article 12-31-2013

Royce Premier Fund Manager Commentary

The calendar-year performance of Royce Premier Fund did little to resolve our conflicted feelings about the portfolio’s recent results, as once again the Fund achieved a solid absolute return while falling short on a relative scale. The Fund gained 27.7% in 2013, trailing its small-cap benchmark, the Russell 2000 Index, which rose 38.8% for the same period. A large number of what we deemed high-quality stocks finished 2012 on a roll, which was instrumental in the Fund outpacing the small-cap index in the last six months of 2012 (+8.6% versus +7.2%). Yet many of these same stocks fell behind in the first three months of 2013. While the Russell 2000 increased 12.4% in the first quarter, the Fund gained only 6.7%.

The next quarter brought increased volatility. The 10-year Treasury yield reached its 2013 low on May 2. The rapid rise of rates during May and June acted as one catalyst. Another was that the Fed began talking taper, announcing in June that it would begin reducing the pace of its monthly bond-buying program later in 2013. Then-Chairman Ben Bernanke was light on the details, neglecting to provide a specific date or dollar amount. And even though he made his comments in the context of a strengthening economy while reiterating that no tapering would begin without a consensus that the expansion was continuing, the markets swooned from roughly mid-June until early July, making for a volatile end to the second quarter. Hopeful that several positions in the portfolio would hold their value effectively in the face of falling stock prices, we were disappointed with its relative showing. Premier gained 1.1% in the second quarter compared to a 3.1% rise for its benchmark. Rising interest rates, however, indicated to us that the economy and equity markets were moving into a more historically typical environment, an observation that seemed justified in light of the Fund’s stronger results in both the second half and from that early May Treasury yield low. Premier underperformed the small-cap index in the third quarter, though by a much narrower margin, rising 9.8% versus 10.2% for the Russell 2000. A similar pattern held in the fourth quarter, in which the Fund gained 7.9% compared to 8.7% for the benchmark.

So while the Fund continued to cede the advantage to the small-cap index for shortand intermediate-term intervals, it held onto its performance edge over the benchmark for longer-term periods. (Recent market cycle results can be found here.) The Fund outpaced the Russell 2000 for the 10-, 15-, 20-year, and since inception (12/31/91) periods ended December 31, 2013. The Fund’s average annual total return since inception was 12.7%, a long-term record that gives us great pride.

Information Technology, Industrials, and Consumer Staples led all of the Fund’s sectors, followed by solid net contributions from Consumer Discretionary and Financials. In fact, seven of the portfolio’s eight equity sectors finished the period in the black. Materials posted a very modest net loss. Within the sector, net gains from chemical companies and, to a lesser degree, paper & forest products were outweighed by net losses in the metals & mining group. For the period, the Fund’s top four largest detractors—and five of its top six—were gold or silver miners. During the first half, we sold our positions in Allied Nevada Gold, Pretium Resources, and Seabridge Gold while we opted to add shares of Pan American Silver and held our stake in Silver Standard Resources. The first half of 2013 was an especially miserable time for mining companies, which dealt with rapidly falling gold and silver commodity prices and increased operational costs. This was part of a string of difficulties that began in 2011 and had not reversed course by the end of 2013. However, we remain optimistic that the most productive and best-managed of these companies can eventually turn things around. We had at least as much confidence in the turnaround potential of genetic diagnostics company—and top-ten holding—Myriad Genetics. The company specializes in genetic testing for cancer and ended 2013 facing increased competition, particularly in breast cancer screening tests, and some still unresolved reimbursement issues that remained under federal review at the end of December. However, we think that the quality of its predictive tests remains the industry’s gold standard and that the firm is more than capable of holding onto market share in this important healthcare niche.

The Fund’s top contributor by an impressively large margin was Nu Skin Enterprises. Premier’s second-largest holding at the end of December, the company 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 full-year guidance for 2013 in October, driven by the success of a limited-time-offer for its new weight management system. Lincoln Electric Holdings is one of our longest-tenured holdings firmwide. Its stock price began to soar in May. Earnings for this welding and cutting products maker kept growing as it’s been able to effectively cut costs in a challenging environment.

Top Contributors to 2013 Performance

Nu Skin Enterprises Cl. A 5.03%
Lincoln Electric Holdings 1.70
Cognex Corporation 1.44
Thor Industries 1.40
Towers Watson & Company Cl. A 1.40
1 Includes dividends

Top Detractors from 2013 Performance1

Allied Nevada Gold -0.82%
Pretium Resources -0.63
Pan American Silver -0.62
Silver Standard Resources -0.59
Myriad Genetics -0.48
1 Net of dividends

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

  QTR YTD 1YR 3YR 5YR 10YR 15YR 20YR Since
Premier 7.86 27.73 27.73 12.17 18.92 11.64 12.05 12.21 12.67 12/31/1991
Russell 2000 8.72 38.82 38.82 15.67 20.08 9.07 8.42 9.27 10.09 N/A

Annual Operating Expenses: 1.06%

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 Investment Class (its oldest class). Operating expenses reflect the Fund’s total annual operating expenses for the Investment Class as of the Fund’s most current prospectus and include management fees and other expenses. Shares of RPR’s Service, Consultant, R, and K Classes bear an annual distribution expense that is not borne by the Investment 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 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 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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