article 12-31-2013

Royce International Premier Fund Manager Commentary

Royce International Premier Fund enjoyed a solid calendar year on both a relative and absolute basis. The Fund was up 18.3% in 2013, outperforming its benchmark, the Russell Global ex-U.S. Small Cap Index, which gained 17.2% for the same period. This result came in the context of markedly lower 2013 performance—and greater levels of volatility—for non-U.S. companies in relation to their domestic peers.

Stocks around the world enjoyed a bullish first quarter, although those outside the U.S. generally turned in lower returns. International Premier participated in the rally, though not to the same extent as its benchmark. The Fund gained 4.1% versus its benchmark’s 6.5% gain in the opening quarter of 2013. The global investment environment became more volatile in the second quarter. An overheated real estate market in China stole many of the headlines as policy makers there sought to cool speculation through credit restrictions that had the unintended consequence of rejuvenating fears of an economic slowdown. Civil unrest in developing nations such as Turkey and Brazil also challenged the underpinnings of the emerging market’s secular growth thesis. The sharp rise in the yield of the 10-year U.S. Treasury note during May and June provided yet another headwind as Ben Bernanke and the U.S. Federal Reserve began to guide financial markets toward a likely reduction in the central bank’s monthly bond purchase program. In this uncertain second quarter, the Fund advanced 0.5% compared to a 4.5% decline for the benchmark index, highlighting the defensive and high-quality attributes of the Fund’s positions.

The global markets recovered nicely in the third quarter, with the European and U.S. small-cap markets especially robust. Indeed, it was notable just how quickly and thoroughly investors managed to shake off many of the same macro concerns that brought considerably more volatility—and lower returns—to stocks in the previous three years. International Premier gained 8.2% in the third quarter, a solid gain though it was not quite strong enough to match its benchmark’s 10.7% return. The rally extended through the end of the year. While more subdued for non-U.S. equities than the first and third quarters, the year’s last three months wound up solidly bullish. RIP outperformed its benchmark for the fourth quarter, advancing 4.5% compared to 4.1% for the Russell Global ex-U.S. Small Cap.

In its three-year history, we believe the Fund has established a solid track record during a challenging period for many markets outside the U.S. The Fund outperformed the Russell Global ex-U.S. Small Cap in the one- and three-year/since inception (12/31/10) periods ended December 31, 2013.

Six of the Fund’s seven equity sectors contributed positively to calendar-year performance, with half of the Fund’s positive contributors at the sector level posting sizable net gains. Health Care led by a wide margin, followed by Industrials and Information Technology. The net loss for Consumer Discretionary was minimal. At the industry level, pharmaceuticals, electronic equipment, instruments & components, health care equipment & supplies, and machinery were the leaders. The textiles, apparel & luxury goods group was the largest detractor at the industry level. The bulk of its net losses came from the Fund’s largest detractor for the calendar year, Daphne International Holdings, which led all of the portfolio’s “Good Ideas at the Time” by a wide margin. Beginning in March 2013, we used its slumping share price to substantially add to our position. The overall slowdown in the Chinese economy has taken its toll on Daphne’s business as lower levels of consumer spending in particular caused sales and revenues to decline. The company is a Chinese footwear maker and retailer that sells Aerosole shoes in China. Its strong management and market position gave us confidence in the company’s longterm potential, though we recognize that this investment is likely to require patience. We did not feel as sanguine about the recovery prospects for South African retailer Lewis Group, which sells household furniture, electrical appliances, and home electronics primarily on credit. Flat sales, high levels of indebtedness in the unsecured credit market, and operational problems at some of its credit-based competitors all hurt its near-term results. Its value was also hampered by the sharp decline of the rand (South Africa’s currency) versus the dollar. Each of these factors led us to sell our shares in the fall.

Tokyo-based was the Fund’s top contributor in 2013. The company provides websites that offer price comparison services and product information on restaurants, hotels, and consumer appliances. An increase in the number of PC and smartphone users, a move into profitability in its travel & real estate segment, and a positive momentum in its restaurant segment helped spark impressive earnings growth. We trimmed shares in August and sold the rest of our position at the end of September. Recordati is a family owned and run pharmaceutical company, with a focus on cardiovascular and urological treatments. It also has an increasing exposure to very rare (known as “orphan”) diseases. In addition to its attractive valuation, we were initially drawn to its impressive profitability and strong balance sheet several years ago. We reasoned that this compelling valuation was related to its being headquartered and listed in Italy, one of the countries then in the eye of the euro storm. Our contention was that Recordati’s domicile created a perception of inefficiency, especially since the majority—and an increasing share—of its revenues were derived from outside its domestic market. Operationally the company continued to execute very effectively, and as Italian stocks have come back into favor, its shares performed consistently well during 2013.

Top Contributors to 2013 Performance
1 1.97%
Recordati 1.23
M3 0.95
Stallergenes 0.90
Domino Printing Sciences 0.89
1 Includes dividends

Top Detractors from 2013 Performance1

Daphne International Holdings -2.38%
Lewis Group -0.53
Lopes Brasil-Consultoria de Imoveis SA -0.30
Media Chinese International -0.27
MegaStudy -0.21
1 Net of dividends

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

  QTR YTD 1YR 3YR Since
International Premier 4.53 18.31 18.31 6.72 6.72 12/31/2010
Russell Glo x US SC 4.05 17.21 17.21 4.24 4.24 N/A

Annual Operating Expenses: Gross 3.54% Net 1.69%

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, and other 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, at or below 1.69% through April 30, 2014 and at or below 1.99% through April 30, 2023. 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 small-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 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.) 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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