Royce Value Plus 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 same period in 2010 when reasonably good corporate performance generated early gains for equities only to be partially unwound by renewed risk aversion related to macroeconomic issues. Growth stocks maintained their leadership position established in the second half of 2010, as investors continued to place a premium on companies with above-average growth in a world otherwise devoid of it.  

For the year-to-date period ended June 30, 2011, Royce Value Plus Fund gained 4.1% compared to a 6.2% return for its small-cap benchmark, the Russell 2000 Index, for the same period. While solid from an absolute standpoint, we were somewhat disappointed that the Fund failed to keep pace with its benchmark in an environment that clearly favored the growth segment of the market. RVP is somewhat unique among our offerings in that it begins with our traditional margin of safety, quality and valuation disciplines and then overlays that framework on companies that we believe offer above-average growth prospects. In that sense, the Fund is not a traditional small-cap growth fund that might adhere to more relative valuation standards. Nonetheless, it is our intention to capture more of the upside in markets than we have in recent periods.

During the strong first quarter, RVP rose 6.9%, falling behind the Russell 2000, which gained 7.9%. In the volatile second quarter, which saw a 10.1% correction in the Russell 2000 from the 2011 high on April 29 to the subsequent low on June 13, the Fund lost a bit more ground, falling 2.6% versus a drop of 1.6% for the benchmark. Examining performance patterns following the cycle lows, we saw the Fund hold its own in the down periods while it struggled to keep pace in the dynamic up periods. From the bottom on March 9, 2009 through June 30, 2011, RVP climbed 124.1% compared to the Russell 2000 Index's advance of 148.6%. (More on the Fund's results over recent market cycles.)

The Fund's intermediate term results have been affected by this out of sync moment, as RVP trailed its benchmark for the one-, three- and five-year periods. However, long-term results remain compelling, with the Fund outperforming over the 10-year and since inception (6/14/01) periods. RVP's average annual return since inception was 13.2%.

Several factors led to the relative underperformance—specifically, the Fund was too conservatively positioned coming out of the recession and bear market precipitated by the financial crisis; the portfolio also contained more special situations and turnaround candidates, and fewer traditional growth companies. We have made, and continue to make, adjustments to amend these issues, and believe that we have more appropriately positioned RVP to participate in an economic environment that is gradually moving from recovery to a slow but sustainable expansion.

Information Technology was the standout sector in the first half, which was very gratifying given our increased exposure. Two of the Fund's three top-performing industries—electronic equipment, instruments & components, and internet software & services—were first and third best, with energy equipment & services taking the second spot. Interestingly, computers & peripherals was the worst-performing industry group during the first half, also coming from within Information Technology.

IPG Photonics, after contributing handsomely in 2010, was also the top performer over the first six months of 2011. This leading manufacturer of fiber lasers and amplifiers experienced continued expansion in end markets for industrial cutting, marking and welding applications that utilize fiber laser technology. Already surpassing 2008 peak earnings levels, we believe that accelerating expansion in global end markets combined with IPG's first mover advantage in numerous laser applications leaves the company well-positioned for continued success.

The Fund also benefited from the continued pick-up in mergers and acquisition activity as Varian Semiconductor Equipment Associates agreed to be acquired in an all cash deal early in the second quarter.

As for those holdings that detracted from performance in the first half, RVP's position in NutriSystem was a clear disappointment. This provider of weight loss management systems that sells directly to consumers through the internet and other media channels had a big drop in new customer starts early in the year and responded with heavy promotions, which had a significant negative impact on margins. While comfortable with the balance sheet and cash flow generation, we decided to sell our position as competition and margin pressure diminished the longer- term growth story of the business.

Finisar, a leading manufacturer of fiber-optic equipment and subsystems for high-speed communications also was a disappointment, though one that we believe is more short term in nature. It suffered from an industry-wide inventory correction that began in late 2010 and continued into 2011. While unpleasant in the short run, we believe that underlying demand for optical systems is very healthy due to increasing demands on networks driven in large part by the explosion in tablet and cloud computing.

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 Plus Fund as of June 30, 2011.

View the complete list of holdings for Royce Value Plus Fund as of the most recent quarter end.

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