article 06-30-2014

Royce European Smaller-Companies Fund Manager Commentary

After mounting a strong comeback and generally outperforming its domestic peers during the last two quarters of 2013, European indexes remained fairly competitive before beginning to lose steam towards the end of the first half of 2014. We were slightly disappointed in Royce European Smaller-Companies Fund’s relative first-half results. The Fund gained 4.6% for the year-to-date period ended June 30, 2014, trailing its benchmark, the Russell Europe Small Cap Index, which advanced 5.5% for the same period.

The Russell Europe Small Cap Index narrowed the performance gap at the end of 2013, finishing the year with a 36.6% gain versus the domestic small-cap Russell 2000 Index’s 38.8% advance. While equities in the U.S. and abroad moderated in the first quarter of 2014, European markets assumed leadership. The Fund participated in this rally, rising 3.9% versus a gain of 6.5% for its benchmark. European equity performance slowed a bit in the second quarter, most notably in June as the Russell Europe Small Cap Index fell into the red while international, domestic (save micro-caps), and global markets were in the black. We were pleased that European Smaller-Cos gained 0.6% in the second quarter, outperforming its benchmark’s 1.0% decline. We were also pleased that the Fund was able to outpace the Russell Europe Small Cap Index for the since inception (12/29/06) period ended June 30, 2014.

Eight of the Fund’s 10 equity sectors finished the first half in positive territory. Health Care made the largest positive contribution to performance, leading by a sizable margin. It was followed by solid net gains for Consumer Discretionary and Industrials. Materials was the Fund’s biggest detractor from performance, though its net loss was minimal. Pharmaceuticals led at the industry level, with household durables and software also posting significant net gains. Net losses at the industry level were modest. At the country level, holdings headquartered in France, the U.K., Norway, and Italy made the most significant contributions while the portfolio’s limited exposure to companies in Cyprus, Spain, and Belgium detracted from first-half results.

Top-three position and Austria-based Semperit AG Holding manufactures specialized rubber products. In late March the company reported record revenues for fiscal 2013. It then made moves to expand its production capacity at its Kamunting, Malaysia site with the construction of a new glove factory late in the second quarter. We added to our stake in the first half. De’Longhi is an Italian company that owns a collection of consumer brands in the domestic appliance market, such as coffee makers, food processors, electric ovens, kettles, toasters, and more. Its stock performance in the first half of 2014 was largely generated in the first quarter after reporting solid earnings for 2013. It also benefited from investors’ generally increased risk appetite for Italian stocks. We sold some shares late in the first half.

F-Secure is a Finnish company that develops software for internet security and content back-up on the cloud. A combination of better-than-expected earnings as well as an announcement in May that it would be providing its services to Facebook helped its stock price to climb. We took some gains that same month. Forbo Holding is a Swiss firm with a global business in flooring and movement systems. Its shares moved higher when the firm reported an optimistic outlook for fiscal 2014. We reduced our position in the first half. We built our position in Eltek into April after first buying shares in February. This Norwegian business makes power systems and solutions for telecommunications and datacenters, power utilities, railway and metro, marine and offshore, solar, and other industries.

Individual stock net losses were modest. French firm Societé Internationale de Plantations d’Heveas produces natural rubber and operates rubber tree plantations in French-speaking Africa. Declining rubber prices had a negative effect on the stock, which prompted us to begin adding shares early in March. Globaltrans Investment GDR runs a private freight rail transportation business that was hit hard by concerns over Russia’s actions in the Ukraine, mixed macroeconomic data, and softer leasing rates. We view most of those issues as temporary, and have been adding to the position based on of its free cash flow generation and market position. Nokian Renkaat is a long established Finnish company that manufactures and sells winter tires. The stock was hit hard by geopolitical concerns in Russia, which accounts for more than half of its profits. We view this as a shorter-term stock-price weakness. The decline created an opportunity to build our stake in what we regard as a first-class business model at attractive valuations.

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

Semperit AG Holding 0.55
De'Longhi 0.54
F-Secure 0.49
Forbo Holding 0.48
Eltek ASA 0.48
1 Includes dividends

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

Societe Internationale de Plantations d'Heveas -0.48
Globaltrans Investment GDR -0.39
Nokian Renkaat -0.26
LPKF Laser & Electronics -0.25
EVS Broadcast Equipment -0.25
1 Net of dividends

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

European Smaller-Cos 0.62 4.59 23.52 5.58 16.72 5.04 12/29/2006
Russell Euro SC -0.95 5.48 36.21 11.06 17.29 3.15 N/A
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Annual Operating Expenses: Gross 2.27% Net 1.7%

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 2% 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. 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 fee waivers and/or expense 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, (excluding brokerage commissions, taxes, interest, litigation expenses, acquired fund fees and expenses, and other expenses not borne in the ordinary course of business), at or below 1.69% through April 30, 2015 and at or below 1.99% through April 30, 2024. 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 companies that are headquartered in Europe. Securities of foreign companies may be subject to different risks than investments in securities of U.S. companies, including adverse political, social, economic, or other developments that are unique to a particular country or region (Please see "Investing in Foreign Securities" in the prospectus). Therefore, the prices of the securities of foreign companies in particular countries or regions may, at times, move in a different direction than those of the securities of U.S. companies. (Please see "Primary Risks for Fund Investors" in the prospectus.) 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.) In addition, as of 6/30/14 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. 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 Europe Small Cap Index is an unmanaged, capitalization-weighted index of European small-cap stocks. Index returns include net reinvested dividends and/or interest income. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.



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