article 06-30-2014

Royce Total Return Fund Manager Commentary

By doing largely what we would expect it to do, Royce Total Return Fund finished the first half of 2014 with a solid absolute result that nonetheless fell short of its benchmark. The Fund gained 2.7% for the year-to-date period ended June 30, 2014 versus a 3.2% increase for its small-cap benchmark, the Russell 2000 Index, for the same period.

For the majority of small-caps, performance in the first half was more muted than it was in 2013, which was as dynamic a year as we have seen for stocks since the initial phase of the post-financial crisis recovery in 2009. Following last year’s very bullish second half, the slackening of the pace in 2014’s first quarter was not surprising. However, we were disappointed that small- and micro-cap dividend payers did not perform better. Total Return rose 0.5% in the first quarter. Volatility, which has been quite low throughout the last 18 months, returned briefly to the small-cap market in early March and persisted through mid-May, making the second quarter a relatively more unsettled period. Equities rallied through the end of May and all of June, undoing the bearish effect. We were pleased to see the Fund narrowly outpace its benchmark during the second quarter, up 2.2% versus 2.0% for the small-cap index. The Fund's pronounced advantage from the 2014 small-cap high on March 4 through the end of June was key to this advantage. (More market cycle results can be found here.)

We have been pleased with the Fund’s performance in more volatile markets over the last two-plus years even as we acknowledge that returns for dividend-paying small-caps during this otherwise mostly bullish period have lagged those for small companies that do not, as well as for the small-cap benchmark as a whole. Small-cap stocks are an asset class in which volatility can be high while dividends are often ignored. We take a typically contrarian view, seeing dividends as a key link on a company’s capital allocation chain. We also see the potential attraction for the sort of conservatively capitalized, dividend-paying small-cap companies that we seek for the Fund’s portfolio going forward: As the Fed’s quantitative easing winds down and interest rates begin to rise, we expect economic growth to pick up speed with a consequent focus on fundamentals from investors.

For periods ended June 30, 2014, the long-term performance advantage remained with dividend payers in the small-cap asset class, as did lower overall volatility as measured by standard deviation. It was unsurprising, then, that Total Return outperformed the Russell 2000 for the 10-, 15-, 20-year, and since inception (12/15/93) periods ended June 30, 2014. The Fund’s average annual total return since inception was 11.6%, a long-term record that gives us great pride.

Nine of Total Return’s 11 equity sectors finished the first half in the black. Financials and Energy led all of the Fund’s sectors while Consumer Discretionary and Consumer Staples holdings as a whole detracted from first-half results. Contributions at the industry level were broad based. Machinery led by a good-sized margin, its results driven by Trinity Industries, a midcap company that was the Fund’s top-performing holding for the semiannual period. Trinity provides products and services for the energy, transportation, chemical, and construction industries in the U.S., Canada, Mexico, the U.K., Singapore, and Sweden. Liking its core business and dividend, we have owned shares since 2001. Pleased to watch its share price rise more or less steadily over the last five years, we particularly enjoyed the boosts its stock received at different points in the first half when the firm announced some canny acquisitions, record fiscal fourth-quarter and full-year 2013 earnings, an increase in its dividend, and a 2-for-1 stock split. We began to take gains in May.

Helmerich & Payne is an oil and gas contract driller that provides drilling rigs, equipment, personnel, and camps on a contract basis. It’s a long-time holding that we have owned for more than a decade in the Fund’s portfolio. Its edge lies in the superiority of its drilling fleet, which has helped the firm to remain profitable even in periods that were more challenging for the energy industry than the first half of 2014. We reduced our stake while its stock price was gushing. Improved operating results, better portfolio performances, and increased assets under management all helped the share price of investment manager AllianceBernstein Holding L.P., another long-term holding, to shine in the first half.

Individual stock losses were mostly modest. Nu Skin Enterprises was embroiled in allegations made in January by a Chinese newspaper that it was running a pyramid scheme. Although by March the firm had paid a small fine and revamped its training procedures, short-term results were challenged. We were re-evaluating our long-term outlook for this personal product manufacturer and distributor, hopeful that its global business could eventually resume its formerly healthy pace of growth. We built our position in Ascena Retail Group, a multiline women’s fashion retailer. Like many in its industry, the firm endured lousy results owing to poor holiday sales and frigid winter weather. We believe that it can rebound.

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

Trinity Industries 0.41
Helmerich & Payne 0.25
AllianceBernstein Holding L.P. 0.19
Franco-Nevada Corporation 0.18
Chemed Corporation 0.17
1 Includes dividends

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

Nu Skin Enterprises Cl. A -0.23
Ascena Retail Group -0.14
Balchem Corporation -0.13
Ethan Allen Interiors -0.12
American Eagle Outfitters -0.12
1 Net of dividends

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

Total Return 2.18 2.74 20.87 13.34 18.28 8.72 10.19 11.92 11.57 12/15/1993
Russell 2000 2.05 3.19 23.64 14.57 20.21 8.70 8.01 9.81 9.37 N/A
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Annual Operating Expenses: 1.18%

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 RTR’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. 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 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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