article 12-31-2013

Royce Value Plus Fund Manager Commentary

Royce Value Plus Fund turned in a terrific performance on an absolute basis in 2013. The Fund gained 32.5% in 2013, trailing its small-cap benchmark, the Russell 2000 Index, which was up 38.8% for the same period. For more than two years, we have been utilizing more of a GARP (growth at a reasonable price) approach in the portfolio, focusing on businesses with better-than-average current growth prospects that also possess attractive valuations. While these efforts have not yet resulted in improved relative performance, they have led to stronger absolute results. We took particular encouragement from the Fund’s strong showing in the second half of 2012. Although this was admittedly a short-term span, we were still pleased that Value Plus beat its benchmark (+8.8% versus +7.2%).

In the first quarter of 2013, investors once more looked to fast-growing and/or defensive areas of the equity marketplace, which caused the more cyclical areas that we tend to favor to give up their briefly held leadership position. The Fund underperformed the Russell 2000 in the opening quarter in part due to the struggles of the Fund’s last remaining holdings in precious metals companies. The Fund gained 9.4% compared to 12.4% for the small-cap index in the first quarter. The more volatile second quarter featured rising interest rates, the announcement by the Fed that it would begin to taper the pace of its monthly bond-buying program later in the year, and discouraging news out of China and other key spots in the developing world. For the quarter, the Fund was up 2.7% while the Russell 2000 gained 3.1%. Once the markets began to digest all of these developments, however, they quickly resumed the fast pace set earlier in the year. The Fund participated, climbing 9.1% compared to the 10.2% increase for its benchmark. December was difficult at times, which led to slightly more subdued results in the fourth quarter. Anxiety about tapering, talk of a possible equity bubble, and concern over holiday retail sales all may have played a role in the mid-December slide, but share prices recovered nicely by the end of the month. Value Plus again did well on an absolute basis while trailing the small-cap index. For the fourth quarter, the Fund rose 8.1% while the Russell 2000 was up 8.7%.

One consequence of continuing to trail the benchmark is that the Fund’s performance advantage was limited to longer-term time spans. The Fund outperformed the Russell 2000 for the 10-year and since inception (6/14/01) periods ended December 31, 2013. (Market cycle results can be found here.) The Fund’s average annual total return since inception was 12.9%.

Information Technology, the Fund’s largest sector, was also its top performer in 2013. Four of the Fund’s five best-performing industry groups were tech businesses—electronic equipment, instruments & components; communications equipment; software; and semiconductors & semiconductor equipment. In addition, two important technology-related themes remain prominent—big data and machine-to-machine (M2M) technology, also known as the “Internet of Things.” The latter typically involves sensors or other technology on one piece of equipment that can capture information that is then relayed through a wireless or wired network to a computer that translates what is gathered into meaningful data. The data can then make machines work better. Sierra Wireless is a wireless data communications equipment company with a global business providing M2M communications and mobile components. We think it’s a well-managed business that executes very effectively. Although we trimmed our stake as its share price rose in 2013, it was the Fund’s sixth-largest holding at the end of 2013.

Strong net gains for the period also came from the Industrials, Consumer Discretionary, Financials, and Health Care sectors. Worthington Industries, from the Materials sector, is a diversified steel processing company. The CEO and son of the firm’s founder made the strategic decision about four years ago to focus on returns and profitability. The firm sold several non-core segments and kept or acquired higher-margin, faster-growing areas such as gas and liquid steel cylinders. Worthington also embarked on a comprehensive lean manufacturing effort that began to bear fruit before the steel-processing business had fully recovered. Its stock price began to slowly recover in the summer of 2012, when we began gradually taking gains.

Net losses were comparatively modest. During the first half of 2013, we reduced the portfolio’s overall exposure to Materials companies, which included selling three precious metals miners that posted large net losses for the calendar year—McEwen Mining, Hochschild Mining, and Alamos Gold. Myriad Genetics detracted most from performance for the period. The company performs molecular diagnostic tests, specializing in genetic testing for cancer—it’s a market leader for the breast cancer gene tests. The company faced several headwinds in 2013: reimbursement change concerns from payers, a Supreme Court decision in June that held that human genes cannot be patented, and new competition in the breast cancer gene testing market. This led its stock to fall, though the company retained its patents on certain genetic testing processes. While reimbursement issues remained unresolved entering 2014, 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. We also like much of its existing and emergent pipeline of new products and services. Statistically, it was arguably one of the Fund’s cheapest positions at the end of December as well as one of its fastest growing—a highly promising combination in our view. It was the Fund’s third-largest holding at year-end.

Top Contributors to 2013 Performance

Sierra Wireless 1.03%
Worthington Industries 1.02
Splunk 0.94
LSI Corporation 0.93
InvenSense 0.89
1 Includes dividends

Top Detractors from 2013 Performance1

Myriad Genetics -0.42%
McEwen Mining -0.30
Hochschild Mining -0.28
Alamos Gold -0.26
Quanex Building Products -0.26
1 Net of dividends

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

  QTR YTD 1YR 3YR 5YR 10YR Since
Value Plus 8.06 32.52 32.52 11.19 18.40 9.38 12.87 6/14/2001
Russell 2000 8.72 38.82 38.82 15.67 20.08 9.07 8.47 N/A

Annual Operating Expenses: 1.46%

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). 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, other expenses, and acquired fund fees and expenses. Acquired fund fees and expenses reflect the estimated amount of 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 RVP’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 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. 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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