article 12-31-2014

Royce 100 Fund Manager Commentary

Fund Performance

Royce 100 Fund was down 3.3% in 2014, underperforming its small-cap benchmark, the Russell 2000 Index, which gained 4.9% for the same period. A difficult year, 2014 began in far more promising fashion, as the year's first six months were both placid and bullish, albeit in a low key way. The Fund was up 2.8% for the six-month period ended through June 30, 2014 compared to 3.2% for the small-cap index.

The third quarter, however, saw increased volatility within small-cap and mostly staggering share prices. 100 lost a surprising 9.0% in the quarter while the Russell 2000 fell 7.4%. This was particularly discouraging because we expect our risk-conscious approach to weather such periods better than the index, as has usually been the case throughout the Fund's more-than-10-year history. Compounding its difficulties, the Fund then failed to participate fully in the rally that enlivened much of the fourth quarter, climbing 3.4% versus 9.7% for the Russell 2000. For most of the year, then, the market did not reward the sort of high-quality companies that we seek for the portfolio. Many of the highest returns went instead to faster-growing, often unprofitable businesses. We were more encouraged by the Fund's longer-term relative and absolute results. 100 outpaced the small-cap index for the 10-year and since inception (6/30/03) periods ended December 31, 2014. The Fund's average annual total return since inception was 10.6%.

What Worked... And What Didn't

100's eight equity sectors were split between four that showed net gains and four that sustained net losses. The largest negative impact came from the Industrials sector, home of 10 of the portfolio's 20 largest detractors in 2014. The stock price of KBR fell throughout the year. During the first half, the company struggled with the cancellation of some engineering and construction projects and losses on a few others while also contending with pushed-out start dates for certain LNG (liquefied natural gas) ventures. Later in the year, the firm's CEO unveiled a restructuring plan. While the plan showed promise, we chose to sell our shares in 100's portfolio and move on. We also chose to exit GrafTech International, which manufactures graphite and carbon material mostly for use in the steel industry. A series of earnings misses, mainly the result of graphite electrode order push outs and weakening international business, helped its shares to decline by more than 50% in the third quarter, eroding our confidence.

The second-half collapse of oil prices caused an unfortunate reversal for many of our Energy holdings. The sector was 100's best performing group through the end of June only to finish the year with the portfolio's second-largest net loss on a sector basis. Our Energy holdings were in the equipment & services industry (as opposed to those exclusively engaged in exploration and production), but these companies were not spared. Unit Corporation, the Fund's eleventh-largest position at the end of the year, is a long-time holding involved in several energy businesses, including oil and natural gas exploration, oil and gas property acquisition, contract drilling services, and natural gas processing. Its ability to do each of these jobs well makes it something of an anomaly in an otherwise rigidly specialized industry. We built our position in the fourth quarter. The core business of Canadian oilfield service company Trican Well Service took us in the opposite direction. Differentiation has become increasingly difficult to establish in the field of hydraulic fracturing. This development, combined with the capital intensity of fracking fleets, leads both existing and potential customers to price aggressively in downturns in order to maintain fleet utilization, prompting us to sell our shares in 100 in December.

Information Technology led those sectors posting net gains in 2014. Sapient Corporation is a marketing and consulting services firm whose acquisition by French advertising giant Publicis Groupe for a more than 40% premium was announced in November. Our take was that the move proved Sapient's value and highlighted the increasing importance (and share gains) of digital marketing for more traditional advertising businesses. Marcus & Millichap is a national commercial real estate and financing brokerage firm. A market leader in the private segment of the investment sales market, it has double the market share of its nearest competitor but in our estimation has ample room to grow. Increased commercial real estate activity supplemented by the company's national network and database of private real estate investors was a key driver of 2014 results.

Top Contributors to Performance
For 2014 (%)

Sapient Corporation 0.58
Marcus & Millichap 0.53
ePlus 0.48
Core-Mark Holding Company 0.45
Liberty Tax 0.43
1 Includes dividends

Top Detractors from Performance
For 2014 (%)

Trican Well Service -0.78
Unit Corporation -0.74
KBR -0.71
GrafTech International -0.65
Destination Maternity -0.53
1 Net of dividends

Current Positioning and Outlook

Effective November 10, 2014, Lauren Romeo became the Fund's lead portfolio manager. Chuck Royce manages the Fund with her. Ms. Romeo previously served as co-manager (2013-2014), portfolio manager (2010-2013), and assistant portfolio manager (2006- 2010). Mr. Royce has managed the Fund since its inception. We are anticipating accelerated economic growth, with many holdings poised for margin expansion when revenue growth improves. While the near-term outlook for energy-related stocks is grim, we have confidence in the long-term prospects for our holdings in or close to that industry. We believe rising capital spending and signs of an upturn in non-residential construction should help many holdings in Industrials, 100's largest sector weighting at year end. We also believe that favorable secular spending trends in semiconductor capital equipment, factory automation, and telecom infrastructure should bode well for many tech-related positions.

Average Annual Total Returns as of Quarter-End 12/31/14 (%)

100 3.43 -3.26 12.18 10.49 8.48 10.58 6/30/2003
Russell 2000 9.73 4.89 19.21 15.55 7.77 10.40 N/A
Annual Operating Expenses: 1.51%

* Not Annualized

Current month-end performance may be obtained at our Prices and Performance page.

Important Performance, Expense, and Disclosure Information

All performance information in this piece 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 30 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). Operating expenses reflect the Fund's gross total annual operating expenses for the Service Class as of the Fund's most current prospectus, 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. Shares of 100's R Class bear an annual distribution expense that is higher than that of the Service Class. Regarding the "Top Contributors" and "Top Detractors" 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 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 December 31, 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 December 31, 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 and mid-cap stocks, which may involve considerably more risk than investing in larger-cap stocks. The Fund also generally invests a significant portion of its assets in a limited number of stocks, which may involve considerably more risk than a more broadly diversified 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. (Please see "Primary Risks for Fund Investors" in the prospectus.) 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 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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