article 12-31-2013

Royce Partners Fund Manager Commentary

Following a strong relative and absolute calendar-year performance in 2012, Royce Partners Fund was unable to beat its benchmark in 2013, its solid absolute results notwithstanding. The Fund gained 32.2% for the calendar year, trailing the 36.8% increase for its benchmark, the Russell 2500 Index, for the same period. After finishing 2012 on a high note by outperforming the small- to mid-cap index in 2012, the Fund was unable to keep up the pace through the consistently bullish first quarter of 2013. Partners did well on an absolute basis but lost ground against the Russell 2500, gaining 10.7% versus 12.9% for the index. The Fund fell further behind in the second quarter, a far more volatile period than this year’s first quarter and somewhat similar to the second and fourth quarters of 2012, which only served to exacerbate our frustration. The period between the beginning of April and the end of June saw underwhelming economic news from China (along with credit issues and the threat of an overheated real estate market), new attempts at fiscal stimulus in Japan, unrest—and plunging markets—in Turkey and Brazil, a spike in the 10-year Treasury rate between mid-May and mid-June, and word from the Federal Reserve that it would likely begin to taper its bond purchase program later in 2013. All of this was enough to push financial markets into a round of selling, especially outside the U.S. Indeed, the major domestic equity indexes stabilized and finished the second quarter in the black. For the second quarter as a whole the Fund gained 1.3% while the Russell 2500 advanced 2.3%.

The bull then began to run again in the third quarter, lifting equities as a whole and pushing most U.S. small-cap and European index returns into double digits. Indeed, investors recovered from the previous quarter’s macro headwinds with remarkable equanimity, making third-quarter returns in some cases similar to those of the year’s first quarter. The Fund returned 8.3% in the third quarter, falling behind its benchmark’s 9.1% increase.

After lagging the Russell 2500 for most of the year, Partners mounted something of a comeback in 2013’s final quarter. Although a brief wave of volatility hit the markets in mid-December, the tone in the fourth quarter was decidedly, though less dynamically, bullish. Partners narrowly outpaced its benchmark for the quarter with an 8.9% gain compared to the Russell 2500’s 8.7% return. The Fund’s average annual total return since inception (4/27/09) was 15.2%, a solid absolute showing that nonetheless lagged its benchmark’s 23.7% increase for the same period.

All eight of the Fund’s equity sectors were positive contributors to 2013 performance, with Financials, the Fund’s largest sectors, leading by a wide margin. Industrials and Information Technology also made sizable contributions to performance. Capital markets led at the industry level and was largely responsible for the lofty net gains in the Financials sector. The industry group’s net gains were substantially bigger than those of any of the portfolio’s other sectors. The Fund’s top contributor to 2013 performance was New York based asset management firm WisdomTree Investments, which sponsors ETFs (exchanged-traded funds) and other financial products to both retail and institutional investors. Robust inflows and strong product line growth helped to attract investors to its stock. After taking gains earlier in the year, we sold our remaining stake in September. Also showing strength in the capital markets group was top-ten holding State Street, which just missed making a second straight appearance on the “Good Ideas that Worked” list.

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 is as a significant emerging growth opportunity that can supplement the firm’s dominant but mature benefits and consulting business. Towers Watson & Company also raised its dividend in November in what we see as a positive sign of shareholder-friendly capital allocation. So while we took gains as its stock price soared, it was a top-ten position at year-end. In the insurance industry, E-L Financial, an investment and insurance holding company based in Toronto, was the top contributor. We like its core business and dividend and were pleased to see other investors attracted to the Fund’s largest holding at year-end.

Two of the Fund’s five-largest detractors came from the metals & mining group and engage in precious metals mining. This industry could not escape the negative impact on revenue and stock prices of the respective 36% and 28% drops in silver and gold prices in 2013. In August we sold our position in Gold Fields, a mining company with operations in Australia, Ghana, Peru, and South Africa. We chose to hold our shares of Fresnillo because we think the London-based gold and silver miner, which operates most of its lower-cost properties in Mexico, is well positioned for an eventual industry turnaround. Sprott is one of Canada’s largest hedge fund managers and focuses primarily on commodities and commodity-oriented businesses. Commodity price weakness hurt its business in 2013. Acacia Research endured 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 subsequent earnings disappointments led its share price to fall.

Top Contributors to 2013 Performanc

Wisdom Tree Investments 1.89%
Towers Watson & Company Cl. A 1.84
E-L Financial 1.38
ManpowerGroup 1.33
MasterCard Cl. A 1.24
1 Includes dividends

Top Detractors from 2013 Performance1

Gold Fields ADR -0.98%
Acacia Research -0.57
Fresnillo -0.46
Sprott -0.39
GrafTech International -0.31
1 Net of dividends

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

  QTR YTD 1YR 3YR Since
Partners 8.88 32.22 32.22 12.14 15.16 4/27/2009
Russell 2500 8.66 36.80 36.80 16.28 23.74 N/A

Annual Operating Expenses: Gross 4.70% Net 1.22%

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. 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 feewaivers and/or 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 1.20% through April 30, 2014 and 1.99% through April 30, 2023. 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 may invest primarily in securities of micro-cap, small-cap, and 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. In addition, as of 12/31/13 the Fund held 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 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 2500 Index measures the performance of the 2,500 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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