article 06-30-2014

Royce Opportunity Fund Manager Commentary

After a record of terrific results on both an absolute and relative basis over the last several years, Royce Opportunity Fund took a slight breather, at least on a relative basis, in the first half of 2014. The Fund advanced 3.0% for the year-to-date period ended June 30, 2014, slightly underperforming its small-cap benchmark, the Russell 2000 Index, which rose 3.2% for the same period. This was not a matter of great concern to us, considering both the narrow gap in first-half results between Opportunity and the small-cap index and the fact that the correction that hit the market between the 2014 small-cap high on March 4 and May 15 presented some buying opportunities, particularly among micro-cap stocks that were hurt more than many larger small-cap businesses.

The year began on the same bullish note on which 2013 ended, though in a much softer tone. For the first quarter, the Fund was up 3.5%. This strong performance helped to mitigate the effect of the subsequent down phase. The correction that began in early March was tougher on the Fund than on its benchmark, though it was consistent with much of what was happening with micro-cap companies. The Fund thus yielded ground to the small-cap index in the second quarter, when it fell 0.5% while the Russell 2000 rose 2.0%.

This did nothing to hurt the Fund’s relative advantage over longer time periods. Opportunity beat the Russell 2000 for the one-, three-, five-, 10-, 15-year, and since inception (11/19/96) periods ended June 30, 2014. The Fund also held a performance edge through recent market cycle periods. (Market cycle results can be found here.) The Fund's average annual total return since inception was 13.6%. We remain quite proud of the Fund’s long-term results on both an absolute and relative basis.

Our historical practice has been to act in a very deliberate and disciplined manner in managing the portfolio’s assets. In the first half, this meant selling many of the portfolio’s strong performers to more momentum-based investors. We think this is a prudent strategy, as it allows us to purchase companies at the attractively low P/B and price-to-sales ratios that make holdings statistically valid for the portfolio.

Many of these newer holdings (or additional shares of existing holdings that have not yet reversed course) endured tough times throughout the second quarter. While disappointing on a short-term basis, we were comfortable with these decisions. It is always important to pare back portfolio successes and use those proceeds in an attempt to set the portfolio up for future growth. Another related reason behind this approach is the absolute importance of maintaining what we believe is a reasonable valuation level for the portfolio taken as a whole. Many of these purchases were in technology, housing, and non-residential construction, including M.D.C. Holdings, William Lyon Homes, M/I Homes, and TRI Pointe Homes. Information Technology was the Fund’s largest sector weighting at the end of June and its largest net gainer for the semiannual period. We remain confident in the prospects for many tech-based industries. Higher corporate profitability looks likely to trigger a round of long-overdue CAPEX spending. The market for PCs has been improving of late. There are also a number of new devices and related technologies due for release in the next year or so on the already robust tablet and mobile fronts. This could result in simultaneously strong markets for PCs, mobile devices, and tablets, which would be excellent news for much of the sector—and many of our holdings within it. The housing market continues to grow and looks to us as though it is in an extended cycle while nonresidential construction looks poised for a long-term recovery following pretty dismal results in 2013, with building activity on the rise so far in 2014.

Two of 2013’s top contributors continued their winning ways in the first half. SunEdison produces electronic-grade polysilicon used for electronics, solar cells, and film devices while also developing solar power projects. The demand for solar technology keeps heating up, with improved technological efficiency helping to lower costs. Tower International runs a global business manufacturing metal automotive components for OEMs (original equipment manufacturers). Demand has held up well worldwide and is rapidly growing in Asia, helping its share price to keep accelerating. Albany Molecular Research benefited from the growing trend toward outsourcing medical research.

As for those holdings that struggled in the first half, we chose to hold shares of Quiksilver, a youth-oriented apparel and footwear maker that operates under its own brand name as well as Roxy and DC. Like so many retailers, it suffered through an awful first half. We like the way it handled the challenges it faced and its new management. Walter Energy produces metallurgical coal and continued to suffer in the wake of China’s sluggish economy, which led us to reduce our position.

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

SunEdison 0.42
Albany Molecular Research 0.36
Tower International 0.35
Basic Energy Services 0.30
Sanmina Corporation 0.26
1 Includes dividends

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

Quiksilver -0.36
Walter Energy -0.21
Extreme Networks -0.19
VOXX International Cl. A -0.19
Molycorp -0.17
1 Net of dividends

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

Opportunity -0.50 3.02 24.76 15.43 23.48 9.53 12.89 13.62 11/19/1996
Russell 2000 2.05 3.19 23.64 14.57 20.21 8.70 8.01 8.69 N/A
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Annual Operating Expenses: 1.17%

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 Investment Class (its oldest class). Operating expenses reflect the Fund’s total annual operating expenses for the Investment Class as of the Fund’s most current prospectus and include management 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. Shares of ROF’s Service, Consultant, R, and K Classes bear an annual distribution expense that is not borne by the Investment 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 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 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. 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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