article 12-31-2013

Royce 100 Fund Manager Commentary

A strong absolute performance but a disappointing relative result left us with mixed emotions about the calendar-year showing for Royce 100 Fund. The Fund gained 30.9% in 2013, trailing its small-cap benchmark, the Russell 2000 Index, which was up 38.8% for the same period.

After finishing 2012 by beating its benchmark in the second half of the year (+9.6% versus +7.2%), we were confident that the kind of stocks that we favor—those with strong balance sheets, high returns on invested capital, and the ability to generate free cash flow, many in cyclical sectors—were poised for a solid run of market leadership after lagging more defensive areas of the market in 2011 and the first half of 2012. This was not the case, however, as 2013 saw a resurgence from those same defensive areas. And while the performance of several Fund holdings in cyclical sectors picked up nicely in the second half of 2013, their improved performance was not enough to vault the Fund past its benchmark for the calendar year.

The opening quarter of 2013 was highly bullish, especially for micro-, small-, and midcap stocks. The Fund did very well on an absolute basis in this period, though it fell behind the Russell 2000, up 11.1% compared to 12.4% for the small-cap index. The Fund then fell further behind in the far more volatile second quarter, which was disappointing—our disciplined approach has historically helped the Fund to weather down and/or volatile periods effectively by losing less than its benchmark. In the second quarter, however, the Fund fell 0.5% versus a 3.1% gain for the Russell 2000. We were pleased to see the Fund bounce back strong in the third quarter, which was a more placid bull phase like the first quarter. Investors had plenty to digest between the end of March and early July: rising interest rates—the 10-year Treasury yield hit a 2013 low on May 2—less-than-encouraging news out of China and other important developing economies, and the Fed’s initially vague promise in June that it would begin to taper its monthly bond-buying program by some amount at some point later in the year. Indeed, investors were uncommonly sanguine through much of 2013. Good contrarians that we are, this new-found serenity was cause for a bit of worry on our part, though it did not keep us from smiling at the Fund’s strong third quarter—up 10.6% versus 10.2% for the Russell 2000. The Fund’s fourth-quarter results were more subdued on a relative basis, with the Fund increasing 7.0% compared to 8.7% for its benchmark.

The Fund, which marked its first full decade of history at the end of June, also beat the Russell 2000 for the 10-year and since inception (6/30/03) periods ended December 31, 2013. (Click here for market cycle results.) The Fund’s average annual total return since inception was 12.0%.

­Industrials led all of the Fund’s equity sectors by a comfortable margin, though strong contributions also came from Information Technology, and all eight sector groups ended the year with net gains. Three of 100’s top performers came from the Industrials sector. Towers Watson & Company saw multiple expansion as several notable client wins and strong enrollment growth solidified its position as the leading provider and manager of private health insurance exchanges. We see this as a significant emerging growth opportunity that can supplement the firm’s dominant but mature benefits and consulting business. So while we took gains as its stock price soared, it was a top-30 position at year-end. Manpower Group runs a global business providing employment services that include temporary staffing services, contract services, and training and testing of temporary and permanent workers. With almost two-thirds of its revenues coming from Europe, this Milwaukee-based firm has become a bellwether for European economic recovery. The company faced staffing growth declines in most European countries, though this came in the context that 2014 would see a rebound. Manpower’s aggressive $150 million SG&A (Selling, General and Administrative Expenses) reduction and tax benefits from a French stimulus plan (France is one of Manpower’s largest revenue sources) powered the rise in its stock price. Operating and shareprice results for CIRCOR International were revitalized by a new CEO who appears to have a solid plan to unlock the untapped earnings power and potentially double profit margins over time for this specialty valve maker.

Fresnillo and Randgold Resources ADR were part of a number of disappointments in the metals & mining industry, which could not escape the negative impact on revenue and stock prices of the 36% and 28% drops in silver and gold prices, respectively, in 2013. Acacia Research was challenged by slow-to-materialize deals with higher valuations as well as increased resistance from certain potential patent licensees—both cyclical characteristics of the tech licensing and patent enforcement business that typically leads to lumpiness in results. This model does not play well on Wall Street, so it was no surprise that its stock’s subsequent earnings disappointments led its share price to fall. We initiated a position in July and built it into September.


GOOD IDEAS THAT WORKED
Top Contributors to 2013 Performance
1

Towers Watson & Company Cl. A 1.26%
ManpowerGroup 1.07
CIRCOR International 0.92
Harman International Industries 0.89
Federated Investors Cl. B 0.84
1 Includes dividends

GOOD IDEAS AT THE TIME
Top Detractors from 2013 Performance1

Fresnillo -0.52%
Acacia Research -0.39
Randgold Resources ADR -0.33
Major Drilling Group International -0.32
Intrepid Potash -0.20
1 Net of dividends

Average Annual Total Returns as of Quarter-End 12/31/13 (%)

  QTR YTD 1YR 3YR 5YR 10YR Since
Inception
Inception
Date
100 7.04 30.85 30.85 10.90 18.63 11.50 11.99 6/30/2003
Russell 2000 8.72 38.82 38.82 15.67 20.08 9.07 10.94 N/A

Annual Operating Expenses: 1.48%

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. All performance and risk information reflects results of the Service Class (its oldest class). Operating expenses reflect the Fund’s gross total annual operating expenses for the Service Class as of the Fund’s most current prospectus, and include management fees, 12b-1 distribution and service fees, other expenses, and acquired fund fees and expenses. Acquired fund fees and expenses reflect the estimated amount of the fees and expenses incurred indirectly by the fund through its investments in mutual funds, hedge funds, private equity funds, and other investment companies. Shares of ROH’s R Class bear an annual distribution expense that is higher than that of the Service Class. 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 performance for 2013.

The thoughts expressed in this piece concerning recent market movements and future prospects for small company stocks are solely the opinion of Royce at December 31, 2013, 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 December 31, 2013 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 micro-cap, small-cap, and mid-cap stocks, 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 any one 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 invest up to 25% of its net assets in foreign securities, 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 2000 Index is an unmanaged, capitalization-weighted index of domestic small-cap stocks. It measures the performance of the 2,000 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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