article 12-31-2013

Royce Dividend Value Fund Manager Commentary

In 2013, Royce Dividend Value Fund did quite well on an absolute basis, although we were not as pleased with its relative results. The Fund rose 30.7% for the calendar year, lagging its small-cap benchmark, the Russell 2000 Index, which was up 38.8% for the same period. This was not only discouraging for its own sake but also in light of the Fund’s strong showing in the second half of 2012, a period in which it handily beat its benchmark, up 11.5% versus 7.2%. However, in 2013 market leadership was once again found among defensive, fast-growing and/or highly levered stocks, as well as in high-yielding (though arguably lower-quality) vehicles. Indeed, the constant hunger for higher yield has only occasionally benefited dividend payers in the small- and mid-cap spaces. Within the Russell 2000, companies that do not pay dividends once again outpaced those that do. Perhaps needless to say, this remains a source of frustration.

After higher-quality stocks (as measured by returns on invested capital) briefly captured market leadership between early June and the end of December 2012, they again took a back seat in the dynamically bullish opening quarter of 2013. The Russell 2000 increased 12.4% between the beginning of January and the end of March while the Fund was up 9.5%, a strong absolute performance that was nonetheless behind its benchmark. The more eventful second quarter featured a bearish April and an unsettled June that was marked by rising interest rates and the panicky reaction to the first public comments from the Fed that it would begin to taper its monthly bond-buying program some time before the end of 2013. In this more challenging period, the Fund was a relative disappointment, up 1.2% versus 3.1% for the Russell 2000.

Once the equity markets had digested some of this news, share prices were mostly on the upswing again. The third quarter was in fact similar to the first, although not quite as strong. Dividend Value gained 8.6% in the third quarter while the small-cap index increased 10.2%. As the pace of the rally began to slacken somewhat toward the end of the year—December being slightly bearish in the middle of the month—the Fund did better on a relative basis. For the fourth quarter, the Fund again gained 8.6% compared to a 8.7% increase for the Russell 2000.

Now in its tenth year of operation, the Fund held on to its longer-term edge over the benchmark. Its market cycle results were, however, more mixed. Dividend Value outpaced the Russell 2000 for the five-year and since inception (5/3/04) periods ended December 31, 2013. The Fund’s average annual total return since inception was 10.4%.

Net losses at the sector, industry, and position level were comparatively modest. However, holdings in the metals & mining industry—primarily gold and silver mining companies— remained major disappointments and detracted most from performance in 2013. Randgold Resources, Fresnillo, and Pan American Silver boasted very attractive valuations (and a dividend that we liked in the case of the third company) throughout 2013. However, we continued to carefully review the long-term prospects for these businesses as ongoing stock price declines during the period were troubling. We finished selling our shares of Gold Fields in December. Outside the mining industry, we increased our position in clothing retailer American Eagle Outfitters through most of the year as its stock price was falling. The firm has faced increased competition in the malls and poor sales, but we think its savvy management and strong niche in the teen clothing market can help its business to eventually reverse course.

Nu Skin Enterprises was the Fund’s top contributor for the period. The company develops and distributes personal care skin products worldwide. After enjoying a strong first half, its share price gained additional momentum in the year’s last six months. In October, the company announced stronger-than-anticipated third-quarter earnings and raised its full-year guidance for 2013, driven by the success of a limited-time offer for its new weight management system. Towers Watson & Company provides human resource, financial consulting and other related services. Its price rose more or less steadily throughout the year. In May the firm’s management raised adjusted EPS (earnings per share) guidance for fiscal 2013 while the stock also gained from the opening of Obamacare insurance exchanges in October. It then increased its dividend in November. We have liked its core business and steady earnings for several years having first bought shares in the Fund’s portfolio in 2007.

Timely selling throughout the year helped to make Pandora A/S a top contributor for the year. A Danish designer, maker, and distributor of hand-finished jewelry, its share price has been mostly on the rise since we first bought shares in July 2012. KKR & Co. is a private equity and venture capital firm that specializes in acquisitions, leveraged buyouts, management buyouts, special situations, and growth equity. We have long admired its business expertise, industry leadership, pristine balance sheet, and dividend. Liking its prospects for continued success, we bought shares in December. It was the Fund’s largest holding at the end of 2013.

Top Contributors to 2013 Performance

Nu Skin Enterprises Cl. A 1.33%
Towers Watson & Company Cl. A 0.87
Pandora 0.76
KKR & Co. L.P. 0.73
ManpowerGroup 0.70
1 Includes dividends

Top Detractors from 2013 Performance1

Gold Fields ADR -0.65%
Fresnillo -0.53
Randgold Resources ADR -0.50
American Eagle Outfitters -0.34
Pan American Silver -0.29
1 Net of dividends

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

  QTR YTD 1YR 3YR 5YR Since
Dividend Value 8.59 30.74 30.74 13.43 21.20 10.41 5/3/2004
Russell 2000 8.72 38.82 38.82 15.67 20.08 9.19 N/A

Annual Operating Expenses: 1.52%

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 monthend 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. 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/or mid-cap stocks, which may involve considerably more risk than investing in larger-cap stocks. (Please see "Primary Risks for Fund Investors" in the prospectus.) The Fund’s broadly diversified portfolio does not ensure a profit or guarantee against loss. 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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