Fund Performance

It was not a successful year for our strategy of investing in conservatively capitalized, dividend-paying micro-cap, small-cap, and mid-cap companies. Royce Dividend Value Fund finished 2014 with a loss of 2.1%, significantly behind its small-cap benchmark, the Russell 2000 Index, which rose 4.9% for the same period. This was especially dispiriting in the context of a strong start to the year, a period of lower but positive returns for most equities following the sky-high returns of 2013. Dividend Value finished the first half of the year just ahead of the small-cap benchmark, up 3.3% versus 3.2% for the Russell 2000.

After eight consecutive positive quarters, the Russell 2000 finished the third quarter in the red. The Fund followed suit, and both fell 7.4% for the quarter. This was something of a disappointment in that Dividend Value has historically lost less than the small-cap index during most down phases, including short-term spans. Unfortunately, the Fund also could not match the fast pace established by the Russell 2000 for most of the year's final quarter. The small-cap index finished the year with an impressive fourth-quarter gain of 9.7% while Dividend Value mustered an advance of 2.3%. Three months, then, sealed a sizable annual advantage for the benchmark. We were more pleased with longerterm results. The Fund beat the Russell 2000 for the 10-year and since inception (5/3/04) periods ended December 31, 2014. Dividend Value's average annual total return since inception was 9.2%.

What Worked... And What Didn't

Of the four equity sectors that posted net losses in the portfolio for 2014, Energy led by a considerable margin, an unsurprising fact in light of the extraordinary decline in oil prices during the second half of the year. Taking our usual contrarian view, we are prepared to live with the negative short-term picture by holding most of our companies in the industry. We believe their long-term prospects will be effectively strengthened in an improved market for energy prices. Having higher operating costs often hurts offshore drillers earlier and harder when crude prices slip, which affected the performance of two companies in the portfolio. Based in Switzerland, Transocean is the world's largest offshore driller. Its shares fell by nearly 60% in 2014 based on both the collapse of oil prices and an oversupplied ultra-deep water drilling market. Louisiana-based Tidewater provides marine service vessels to offshore energy companies. Its low-debt balance sheet and strong market position gave us confidence going forward.

We thought that Nu Skin Enterprises managed its way well through a highly challenging year. It settled issues with the Chinese government by paying fines and improving training, restructured its debt, and positively reversed its cash flows. These positive developments notwithstanding, a rebound in the Chinese market probably needs to happen before its stock can really come back. We demonstrated our confidence in this eventually occurring by adding shares through most of 2014. The ongoing struggles of tween girl retailer Justice and plus-size women's retailer Lane Bryant were major factors in depressing the shares of multiline fashion business Ascena Retail Group. We trimmed our stake in 2014. The ongoing strength of the U.S. dollar combined with the Fund's sizable exposure to non-U.S. companies (more than 24% of net assets at the end of 2014) also created a drag on results, hurting the value of holdings headquartered abroad.

Six equity sectors finished the year in the black, with the largest contribution coming from Financials. Three of Dividend Value's top four industry groups came from that sector—capital markets stocks, insurance companies, and real estate investment trusts (REITs). The last group, one of the strongest for small-caps in 2014, is not an area of primary investment focus, for us as we were significantly underweight REITs versus the Russell 2000. The Fund's topperforming stock was Cintas Corporation, which provides corporate identity uniforms and related business services. Stronger-thanexpected earnings in its first and second fiscal quarters boosted its shares in the second half, when we took gains. Low debt and a solid dividend drew us to C.H. Robinson Worldwide, a third-party logistics company that provides freight transportation services and logistics solutions. Rising earnings drove interest in its stock and led us to reduce our position in November.

Chemed Corporation runs hospice care provider Vitas and plumbing and drain cleaning service company Roto-Rooter. Its shares seemed to climb mostly as a result of a "no news is good news" scenario concerning Vitas. In 2013 the Justice Department began looking into its Medicare enrollment and billing rates. Offering more critical care than is typical in the hospice industry may have been a factor. However, margins for critical care are not much higher than for other elements of hospice care, and Vitas is one of the few delivering it on a nationwide basis. The absence of any additional developments in the investigation appeared to reassure investors. We reduced our position as its stock price rose.

Current Positioning and Outlook

We continue to focus on what we regard as well-run dividendpaying businesses. We have positioned the portfolio for improved performance from cyclical sectors in 2015, basing this decision on our confidence in both the ongoing expansion of the U.S. economy and an earnings-led rally for small-cap stocks.

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

* Not Annualized

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

Important Performance, Expense, and Disclosure Information