article 01-07-2015

Small-Caps Rebound in 4Q But Lag for 2014

We believe that widening credit spreads, increasing volatility, and decreasing stock correlation should help active management and allow stock pickers to emerge as performance leaders. We also expect equity returns to remain attractive, though we anticipate a decrease from their currently high levels.

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After a dreadful third quarter, small-caps rallied in October and December to outpace their large-cap counterparts in the fourth quarter. The small-cap Russell 2000 Index was up 9.7% for the quarter versus gains of 4.9% for both the large-cap Russell 1000 and S&P 500 Indexes. The tech-oriented Nasdaq Composite was up 5.4%, just ahead of its large-cap counterparts.

Rising Rates, Rising Equities
Cumulative Performance Beginning 5/2/13 (Treasury Yield Low) Through 12/31/14 (%)

For the year ended 12/31/14, however, small-caps were no match for their larger siblings. The Russell 2000 finished the year up 4.9% compared to gains of 13.2%, 13.7%, and 13.4% for the Russell 1000, S&P 500, and the Nasdaq Composite, respectively.

Although all four indexes delivered outstanding performance for the trailing three- and five-year periods ended 12/31/14 (15%+ on an average annual total return basis), small-caps lagged large-caps for the three-year period (largely due to 2014 performance).

While the Russell 2000, Russell 1000, and S&P 500 reached new highs in December, the high established by the Nasdaq Composite in March 2000 remained intact.

In sharp contrast to their domestic peers, non-U.S. equities extended their third-quarter performance woes through the end of 2014. The Russell Global ex-U.S. Small Cap Index was off 4.5% while the Russell Global ex-U.S. Large Cap Index was down 3.7% during 2014's fourth quarter. For the full year the story was similar. Both indexes were in negative territory, with the Russell Global ex-U.S. Small Cap and Russell Global ex-U.S. Large Cap Index off 3.6%.

Domestic Small Stands Tall
Trailing One-, Three-, Five-, and 10-year Average Annual Total Returns Ended 12/31/14 (%)

Within the Russell 2000, Utilities and Health Care were the best-performing sectors for the quarter and the full year.

For the second consecutive quarter, growth led value within small-cap. The Russell 2000 Growth Index finished the quarter up 11.1% versus a gain of 9.4% for the Russell 2000 Value Index. Full year results were similar as the Russell 2000 Growth gained 5.6% versus 4.2% for the Russell 2000 Value Index. Three-, five-, and 10-year results also favored growth.

Micro-cap results, as measured by the Russell Microcap Index, improved significantly during the quarter, with the index up 11.2%; for the full year, the micro-cap index was up 3.6%, trailing its larger peers. In contrast, the Russell Midcap Index continued its solid performance for the quarter (up 5.9%) and for the full year (up 13.2%).

Important Disclosure Information

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. Investments in securities of micro-cap, small-cap, and/or mid-cap companies may involve considerably more risk than investments in securities of larger-cap companies. (Please see “Primary Risks for Fund Investors” in the prospectus.) Investments in foreign companies may be subject to different risks than investments in securities of U.S. companies, including adverse political, social, economic, or other developments that are unique to a particular country or region. (Please see “Investing in International Securities” in the prospectus.)

The thoughts concerning recent market movements and future prospects for small-company stocks are solely those of Royce & Associates, LLC, and, of course, there can be no assurances with respect to future small-cap market performance. All indexes referenced are unmanaged and capitalization-weighted. All index returns include net reinvested dividends and/or interest income. 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 2000 Index is an index of domestic small-cap stocks that measures the performance of the 2,000 smallest publicly traded U.S. companies in the Russell 3000 Index. The Russell 1000 index is an index of domestic large-cap stocks. It measures the performance of the 1,000 largest publicly traded U.S. companies in the Russell 3000 index. The Russell 2000 Value and Growth indexes consist of the respective value and growth stocks within the Russell 2000 as determined by Russell Investments. The Russell Microcap Index includes 1,000 of the smallest securities in the small-cap Russell 2000 Index, along with the next smallest eligible securities as determined by Russell. The Russell Midcap Index measures the performance of the mid-cap segment of the U.S. equity universe. It includes approximately 800 of the smallest securities in the Russell 1000 Index. The Russell Global ex-U.S. Small Cap Index is an index of global small-cap stocks, excluding the United States, The Russell Global ex-U.S. Large Cap Index is an index of global large-cap stocks, excluding the United States. The S&P 500 is an index of U.S. large-cap stocks selected by Standard & Poor's based on market size, liquidity, and industry grouping, among other factors. The Nasdaq Composite is an index of the more than 3,000 common equities listed on the Nasdaq stock exchange. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.

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