article 06-30-2014

Royce Financial Services Fund Manager Commentary

For the year-to-date period ended June 30, 2014, Royce Financial Services Fund gained 3.6%, which was ahead of the smallcap Russell 2000 Index, which was up 3.2%, but trailed the Russell 2500 Financial Services Index, which rose 5.8% for the same period.

The market remained in a bull phase as 2014 began, though it moved at a much slower pace following the speedway clip of the previous year. Equity returns thus remained mostly positive amidst a lot of talk about whether or not valuations were unreasonably high. The Fund gained 1.5% in the first quarter versus respective gains of 1.1% for the Russell 2000 and 2.7% for the Russell 2500 Financial Services Index. We were not overly concerned about these results considering both the short time period and the Fund’s wide relative advantage over both benchmarks coming into 2014.

The second quarter was in general a more challenging period for small-cap stocks. The Russell 2000 reached its year-to-date high on March 4 and mostly fell through May 15. The Fund outpaced both indexes from that early March interim high through the end of June. For the second quarter, Financial Services essentially tied the small-cap index—both advanced 2.0%—while the financial services component of the Russell 2500 rose 3.1% for the same period. We remained pleased with the Fund’s longerterm results. Financial Services outpaced both indexes for the one- and 10-year periods ended June 30, 2014. The Fund also beat the Russell 2000 for the three-year period ended June 30, 2014. In addition, the Fund outperformed the Russell 2500 Financial Services Index for the since inception (12/31/03) period ended June 30, 2014. The Fund’s average annual total return since inception was 8.9%.

We are seldom surprised when the Fund is out of sync with the financial services companies in the Russell 2500 Index. (Being a sector fund, the Fund has also frequently moved in a different direction than the Russell 2000.) Our preference is for conservatively capitalized, fundamentally strong financial services businesses that we believe are well run and trading at attractively low valuations based on our estimate of the company’s intrinsic worth. This has historically resulted in a significant underweight in banking stocks, which, regardless of their other merits, typically lack the balance-sheet strength that is so important to us. This bias toward strong balance-sheets and other metrics indicating financial health, such as high returns on invested capital, free cash flow generation, and a history of earnings, has also led us historically to overweight asset management businesses as well as invest in an ample number of insurance companies and tech-related financial services businesses.

The ongoing bull market for stocks was obviously a factor in the robust results for many investment management firms. The fact that the much-discussed mass exodus from bonds into equities has not yet occurred to any notable degree helped those companies with more fixed income exposure. A recovery in precious metal commodity prices, however, was among the factors driving success for two asset managers—U.S. Global Investors and top-5 position Sprott. The latter is a Canadian investment management company that has been in business since 1981 and has expertise in natural resource and commodity-based investing. U.S. Global Investors is an American investment advisory firm that specializes in natural resources and emerging markets. While a recovery for the second of these groups has been spotty, the first improved enough to renew interest in its stock. We built a position in both when their respective share prices were declining in 2013.

Two non-U.S. capital markets companies enjoyed a strong first half. Egyptian Financial Group-Hermes Holding Company is the leading investment bank in the Arab world and provides services such as asset management, securities brokerage, research, and private equity. Improved revenues seemed to draw more investors to its stock. CETIP Mercados Organizados organizes the overthe- counter (OTC) markets in Brazil. The company offers an electronic platform for conducting online transactions, such as auctions and government bond trading, corporate bonds, and fixed-income securities. CETIP also provides central securities depository, outsourcing, market data, and risk management services. Its shares rose on what we suspect was a flight to company quality in Brazil’s first-half bear market. CRISIL, the Fund's top performer in the first half, comes from outside the capital markets group. An India-based global analytical company providing ratings, research, and risk and policy advisory services, its shares seemed to rise on an improved economic and market climate in India.

We added shares of ETF specialist WisdomTree Investments as its share price slipped while we slightly trimmed our stake in Towers Watson & Co., a benefits consultant whose shares seemed to correct on profit taking following a run-up in 2013 and a slight slowdown in its business during the first half.

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

U.S. Global Investors Cl. A 0.47
Egyptian Financial Group-Hermes Holding Company 0.44
CETIP - Mercados Organizados 0.39
Sprott 0.38
1 Includes dividends

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

WisdomTree Investments -0.34
Towers Watson & Co. Cl. A -0.25
Financial Engines -0.24
Waddell & Reed Financial Cl. A -0.22
Japan Exchange Group -0.19
1 Net of dividends

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

Financial Services 2.03 3.62 23.76 15.37 16.71 9.25 8.90 12/31/2003
Russell 2000 2.05 3.19 23.64 14.57 20.21 8.70 8.95 N/A
Russell 2500 Fnl Svc 3.06 5.80 19.41 16.01 19.20 6.48 6.70 N/A
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Annual Operating Expenses: Gross 1.97% Net 1.57%

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. Gross operating expenses reflect the Fund’s gross total annual operating expenses for the Service Class 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 fees and/or reimburse 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 1.49% through April 30, 2015. 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 equity securities in the financial services sector. The Fund is not a complete investment program. It is designed for long-term investors who can accept the risks of investing in a fund with common stock holdings primarily in smaller-cap financial services companies. Therefore, the Fund is subject to certain risks associated with the industry, including, among other things, changes in government regulations, interest rate levels, and general economic conditions. The Fund invests primarily in micro-cap, 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. 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. The Fund may invest up to 35% of its net assets (measured at the time of investment) in securities of companies headquartered in foreign countries, 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 Russell 2500 index represents the smallest 2,500 companies in the Russell 3000 index. The returns for the Russell 2500—Financial Sector represent those of the financial services companies within the Russell 2500 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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