article 12-31-2013

Royce Low-Priced Stock Fund Manager Commentary

It was a challenging and disappointing year for Royce Low-Priced Stock Fund. The Fund was up 12.9% in 2013, trailing its small-cap benchmark, the Russell 2000 Index, which gained 38.8% for the same period. In light of the generally robust performance for stocks since the post-Financial Crisis bottom on March 9, 2009 and the Fund's once-stalwart intermediate- and long-term advantage relative to the Russell 2000, the last three years have been particularly tough.

The year began with a bang for many stocks, with most of the major domestic indexes touching double-digit returns in the first quarter. The Fund, however, barely participated in the good times, up 1.4% compared to 12.4% for the Russell 2000. This wide spread accounted for the bulk of the Fund's relative disadvantage for the year. In the more volatile second quarter the Fund fell 2.6% versus a gain of 3.1% for the Russell 2000. On both an absolute and relative basis, the Fund recovered somewhat in the third quarter, gaining 9.9% versus 10.2%, sparked by strong results from the Materials, Financials, and Industrials sectors. When the markets cooled off a bit in the year's final quarter, the Fund was unable to keep up this promising momentum; the Fund was up 4.0% while its benchmark rose 8.7%.

The difficult year hurt performance over intermediate- and market cycle periods. Low-Priced Stock outperformed the Russell 2000 for the 15-, 20-year, and since inception (12/15/93) periods ended December 31, 2013. The Fund's average annual total return since inception was 11.7%. We remain very proud of the Fund's long-term record.

The portfolio's heavy concentration in more economically sensitive cyclical sectors such as Energy, Industrials, Materials, and Technology continued to work against it in 2013—especially in the first half of the year—as did the market's ongoing penchant for defensive stocks and fast-growing companies that in many cases were carrying considerable debt. For much of 2013, investors also remained enamored with higher-yielding vehicles, especially REITs, MLPs, and Utilities, while also demonstrating a preference for fixed-income securities. It bears repeating that these are not the sorts of investments that we seek in the Fund's portfolio, focusing instead on companies with solid balance sheets, high returns on invested capital, and positive cash flow. Many companies that fit those criteria have been out of favor in the era of multiple rounds of quantitative easing and zero interest rates. In addition, a number of industries that had been very successful in the initial recovery phase following the Financial Crisis began correcting sharply in 2011, such as precious metals mining companies, and are yet to make recoveries. Indeed, the metals & mining industry remained a trouble spot in 2013, accounting for four of the Fund's top five, eight of its top 10, and 12 of its top 20 detractors. We sold our shares of Allied Nevada Gold, reduced our position in Pretium Resources, and in the second half added to our stakes in Hochschild Mining and Pan American Silver, believing that each was a well-managed business with the resources to turn things around.

Performance for several industries in other cyclical sectors that we have liked best over the last several years—Energy, Industrials, and Technology—began to pick up in the second half of 2013. The Fund's top-contributing sectors for the period were Information Technology, Financials, Industrials, and Consumer Discretionary while the top industry groups were semiconductor & semiconductor equipment (Information Technology), personal products (Consumer Staples), and energy equipment & services. Low-Priced Stock's top contributor by a wide margin was Nu Skin Enterprises, which develops and distributes personal care skin products worldwide. A top net gainer in the first half, its share price gained additional momentum after the company announced stronger-than-anticipated third-quarter earnings and raised its fullyear guidance for 2013 in October, driven by the success of a limited-time offer for its new weight management system. Shanghai-based E-House China Holdings is a leading real estate services business in China whose shares took off in the second half, in particular following the September announcement by Chinese President Xi Jinping that the government was committed to solving the economy's problems.

Over the last year, we have sought to high-grade the portfolio by selling positions that we thought had reached or exceeded their full value and those in which our conviction level had declined. This resulted in the portfolio holding a significantly lower number of securities at the end of 2013 than it did at the end of 2012, 100 versus 154. With substantial investments of our own in the Fund, we understand how hard the last few years have been. However, we firmly believe that a business-buyer's approach to investing, as unpopular as it has been over the last few years, remains viable within the low-priced universe and elsewhere. While many of what we regard as the most compelling values that we have found during this period have not developed as we expected, we have chosen to remain patient with many of them, encouraged by some of the subtle shifts that we saw in the last six months of 2013 as expectations about tapering have begun to create a more historically typical interest-rate environment.

Top Contributors to 2013 Performance

Nu Skin Enterprises Cl. A 2.66%
E-House China Holdings ADR 1.04
Kennedy-Wilson Holdings 0.84
Medicines Company (The) 0.82
GameStop Corporation Cl. A 0.80
1 Includes dividends

Top Detractors from 2013 Performance

Allied Nevada Gold -2.11%
Hochschild Mining -1.41
Pretium Resources -1.18
Pan American Silver -0.72
Acacia Research -0.65
1 Net of dividends

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

  QTR YTD 1YR 3YR 5YR 10YR 15YR 20YR Since
Low-Priced Stock 3.97 12.91 12.91 0.25 15.27 7.05 11.01 11.67 11.65 12/15/1993
Russell 2000 8.72 38.82 38.82 15.67 20.08 9.07 8.42 9.27 9.44 N/A

Annual Operating Expenses: Gross 1.58% Net 1.50%

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). Price and total return information is based on net asset values for shareholder transactions. Certain immaterial adjustments were made to the net assets of Royce Low-Priced Stock Fund at 6/30/13 for financial reporting purposes, and as a result the net asset values for shareholder transactions and the calendar year total returns based on those net asset values differ from the adjusted net asset values and calendar year total returns reported in the Financial Highlights. Gross operating expenses reflect the Fund’s gross total annual operating expenses for the Service Class, including 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 fees and/or reimburse operating expenses to the extent necessary to maintain the Service Class’s net annual operating expenses, other than acquired fund fees and expenses, at or below 1.49% through April 30, 2014. 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 RLP’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 small-cap and micro-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 35% 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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