article 12-31-2013

Royce Value Fund Manager Commentary

A very solid absolute return in 2013 was not enough to give Royce Value Fund an advantage over its small-cap benchmark. The Fund gained 27.8% for the calendar year, trailing the 38.8% increase for the Russell 2000 Index for the same period. We were frustrated by coming up short versus the benchmark, notwithstanding Value’s strong absolute result.

­The equity markets started strong in 2013, as they did in the previous three years. The Russell 2000 climbed 12.4% in the first quarter, while the Fund managed a 3.1% gain. The Fund’s failure to more fully participate in the dynamic first quarter accounted for the bulk of the Fund’s calendar-year disadvantage versus the benchmark.

Over the previous two calendar years, the Fund’s results were not as strong as we would have liked, which led us to make changes to the portfolio during the first quarter of 2013. Some of these changes quickly bore fruit and were a factor in the Fund’s results in the second quarter, the year’s most volatile and challenging period. The rise in interest rates, which began following the 2013 low for 10-year Treasury yields on May 2, was quickly followed by the first instance of taper talk, which sent share prices plummeting from mid-May until the beginning of July. Value outpaced the Russell 2000 in the second quarter, up 5.2% versus 3.1%.

­The market then resumed its fast pace of growth early in the third quarter, in which the Fund gained 8.6% compared to a 10.2% advance for the small-cap index. Stock prices kept moving mostly upward into the fourth quarter—the Russell 2000 reached a new high on the last day of the year. December was a more volatile, at times bearish month, though not enough to keep fourth-quarter returns from remaining solidly positive. The Fund gained 8.4% in the year’s
final quarter compared to a gain of 8.7% for the Russell 2000. However, relative results over the last one-, three-, and five-year periods ended December 31, 2013 remained disappointing. Recent market cycle results through the end of 2013, which can be found here, were also underwhelming on a relative basis. Over longerterm periods, however, we were pleased with the Fund’s performance. The Fund outperformed the Russell 2000 for the 10-year and since inception (6/14/01) periods ended December 31, 2013. Value’s average annual total return since inception was 11.8%.

There were three significant changes to the portfolio in the first half. First, Whitney George, who served as co-manager from 2004-2012, became assistant portfolio manager on March 6, 2013. Jay Kaplan now serves as portfolio manager after having served as co-manager from 2003 through 2012. Second, we substantially reduced the Fund’s exposure to the Materials sector, which accounted for 17.9% of net assets at December 31, 2012 but only 9.0% of net assets at the end of 2013. Finally, we increased the portfolio’s exposure to U.S. stocks, which went from 81.1% of net assets as of December 31, 2012 to 89.9% of net assets at the end of 2013.

This shift was fortuitously timed as a number of non-U.S. stocks performed poorly in the second quarter. Many of the Fund’s non-U.S. holdings that we sold came from the metals & mining and capital markets industries. The first of these groups, in the Materials sector, has struggled since 2011. However, we sold based on a diminished emphasis in the portfolio on many commodity-based areas—energy, steel, and chemicals being exceptions. The general dependence of commodity-based industries on capital markets, along with the cash flow characteristics of many of these businesses, was a growing source of concern. This led us to sell Allied Nevada Gold, Silver Standard Resources, Hochschild Mining, and Seabridge Gold, among other smaller holdings in the metals & mining group.

Consumer Discretionary led all of the Fund’s sectors by a wide margin in 2013, though Financials, Information Technology, Consumer Staples, and Energy also made notable net contributions. The Consumer Staples sector was home to the Fund’s top performer for the calendar year. Nu Skin Enterprises develops and distributes personal care skin products worldwide. After enjoying a strong first half, its share price gained additional momentum in the year’s last six months. In October, the company announced stronger-than-anticipated third-quarter earnings and raised its full-year guidance for 2013, driven by the success of a limited-time-offer for its new weight management system. We reduced our position at rising prices through much of 2013.

Both the Fund’s second-largest contributor and second-largest detractor came from the Consumer Discretionary sector. GameStop Corporation is a video game retailer that sells new and pre-owned gaming products, including hardware and software. Most of Wall Street thought that its business was destined for obsolescence, similar to Blockbuster Video. We saw value and a well-managed business with advantages that Blockbuster never had. Its business recovered very nicely throughout 2013. We reduced our position as its share price soared, though we held enough to make it the Fund’s thirteenth largest holding at year-end. One of Value’s 10 biggest contributors in 2012, clothing retailer American Eagle Outfitters, struggled with stiff competition in malls and declines in sales. We sold some shares in 2013, though we still think this well-managed business with a strong niche in teen clothing can turn things around. It was a top-thirty holding at the end of December.


GOOD IDEAS THAT WORKED
Top Contributors to 2013 Performance
1

Nu Skin Enterprises Cl. A 3.77%
GameStop Corporation Cl. A 2.60
Molex Cl. A 1.75
Helmerich & Payne 1.46
Reinsurance Group of America 1.41
1 Includes dividends

GOOD IDEAS AT THE TIME
Top Detractors from 2013 Performance1

Allied Nevada Gold -1.02%
American Eagle Outfitters -0.89
Silver Standard Resources -0.49
Hochschild Mining -0.49
Seabridge Gold -0.49
1 Net of dividends

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

  QTR YTD 1YR 3YR 5YR 10YR Since
Inception
Inception
Date
Value 8.44 27.76 27.76 9.03 18.57 11.11 11.76 6/14/2001
Russell 2000 8.72 38.82 38.82 15.67 20.08 9.07 8.47 N/A

Annual Operating Expenses: 1.45%

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 Service Class (its oldest class). Operating expenses reflect the Fund’s total annual operating expenses for the Service Class as of the Fund’s most current prospectus and include management fees, 12b-1 distribution and service fees, and other expenses. Shares of RVV’s Consultant and R Classes 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 mid-cap stocks, which may involve considerably more risk than investing in larger-cap stocks. 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 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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