We were very pleased with the relative and absolute performance from Royce International Micro-Cap Fund in the first half of 2014. The Fund climbed 7.9% for the year-to-date period ended June 30, 2014, beating its benchmark, the Russell Global ex-U.S. Small Cap Index, which returned 7.5% for the same period.

Whereas in the first quarter of 2013 domestic small-cap indexes generally outpaced their non-U.S. peers, the first quarter of 2014 saw signs of a reversal of leadership and the start of a strong comeback for many non-U.S. small-caps. In the first quarter of 2014, the Fund posted an impressive 3.0% gain, just shy of its benchmark’s 3.2% gain. The Fund’s exposure to holdings in Hong Kong—which, like most Asian markets in the first quarter, struggled to keep pace with their Western peers—was a significant detractor to firstquarter performance. Holdings in Japan, as well as Brazil, also hurt performance.

While European markets pulled back, many parts of Asia made a recovery in the second quarter. Holdings in Japan, India, and South Korea also made significant contributions to second-quarter performance. During this period, International Micro-Cap rose 4.7% versus a gain of 4.2% for the Russell Global ex-U.S. Small Cap. The Fund also outperformed the index in the one-year period ended June 30, 2014.

Six of the Fund’s eight equity sectors were positive contributors to first-half performance. Industrials made the largest impact by a wide margin, with Information Technology and Materials also making sizable impacts. Detracting from performance at the sector level were Consumer Discretionary and Financials. At the industry level, machinery, semiconductors & semiconductor equipment, and software were top contributors to performance, while media detracted. Pico Far East Holdings is a Hong Kong-based business that makes displays for companies presenting at conventions. We like that major global brands such as Mercedes Benz, Lexus, and Citibank trust the company to build signs and displays that accurately portray their brand images. The slowdown in China’s economy hurt Pico Far East’s business, but management keeps a close eye on costs and focuses on the long term. We increased our stake in January.

Anxin-China Holdings is a Hong Kong-based provider of safety monitoring hardware and software. The stock declined throughout the first half, the fall driven largely due to a slowdown in the number of government projects being awarded as a result of a nationwide corruption probe. Brazil’s stock market suffered through a miserable first half, which helped two holdings earn spots on RMI’s list of detractors. Brasil Brokers Participacoes is one of the country’s two leading real estate brokerages. Its business has been hurt by poor consumer sentiment (the worst since 2008) and possibly some modest erosion in market share. We built our stake during the first half while initially choosing to part ways with another, similarly named Brazilian company Brasil Insurance Participacoes e Administracao, which operates insurance brokerages. In July, we re-evaluated the situation and reinitiated a position. The nosedive in its share price in the spring created greater losses than we were prepared to accept.

Top holding and largest contributor to year-to-date performance Magellan Aerospace is an Ontario-based company that serves the civil aerospace and defense market. We like the business’s unlevered balance sheet and that management runs the business with a long-term focus similar to our own. The company’s share price was basically flat going into the second quarter, dipping briefly in mid-March before the stock gradually ascended. This seemed to be the result of management executing effectively and the market beginning to take more notice of the business. We started reducing our position in April. Australia-based TFS Corporation owns and manages sustainable sandalwood plantations. We first bought shares three years ago when negative news surrounded the company’s management. During these hard times the CEO was buying shares, which helped to bolster our confidence in what we thought was a good business. In late February the stock significantly climbed after the announcement of an exclusive long-term supply agreement with a global pharmaceutical company that wanted to use sandalwood for dermatology treatments. RIB Software makes specialized software for the construction industry. Based in Stuttgart, the company enjoyed a more or less steadily rising share price during the first half, driven in large part by the announcement in March of strong revenue growth in fiscal 2013. We began to sell our shares in January.

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

Annual Operating Expenses: Gross 3.88% Net 1.71%

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

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