Over the last two calendar years, Royce Micro-Cap Opportunity Fund (formerly Royce Opportunity Select Fund) put together a record of terrific results on both an absolute and relative basis. This trend continued in the first half of 2014. The Fund advanced 3.3% for the year-to-date period ended June 30, 2014, slightly outpacing its small-cap benchmark, the Russell 2000 Index, which rose 3.2% for the same period.

The year began on the same bullish note on which 2013 ended, though in far less dynamic fashion. For the first quarter, the Fund gained 5.9%, a strong performance that helped to mitigate the effect of the subsequent down phase. The correction that began in early March was tougher on the Fund than on its benchmark. It put the Fund out of sync with many larger small-caps, though it was consistent with what was happening with micro-cap companies. The Fund fell 2.5% in the second quarter. However, second-quarter underperformance did nothing to hurt the portfolio’s relative advantage over longer time periods. Micro-Cap Opportunity beat the Russell 2000 for the one-, three-year, and since inception (8/31/10) periods ended June 30, 2014. The Fund’s average annual total return since inception was 22.5%. We remain quite pleased with Fund’s absolute and relative long-term results.

Information Technology was the Fund’s largest sector at the end of June and a net gainer for the semiannual period. Higher corporate profitability looks likely to trigger a round of long-overdue CAPEX spending. The market for PCs has been also improving of late, and there are a number of new devices and related technologies due for release in the next year or so on the already robust tablet and mobile device fronts. This could result in simultaneously strong markets for PCs, mobile, and tablets, which would be excellent news for much of the sector—and many of our holdings within it. In addition, the housing market continues to grow and looks to us as though it is in an extended cycle while non-residential construction looks poised for a long-term recovery following pretty dismal results in 2013. Building activity has been on the rise so far in 2014. Many retailers suffered through the first half, pushing stock prices down to attractively cheap levels.

Six of the Fund’s eight equity sectors posted net gains in the first half. Energy was the portfolio’s top performer, followed by Industrials. The Fund’s leading industries were the semiconductors & semiconductor equipment groups and oil, gas & consumable fuels stocks. The first of these was home to two of the portfolio’s top performers year-todate through the end of June. RF Micro Devices makes radio frequency (or RF) chips primarily for wireless applications. Its performance is often in line with the tech business cycle, though it has historically shown increased volatility based on the presence or absence of hot-selling new devices. We built our stake when its price was falling in order to gain exposure to the fast-growing wireless flash niche. SunEdison, which was 2013’s top contributor, produces electronic-grade polysilicon used for electronics, solar cells, and film devices while also developing solar power projects. The demand for solar technology keeps heating up, with improved technological efficiency helping to lower costs. Oil and natural gas company Goodrich Petroleum benefited from the sharp increase in drilling activity in Texas and North Dakota.

We substantially increased our position in Extreme Networks, which provides switching solutions for local area networks (LAN). Disappointing earnings, based in part on lowerthan- expected sales to government entities, and revised guidance drove investors away. We like its recent acquisition of a complementary business, which we think can help the company to achieve a solid earnings stream. Quiksilver is a youth-oriented apparel and footwear maker that operates under its own brand name as well as Roxy and DC. Like many retailers, it suffered through an awful first half. We like the way it handled the challenges it faced and its new management.

We typically act in a very deliberate and disciplined manner in managing the portfolio’s assets. In the first half, this meant selling many strong performers to more momentum-based investors. We think this is a prudent strategy, as it allows us to refresh the portfolio with companies trading at attractively low P/B and price-to-sales ratios. Many of these newer holdings (or additional shares of existing holdings that have not yet reversed course) endured tough times throughout the second quarter. While disappointing on a short-term basis, we were comfortable with these decisions. It is important to pare back portfolio successes and reposition the proceeds in an attempt to set the portfolio up for future growth. We also want to maintain what we believe is a reasonable valuation level for the portfolio taken as a whole. Many of these purchases were in technology, housing, retail, and non-residential construction, including M.D.C. Holdings, Louisiana-Pacific Corporation, and J.C. Penney Company.

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

Annual Operating Expenses: Gross 1.78% Net 1.29%

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

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