article 07-06-2015

2Q15 Market: Is a More Normalized Environment on the Horizon?

After five years of higher-than-usual returns, we believe that U.S. equity results are moving closer to their longer-term averages, that stocks of economically sensitive companies will be rewarded while interest rate sensitive stocks look likely to lag, and that U.S. small-caps offer attractive risk/return profiles given their greater potential for earnings growth and reasonable valuations.

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Greek Drama Created Underwhelming Results
The Greek default late in June eroded gains—giving equities second-quarter results that more closely hugged the flat line. The tech-oriented Nasdaq Composite was the leader, up 1.8%, followed by the small-cap Russell 2000, which finished the quarter with a gain of 0.4%. The large-cap S&P 500 and Russell 1000 Indexes rose 0.3% and 0.1%, respectively.

Nasdaq and Small-Cap Lead the Way
Based on its strong second-quarter showing, the Nasdaq Composite was the year-to-date leader through 6/30/15, up 5.3% versus a 4.8% return for the Russell 2000 and respective gains of 1.2% and 1.7% for the S&P 500 and Russell 1000.

Long-Term Returns in Excess
Both large-cap and small-cap indexes' three- and five-year average annual total returns for the periods ended 6/30/15 were above 17%, well in excess of each index's historical average.

What a Difference Five Years Makes
Trailing 1-, 3-, 5-, and 10-Year Average Annual Total Returns Ended 6/30/15 (%)

Higher and Higher...
The four major indexes, S&P 500, Russell 1000, Russell 2000, and NASDAQ Composite, all made new all-time highs in the quarter. Notably for the NASDAQ, this index's prior all-time high was established 15 years ago in March 2000.

The Cycle Belonged to Small-Cap
Small-caps continued to lead from the 10/13/14 market low, with the Russell 2000 up 20.6% versus respective gains of 11.7% and 12.5% for the S&P 500 and Russell 1000.

Small-Cap Growth Outgrows Value
Within small-cap, the Russell 2000 Growth Index was up 2.0% for the second quarter versus a loss of 1.2% for the Russell 2000 Value Index. Year-to-date through 6/30/15, the advantage was even more dramatic, with the small-cap growth index rising 8.7% versus a gain of 0.8% for small-cap value. Trailing returns for the one-, three-, five-, and 10-year periods all favored small-cap growth while longer-term spans—15, 20, 25, 30, and 35 years saw outperformance by small-cap value.

Healthy and Informed
Health Care and Information Technology were the best performing sectors in the Russell 2000 through 6/30/15, with the first of the two leading by a wide margin, while Utilities and Materials were the worst performers in the year's first half.

Rising Rates Present No Problem for Equities
Cumulative Performance Beginning 5/2/13 (Treasury Yield Low) Through 6/30/15 (%)

A Global Bull Encounters a Greek Drama
Late in June, equity investors had to address the potential consequences of an economic Greek tragedy. Investors' concerns about a Greek default stalled what was otherwise a robust recovery in non-U.S. equities. The Russell Global ex-U.S. Small Cap Index returned 3.9% versus a gain of 0.7% for the Russell Global ex-U.S. Large Cap Index for the second quarter. Year-to-date results remained quite solid—the small-cap index led the way, with a gain of 7.7% while the Russell Global ex-U.S. Large Cap Index rose 4.2%.

Micro-Caps Strong While Mid-Caps Stumble
Micro-caps also remained on the upswing, with the Russell Microcap Index up 2.8% during the quarter and 6.0% year-to-date through 6/30/15. Mid-caps, as measured by the Russell Midcap Index, stumbled late in the quarter and fell 1.5%, though they remained in the black year-to-date, up 2.4%.

Royce Funds with Highest Average Annual Total Returns - Five Years Ended 6/30/15 (%)

U.S. Funds QTR* YTD* 1YR 5YR 10YR Gross
Operating
Expenses
Net
Operating
Expenses
Opportunity -0.44 0.67 -2.75 15.62 8.58 1.15 1.15
Pennsylvania Mutual -1.06 0.08 -2.61 13.40 7.71 0.92 0.92
Smaller-Companies Growth 4.05 9.05 8.92 14.20 8.85 1.45 1.45
Dividend Value 1.65 2.71 -2.54 13.75 9.10 1.55 1.55
Total Return -1.01 0.74 -0.63 13.70 7.42 1.19 1.19
Global/International Funds QTR* YTD* 1YR 5YR 10YR Gross
Operating
Expenses
Net
Operating
Expenses
Global Financial Services 4.41 7.22 7.05 17.07 8.71 1.93 1.74
European Small-Cap 6.55 11.64 -9.03 9.58 N/A 2.98 1.29
International Small-Cap 5.08 4.55 -8.92 7.01 N/A 1.841 1.541
Global Value 5.20 7.71 -8.38 6.74 N/A 1.651 1.541
Indexes QTR* YTD* 1YR 5YR 10YR Gross
Operating
Expenses
Net
Operating
Expenses
Russell 2000 Index 0.42 4.75 6.49 17.08 8.40 N/A N/A
Russell Global Small Cap Index 2.39 6.37 0.34 11.77 7.36 N/A N/A
Russell Global ex-U.S. Small Cap Index 3.93 7.74 -3.46 8.99 7.07 N/A N/A
Russell Europe Small Cap Index 6.19 10.01 -4.56 13.09 7.33 N/A N/A

* Not Annualized
1 Restated to reflect the Fund's revised contractual investment advisory fee rate as of July 1, 2015.

Important Performance and Expense Information

All performance information reflects past performance, is presented on a total return basis, and reflects the reinvestment of distributions. Returns are those of the Funds’ Investment Class or Service Class if no Investment Class exists. Performance prior to the date of commencement of certain Funds’ Investment Class shares (Royce Smaller-Companies Growth Fund - 3/15/2007, Royce Dividend Value Fund - 9/14/2007, and Royce Global Value Fund – 8/31/10) reflects Service Class results. Shares of a Fund's Service, Consultant, R, and K Classes bear an annual distribution expense that is not borne by the Fund’s Investment Class. Past performance is no guarantee of future results. Current performance may be higher or lower than performance quoted. Returns as of the most recent month-end may be obtained here. Investment return and principal value will fluctuate, so that shares may be worth more or less than their original cost when redeemed. For detailed information on the one-, five-, 10-year, and since inception performance as of quarter-end and for expense information for The Royce Funds, please see our Prices and Performance page.

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. 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. All index returns for the Russell Global ex-U.S. Small Cap and the Russell Global ex-U.S. Large Cap indexes include net reinvested dividends and/or interest income. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.

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