article 06-30-2014

Royce Dividend Value Fund Manager Commentary

Our penchant for dividend-paying small- and mid-cap stocks remains strong, even though many investors in the current market cycle have not consistently favored them. We were therefore pleased to see Royce Dividend Value Fund outpace its small-cap benchmark, the Russell 2000, for the year-to-date period ended June 30, 2014, up 3.3% compared to 3.2% for the small-cap index.

After the market’s extraordinary run in 2013, it was not surprising to see the pace of equity returns slow. This was certainly the case in the first quarter of 2014, when the Fund increased 0.2%. The Russell 2000 reached its year-to-date high on March 4, with investors concerned, if only briefly, about a possibly overheated stock market, a new chair at the Federal Reserve, and the economic effects of the cold and stormy winter. Small-cap share prices mostly fell into mid- May before moving upward again through the end of June. It was during this brief, mostly benign downturn, in which the Russell 2000 fell 9.1%, that the Fund gained its advantage. For the second quarter, the Fund gained 3.2% versus a 2.0% advance for its benchmark. The Fund remained behind the small-cap index for the one-, three-, and five-year periods ended June 30, 2014. (Market results can be found here.) However, Dividend Value outperformed the Russell 2000 for the 10-year and since inception (5/3/04) periods ended June 30, 2014. The Fund’s average annual total return since inception was 10.2%.

The post-financial crisis period has often been immensely frustrating, though we have been seeing signs of a turnaround for our disciplined and active approach, which seeks fundamentally strong dividend-paying companies trading for less than what we believe they are worth. In Dividend Value, we try to select companies with good or especially promising cash flow profiles, those that allow the business to return cash to shareholders for a solid total return as opposed to a big coupon. We also see dividends as an excellent indicator of effective capital allocation. This belief has not been popular in the market over the last five or six years. However, we still look at dividends and growth as not being mutually exclusive. In our view, companies that generate free cash flow can reinvest in their businesses, do what they need to do to grow, and still return cash to shareholders. While the market has shown a marked preference for higher-yielding and/or faster-growing vehicles, we continue to focus on what we regard as well-run businesses that pay dividends. We suspect that the growing economy will result in more investors focusing on the attributes that we seek. Effective May 1, 2014, the Fund invests primarily in undervalued dividend-paying companies with market capitalizations up to $15 billion (up from $5 billion).

The Fund’s best-performing sector in the first half was Materials, which was dominated by the resurgence of metals & mining companies, primarily those involved in gold and silver mining. Holdings in this industry were among the Fund’s largest detractors in 2013, so the rebound was satisfying. We initiated or built most of our positions in this industry late in 2012 or in 2013 when it seemed to us that they were at or near rock-bottom valuations. They roared back in the first half of this year mostly owing to a recovery in commodity prices, historically the driver of mining businesses’ fortunes. Gold and silver miners Agnico Eagle Mines and Randgold Resources ADR were top-20 positions at the end of June while dividend-paying Pan American Silver was among the top-60. Specialty metals supplier Allegheny Technologies saw gradual improvements in the industrial metals industry that helped to galvanize its shares. From outside the metals & mining group, long-time Royce favorite and top-five position Helmerich & Payne experienced a steadily rising share price. The company specializes in technologically advanced drilling rigs and equipment that were in high demand during the first half.

Net losses were mild across the portfolio. Both Consumer sectors were underwater in the first half, and the specialty retail group (from Consumer Discretionary) posted the highest net losses for the semiannual period. The first half was particularly difficult for many retailers. It started with a disappointing holiday season and was made worse by the grim winter, which kept shoppers indoors and unwilling to spend. Still, we have every confidence that this important industry will bounce back. We held a goodsized position in Ascena Retail Group, which specializes in apparel for women and ’tween girls and boys. The company operates under various brands, including Justice, Lane Bryant, maurices, and dressbarn. We also increased our stake in Buckle (The), which sells casual apparel, footwear, and accessories for young men and women here in the U.S. We have long liked the firm’s approach in its highly competitive industry and think it has handled its most recent challenges effectively. It was a top-20 holding at the end of June. Nu Skin Enterprises, from the Consumer Staples sector, makes personal care products and distributes them across the globe. One of last year’s top contributors, its momentum was blunted by allegations in a Chinese newspaper back in January that it was running a pyramid scheme. The firm moved quickly and, we think, effectively to deal with the issue. However, its recent solid results showed that other investors are still not convinced.

Top Contributors to Performance
Year-to-Date through 6/30/14

Helmerich & Payne 0.43
Agnico Eagle Mines 0.39
Randgold Resources ADR 0.29
Allegheny Technologies 0.22
Pan American Silver 0.19
1 Includes dividends

Top Detractors from Performance
Year-to-Date through 6/30/14

Nu Skin Enterprises Cl. A -0.20
Ascena Retail Group -0.18
Brink's Company (The) -0.17
Buckle (The) -0.15
Towers Watson & Co. Cl. A -0.15
1 Net of dividends

Average Annual Total Returns as of Quarter-End 6/30/14 (%)

Dividend Value 3.18 3.35 21.85 12.97 19.38 10.34 10.24 5/3/2004
Russell 2000 2.05 3.19 23.64 14.57 20.21 8.70 9.06 N/A
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Annual Operating Expenses: 1.52%

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 gross 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 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 year-to-date performance for 2014.

The thoughts expressed in this piece concerning recent market movements and future prospects for small company stocks are solely the opinion of Royce at June 30, 2014, 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 June 30, 2014 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/or 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 (measured at the time of investment), 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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