elect campaigned on the idea of nationalizing or heavily taxing the country's mining industries. Although he took a far more moderate position after being elected, these threats exacerbated the share prices decline of many silver mining businesses back in April. Our own thought was that this leading low-cost silver producer's exposure to Peru is at a manageable level, and the long-term prospects of current operations in Mexico and Argentina were enough to keep us happily holding at the end of June.

The prospect of new, margin-contracting regulations from the U.S. government played a large role in the struggles of LHC Group in the first half. The company provides home healthcare and in our view is a well-managed business in an attractive niche. Its stock was trading cheaply when we were building our position in 2010 because of uncertainty about how the Affordable Care Act would affect its industry. However, we are now carefully watching the stock, thinking that it could potentially benefit from the wave of industry consolidation that may result once new home healthcare rules are in place, and as long as the new regulations do not depress margins too greatly.

One potential benefit of owning small-cap stocks is that larger businesses are often interested in acquiring them, which was the case with the Fund's top contributor in the first half, Varian Semiconductor Equipment Associates. Re-initiating a position in August 2010, we had built a large stake by the end of last year. For several years, we had liked the company's market leadership position in the semiconductor capital equipment business as well as its low-debt balance sheet. We began to take gains after hearing the news of its acquisition at a healthy premium.

Top-ten position Helmerich & Payne is a contract driller that provides offshore drilling services worldwide and land drilling in the U.S. Its stock price moved around quite a bit during the year's opening half, as oil prices were very volatile. However, it finished June near its 2011 high, due in large part to demand for its innovative services and the company's large number of new, modernized rigs that offer both higher safety and increased efficiency. We were impressed that management chose to upgrade its rig supply when most competitors were content to refurbish theirs.

The price of Unit Corporation was similarly volatile in the first half and also ended the period higher than where it began. First buying shares in the portfolio late in 2002, we have long been interested in its position as a hybrid business in the oil and natural gas industry. It provides services to other exploration and production companies well as operating its own business in those areas. Still liking its long-term potential, we added to our stake in June.

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 Value Fund as of June 30, 2011.

View the complete list of holdings for Royce Value Fund as of the current quarter end.

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