article 06-30-2014

Royce Enterprise Select Fund Manager Commentary

Royce Enterprise Select Fund enjoyed a strong first half on an absolute basis. The Fund rose 5.8% for the year-to-date period ended June 30, 2014 compared to the 5.9% gain for its small- and mid-cap benchmark, the Russell 2500 Index, for the same period.

As the year began, there was a lot of speculation as to what direction equities would take. Considering the breakneck pace of returns in 2013, many market watchers argued that valuations were unsustainably high. Others held that with interest rates still basically at zero and the economy growing slowly but steadily, the case for a “melt up” remained strong. Returns for most stocks continued to climb in the first quarter, though overall results were far more muted. The Fund participated in this lower key-up phase, gaining 1.7% for the first quarter. The arrival of spring saw many markets pausing and trying to make sense of a terrible winter, a new Federal Reserve chair, and some alarming events in Syria and Ukraine. These worries proved short-lived, though they did create a bit more volatility than we saw in the earlier part of the year. For the second quarter, we were pleased that Enterprise Select outpaced the Russell 2500, increasing 4.0% versus 3.6%. The Fund’s average annual total return since inception (9/28/07) was 8.3%.

Although it was not a stalwart performer in the market as a whole, the Consumer Discretionary sector was the portfolio’s top contributor during the first half, helped by strong results from the auto components, specialty retail, and household durables industries. Effective stock picking was critical to the sector’s net gains. Standard Motor Products manufactures and distributes replacement automotive parts. Its business has benefited from the aging of U.S. vehicles as well as its vertical integration strategy of acquiring suppliers, which included buying some eight companies over the last three years. To a lesser extent, its temperature control replacement parts segment, which serves the HVAC marketplace, has managed well through unfavorable weather that seemed to be turning for the better by the end of June. From the Energy sector, Helmerich & Payne provides contract drilling of oil and gas wells in the Gulf of Mexico and South America and operates land and platform rigs. The company has long enjoyed an advantage in its industry by making higher-quality, technologically superior rigs. In late April, the firm reported record quarterly revenues and rig activity, part of a longer-term string of success that helped to push its share price higher. Its technologically superior offerings are driving market share gains for companies eager to reduce drilling costs by upgrading to its more efficient rigs. Information Technology business Skyworks Solutions is a leading supplier of radio frequency (RF) chips to wireless smartphones. Its success has been driven by three industry tailwinds: continued smartphone adoption on a global basis, 4G network build outs in Europe and China, and increased RF chip content in 4G networks compared to 3G. We also like its diversification strategy into industrial, home automation, smart metering, and automotive applications.

Individual stock losses were modest. We chose to hold our shares of Mohawk Industries in spite of its volatile, downward sloping stock price. The company designs, manufactures, and distributes flooring for the residential and commercial markets. The company offers carpet, ceramic tile, laminate, wood, stone, vinyl, and rugs. The domestic carpet business continues to struggle even as housing has rebounded. Mohawk, however, has managed to grow revenues and operating income in part by what we think was a savvy strategy of diversifying into a number of other flooring types, such as wood and laminate. It has also held onto market share and cut costs. We reduced our position in AVX Corporation in the first quarter for valuation reasons. The company makes a variety of passive electronic components, including ceramic and tantalum capacitors that are used in many electronic products to store, filter, or regulate electric energy.

We continue to be more disposed toward (and thus positioned in) cyclical sectors. Industrial companies remain an area of focus, with particular attention on areas that are positioned to take advantage of the U.S.’s edge in feedstock for natural gas and derivatives, whether in the form of capital equipment businesses and/or specialty chemical companies that benefit from our country’s current structural advantage in energy. Technology also remains an area of high interest. Our preference remains with companies that are levered for ongoing smartphone penetration globally. More specifically, we are focused on the massive build out of 4G telecom networks around the world, including top-15 position Rogers Corporation and Skyworks Solutions. More recently, we have also been building positions in certain Consumer Discretionary names, such as Dollar Tree and Finish Line (The).


GOOD IDEAS THAT WORKED
Top Contributors to Performance
Year-to-Date through 6/30/14
1

Helmerich & Payne 0.67
Skyworks Solutions 0.65
Standard Motor Products 0.56
Kennedy-Wilson Holdings 0.46
Westlake Chemical 0.41
1 Includes dividends

GOOD IDEAS AT THE TIME
Top Detractors from Performance
Year-to-Date through 6/30/14
1

Mohawk Industries -0.16
AVX Corporation -0.16
SEACOR Holdings -0.14
Support.com -0.13
Kennametal -0.12
1 Net of dividends

Average Annual Total Returns as of Quarter-End 6/30/14 (%)

  QTR YTD 1YR 3YR 5YR SINCE
INCEPTION
INCEPTION
DATE
 
Enterprise Select 3.97 5.78 22.09 14.23 16.93 8.30 9/28/2007
Russell 2500 3.57 5.95 25.58 15.51 21.63 8.31 N/A
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Annual Operating Expenses: Gross 3.08% Net 1.24%

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

Important Disclosure Information

All performance information in this Report reflects past performance, is presented on a total return basis, reflects the reinvestment of distributions, and does not reflect the deduction of taxes that a shareholder would pay on fund distributions or the redemption of fund shares. Past performance is no guarantee of future results. Investment return and principal value of an investment will fluctuate, so that shares may be worth more or less than their original cost when redeemed. Shares redeemed within 180 days of purchase may be subject to a 1% redemption fee, payable to the Fund, which is not reflected in the performance shown above; if it were, performance would be lower. Current month-end performance may be higher or lower than performance quoted and may be obtained here. Gross operating expenses reflect the Fund’s total gross annual operating expenses and include management fees and other expenses. Net operating expenses reflect contractual fee waivers and/or expense reimbursements. All expense information is reported as of the Fund’s most current prospectus. Royce & Associates has contractually agreed to waive fees and/or reimburse operating expenses to the extent necessary to maintain the Fund’s net annual operating expenses, (excluding dividend and interest expenses relating to short sale activities, brokerage commissions, taxes, interest, litigation expenses, acquired fund fees and expenses, and other expenses not borne in the ordinary course of business), at or below 1.24% through April 30, 2015 and at or below 1.99% through April 30, 2024. Regarding the two “Good Ideas” tables shown above, the sum of all contributors to, and all detractors from, performance for all securities in the portfolio would approximate the Fund’s year-to-date performance for 2014.

The thoughts expressed in this piece concerning recent market movements and future prospects for small company stocks are solely the opinion of Royce at June 30, 2014, and, of course, historical market trends are not necessarily indicative of future market movements. Statements regarding the future prospects for particular securities held in the Funds' portfolios and Royce's investment intentions with respect to those securities reflect Royce's opinions as of June 30, 2014 and are subject to change at any time without notice. There can be no assurance that securities mentioned above will be included in any Royce-managed portfolio in the future.

This material is not authorized for distribution unless preceded or accompanied by a current prospectus. Please read the prospectus carefully before investing or sending money. The Fund invests primarily in small-cap and mid-cap companies, which may involve considerably more risk than investing in larger-cap stocks. The Fund also invests primarily in a limited number of stocks, which may involve considerably more risk than a less concentrated portfolio because a decline in the value of these stocks would cause the Fund's overall value to decline to a greater degree. (Please see "Primary Risks for Fund Investors" in the prospectus.) The Fund may sell securities short which involves selling a security it does not own in anticipation that the security's price will decline. Short sales present unlimited risk on an individual stock basis since the Fund may be required to buy the security sold short at a time when the security has appreciated in value. The Fund may invest up to 25% of its net assets in foreign securities (measured at the time of investment), which may involve political, economic, currency, and other risks not encountered in U.S. investments. (Please see "Investing in Foreign Securities" in the prospectus.) Russell Investment Group is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. Russell® is a trademark of Russell Investment Group. The Russell 2500 Index measures the performance of the 2,500 smallest publicly traded U.S. companies in the Russell 3000 Index. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.

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