article 12-31-2013

Royce International Micro-Cap Fund Manager Commentary

We were pleased with the calendar-year performance of Royce International Micro-Cap Fund on both an absolute and relative basis, especially considering that non-U.S. companies generally provided lower returns than their domestic cousins. The Fund gained 19.0% in 2013, outperforming its benchmark, the Russell Global ex-U.S. Small Cap Index, which gained 17.2% for the same period.

During the bullish first quarter, Internatinoal Micro-Cap’s diverse assemblage of what we deem to be quality micro-cap companies struggled to keep pace with the solid gains turned in by its benchmark index, which rose 6.5% for the period versus the Fund’s 2.2% advance. This stood in contrast with the more uncertain second quarter in which international markets diverged meaningfully from the generally positive results in the U.S. First-quarter gains gave way to a more volatile market as investors weighed developing economic risks around events in the emerging world, Europe, and the U.S. China was back in the spotlight as growing credit risks in its increasingly overheated real estate market brought swift action by that country’s central bank to improve and gain greater control over lending standards. Volatility in global bond markets also gave investors pause as the possibility—and later reality—of tapering the pace of the U.S. Federal Reserve’s monthly bond purchases (quantitative easing) was introduced and reinforced in May and June, sending yields 100 basis points higher on the 10-year Treasury note. The Fund benefited from its margin of safety discipline (a hallmark of the Royce investment approach) during this period by falling a modest 2.6% compared to the Russell Global ex-U.S. Small Cap, which lost 4.5% in the second quarter.

Despite the international market’s ongoing challenges, equities as a whole rallied once again in the third quarter, with Europe showing particular strength. During this period, the Fund gained 12.0% versus its benchmark’s 10.7% increase. The Fund’s fourth-quarter performance nicely enhanced its solid calendar year record. Despite a brief period of volatility, the last three months of the year were strong, though not as wildly bullish as the first and third quarters. The Fund outpaced its benchmark in the year’s final quarter, up 6.7% compared to the international small-cap index’s 4.1% gain. The Fund’s three-year/since inception (12/31/10) results were less inspiring, though we remain confident in the Fund’s long-term potential. On October 22, 2013, Jim Harvey and Dilip Badlani began to co-manage the portfolio with David Nadel—who had served as the Fund’s portfolio manager from its inception through October 21, 2013—remaining as assistant portfolio manager.

Seven of the Fund’s nine equity sectors contributed positively to calendar-year performance, led by Industrials, which was out in front by a good-sized margin. Information Technology, Consumer Discretionary, and Health Care also posted sizable net gains. Energy and Materials ended 2013 in the red, though the former’s net losses were fairly modest. The metals & mining industry was the most significant detractor within the Materials sector. Precious metals miners—an ample presence among our holdings in the industry—endured plummeting revenues and stock prices in light of the respective 36% and 28% drops in silver and gold prices in 2013. We reduced the Fund’s exposure to the industry as a whole, holding positions only in those companies that we believe are well funded, conservatively managed, or otherwise well positioned to rebound when the metals & mining industry recovers. We parted ways with Australian gold miners Evolution Mining and Troy Resources in October after selling our shares in French mineral driller Foraco International in May. We also sold our position in Indian specialty pipe and tube maker Maharashtra Seamless in November as slowing growth in the Indian economy and ongoing pipe dumping in that country led to a steep decline in demand and order inflow. Beginning in March, we gradually added to our stake in Imdex, an Australian company that supplies drilling fluids and downhole survey instruments to the mining, oil and gas, water well, HDD, and civil engineering industries worldwide. We like its low-debt balance sheet and position as an industry leader, though with mineral drilling activity likely to remain subdued, we recognize the possible need for patience.

TFS Corporation was the Fund’s top contributor in 2013 and its fifteenth-largest position at year-end. Based in Australia, TFS manages the globe’s largest sustainable supply of Indian Sandalwood while also offering a sustainable supply of Western Australian Sandalwood oil and wood products for the global market. Its products have uses in the pharmaceutical and fragrance industries. The company survived the fallout from widespread collapses in Australian MIS (managed investment scheme) vehicles and also saw the harvest of its first Indian sandalwood plantation, planted in 1999. Clinigen Group is a U.K.-based specialty pharmaceuticals and pharmaceutical services business serving patients, the medical community, and the healthcare industry. Its share price rose based on the impressive growth in its global business and consequent earnings improvement. We sold our shares between May and October. The latter month also saw us selling our position in Century Casinos as its rising share price proved to be a winning bet for the Fund. Based in Colorado Springs, the company owns and operates casinos, hotels, and resorts in the U.S., Canada, South Africa, and the Czech Republic and also operates casinos on luxury cruise ships. Strong earnings seemed to draw investors to the stock.


GOOD IDEAS THAT WORKED
Top Contributors to 2013 Performance
1

TFS Corporation 1.00%
Clinigen Group 0.97
Century Casinos 0.96
Makalot Industrial 0.92
Clarkson 0.88
1 Includes dividends

GOOD IDEAS AT THE TIME
Top Detractors from 2013 Performance1

Evolution Mining -0.82%
Maharashtra Seamless -0.78
Imdex -0.74
Troy Resources -0.69
Foraco International -0.0.57
1 Net of dividends

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

  QTR YTD 1YR 3YR Since
Inception
Inception
Date
International Micro-Cap 6.68 18.95 18.95 1.98 1.98 12/31/2010
Russell Glo x US SC 4.05 17.21 17.21 4.24 4.24 N/A

Annual Operating Expenses: Gross 3.97% Net 1.76%

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 2% 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. Gross operating expenses reflect total gross annual operating expenses and include management fees, 12b-1 distribution and service fees, other expenses, and acquired fund fees and expenses. Net operating expenses reflect contractual fee waivers and/or expense reimbursements. All expense information is reported as of the Fund’s most current prospectus. Royce & Associates has contractually agreed to waive its fees and/or reimburse operating expenses, to the extent necessary to maintain the Fund’s net annual operating expenses other than acquired fund fees and expenses, at or below 1.69% through April 30, 2014 and at or below 1.99% though April 30, 2023. Expenses are estimated for the current fiscal year. 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 stocks, which may involve considerably more risk than investing in larger-cap stocks The Fund may invest a significant portion of its assets in foreign companies which 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 Foreign Securities" in the prospectus.) Therefore, the prices of the securities of foreign companies in particular countries or regions may, at times, move in a different direction than those of the securities of U.S. companies. (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. 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 Global ex-U.S. Small Cap Index is an unmanaged, capitalization-weighted index of global small-cap stocks, excluding the United States. Index returns 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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