article 06-30-2014

Royce Special Equity Multi-Cap Fund Manager Commentary

A relatively slow start to 2014 led Royce Special Equity Multi-Cap Fund to lose some ground to its benchmark in the first half. The Fund advanced 5.3% for the year-to-date period ended June 30, 2014, trailing its benchmark, the Russell 1000 Index, which increased 7.3% for the same period.

The second half of 2013 was a highly bullish period, though one in which leadership remained with lower-quality stocks. This has mostly remained the case so far in 2014. For the first quarter, the Fund was up 0.6% versus a gain of 2.0% for its benchmark. The Fund’s underweight in Utilities and overweight in Consumer Discretionary had a negative impact on first-quarter returns. It has not been pleasant to be overweight in the latter sector so far in 2014. However, we believe that as the economy continues to improve (as we believe it will), results should improve, perhaps dramatically. The outlook for consumer spending looks healthy as a result of tame inflation, still restrained mortgage rates, rising household net worth, repaired household balance sheets, and improved consumer confidence. In addition, capacity utilization in the U.S. is inching towards the 80% rate; at this level we should start to see more hires and capital expenditures, reigniting the economy.

Large-cap performance was in general more consistent in the first half, not correcting as small-caps did from early March through mid-May. For the second quarter, the Fund gained 4.7%. In addition to posting strong results on an absolute basis, Special Equity Multi-Cap continued to hold a relative advantage over its benchmark for the three-year and since inception (12/31/10) periods ended June 30, 2014. The Fund’s average annual total return since inception was 16.7%.

The market is much narrower than it has been in the recent past, with greater stock selection at work, which should help the Fund’s results in time. Through April 24, the top 10 contributors in the S&P 500 equaled 99.3% of the large-cap index’s advance, while for the same period last year it was only 25.3%, which shows the narrower focus. Many have observed that for a validation of the improving prospects for the economy, rates on Treasuries should be rising. They have not as of yet. This is an interesting point, as it suggests that rising rates, due to stronger economic activity, will not weigh down the market. We believe we are close to a move towards greater cyclical exposure in the marketplace. We think that investors will increasingly abandon their obsession with counter-cyclicals and start to embrace anything with economic leverage in the U.S.

Consumer Discretionary stocks remained the portfolio’s most significant detractors for the entire first half, its largest net losses coming from the specialty retail industry. The sector’s losses as a whole were mitigated by robust results for multiline retailer Nordstrom, which bucked the trend for its own industry as well as that of specialty retailers, and Lear Corporation, a maker of automotive seating, electrical distribution systems, and related components primarily to automotive original equipment manufacturers. Each of these companies was among the Fund’s larger positions at the end of the first half. The Fund's fifthlargest holding at the end of June, Bed, Bath & Beyond led all detractors. We increased our position throughout the first half in this New Jersey-based retailer of a wide variety of domestic merchandise. Office products retailer Staples was also a large detractor from performance through the end of June, hurt by poor sales.

While holdings in the Energy and Health Care sectors posted more-than-respectable net gains in the first half, the Information Technology sector was a source of particular strength, contributing most to results for the semiannual period. Four tech-based names stood out with impressive net gains—SanDisk Corporation, KLA-Tencor, Microsoft Corporation, and Cisco Systems. The stock making the most significant positive impact, however, came from the Energy sector. Helmerich & Payne is a contract drilling company in North and South America that provides drilling rigs, equipment, personnel, and camps on a contract basis. The stock of this Tulsa, Oklahoma-based business appeared to benefit from growing demand for its services in a brisk market for energy services companies.

An economic outcome that we increasingly believe in resembles Bill Gross’s “new neutral:” Slower but more consistent growth than we have seen in the past with resulting lower-thanexpected inflation and interest rates. This is a variation of the “Goldilocks” outcome—not too hot or too cold. If this is indeed the case, P/E multiples will likely stay at current levels and possibly even increase.

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

Helmerich & Payne 1.44
SanDisk Corporation 1.03
KLA-Tencor 0.69
Microsoft Corporation 0.65
Nordstrom 0.61
1 Includes dividends

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

Bed Bath & Beyond -1.57
Staples -1.24
Coach -0.34
Emerson Electric -0.26
Parker Hannifin -0.10
1 Net of dividends

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

Special Equity Multi-Cap 4.72 5.35 21.85 16.83 16.73 12/31/2010
Russell 1000 5.12 7.27 25.35 16.63 16.14 N/A
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Annual Operating Expenses: Gross 1.46% Net 1.24%

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). Gross operating expenses reflect 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. 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. Net operating expenses reflect contractual fee waivers and/or 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 operating expenses to the extent necessary to maintain the Service Classes’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 1.24% through April 30, 2015. 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 mid-cap and large-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. 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 1000 index is an unmanaged, capitalization-weighted index of domestic large-cap stocks. It measures the performance of the 1,000 largest 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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