article 12-31-2014

Royce Financial Services Fund Manager Commentary

Fund Performance

Royce Financial Services Fund was up 3.5% in 2014, trailing both its small-cap benchmark, the Russell 2000 Index, which was up 4.9%, and the Russell 2500 Financial Services Index, which rose 11.2% for the same period. The market remained in a bull phase as 2014 began, though it moved at a much slower pace following the speedway clip of the previous year. Equity returns thus remained mostly positive amidst a lot of talk about whether or not valuations were unreasonably high. The Fund advanced 3.6% for the sixmonth period ended June 30, 2014 compared to respective gains of 3.2% and 5.8% for its benchmark and the Russell 2500 Financial Services Index.

The next few months saw a temporary end to the bullish phase, though the downdraft was mostly confined to small-cap and, to a lesser extent, mid-cap stocks. After reaching a year-to-date high on July 3, and interrupted by an August rally, the Russell 2000 was mostly in decline into mid-October. This made for higher volatility as well as falling stock prices. For the third quarter, Financial Services was down 4.2%, holding its value better than its small-cap benchmark, which lost 7.4%, but losing some ground to the financial services component of the Russell 2500, which fell 3.9% for the same period. Share prices began to recover in October. For the fourth quarter the Fund gained 4.2% compared to respective gains of 9.7% and 9.5% for the small-cap index and the financial services companies in the Russell 2500. While 2014's results were far from ideal, we were pleased with the Fund's longer-term results. The Fund outperformed the Russell 2000 for the three-year and 10-year periods ended December 31, 2014 and narrowly trailed the small-cap index for the since inception (12/31/03) period (+8.5% versus +8.7%). In addition, Financial Services was ahead of the Russell 2500 Financial Services Index for the three-year, 10-year, and since inception periods ended December 31, 2014.

What Worked... And What Didn't

The Fund's largest-detracting position in 2014 was Ashmore Group, a London-based asset manager and global leader in emerging market investing. Its shares were challenged by worries about the debt cycle and bad news out of Russia and other emerging markets in 2014. Earnings have been adversely affected but revenues have remained fairly steady. We added shares early in 2014 (as well as in January 2015) and held a good-sized stake at year end. In June, we built our stake in Financial Engines, a large independent investment adviser specializing in retirement plan services. Earnings were a bit lower than expected, which seemed to be a factor in the descent of its stock price, as was the news in November that its founder-CEO would be retiring in 2015. We focused on the company's ongoing financial and operating strength as well as its expertise in a niche that legions of retiring Baby Boomers should keep in high demand in the years ahead.

Two industry groups—capital markets, which includes asset management businesses, and insurance companies—dominated calendar-year performance. Minneapolis-based asset manager Piper Jaffray led all of the portfolio's net contributors. The firm enjoyed steady asset growth year-over-year in addition to revenue and earnings improvement, all of which seemed to draw investors to its stock. It was the Fund's fourteenth-largest position at the end of 2014. CRISIL is an India-based global analytics company that provides ratings, research, and risk and policy advisory services. Its shares seemed to rise on the improved economic and market climate in India following the elections in May 2014, which helped to make it a top-20 holding at year end. Egyptian Financial Group-Hermes Holding Company is the leading investment bank in the Arab world. The company offers services such as asset management, securities brokerage, research, and private equity. Improved revenues seemed to draw more investors to its stock, especially in the first half of the year.

Top Contributors to Performance
For 2014 (%)

Piper Jaffray 0.58
Egyptian Financial Group-Hermes Holding Company 0.40
Monroe Capital 0.39
SS&C Technologies 0.38
1 Includes dividends

Top Detractors from Performance
For 2014 (%)

Ashmore Group -0.54
Financial Engines -0.51
Dundee Corporation Cl. A -0.35
Hellenic Exchanges - Athens Stock Exchange -0.31
Xoom Corporation -0.28
1 Net of dividends

Current Positioning and Outlook

Throughout its history, Financial Services has at times been out of sync with the financial services companies in the Russell 2500 Index. (Being a sector fund, Financial Services has also frequently moved in a different direction than the Russell 2000.) We would expect this to continue, especially considering the portfolio's comparatively low exposure to banks and REITs. Banks were one of the larger, and REITS one of the better-performing, groups within the Russell 2500 Financial Services Index. Our preference is for conservatively capitalized, fundamentally strong financial services businesses that we think are both well managed and trading at attractively low valuations based on our estimate of the company's intrinsic worth. This predisposition toward strong balance sheets and other metrics indicating financial health, such as high returns on invested capital, free cash flow generation, and a history of earnings, has led us historically to overweight asset management businesses and invest in an ample number of insurance companies and tech-related financial services businesses. This was the case at the end of 2014.

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

Financial Services 4.20 3.45 21.04 13.26 7.82 8.46 12/31/2003
Russell 2000 9.73 4.89 19.21 15.55 7.77 8.69 N/A
Russell 2500 Fnl Svc 9.47 11.25 20.36 15.33 5.35 6.87 N/A
Annual Operating Expenses: Gross 1.97% Net 1.57%

* 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. Gross operating expenses reflect the Fund's 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. Net operating expenses reflect contractual fee waivers and/or expense 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 expenses to the extent necessary to maintain the Fund'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 1.49% through April 30, 2015. 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. 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 equity securities in the financial services sector. The Fund is not a complete investment program. It is designed for long-term investors who can accept the risks of investing in a fund with common stock holdings primarily in small-cap and mid-cap financial services companies. Therefore, the Fund is subject to certain risks associated with the industry, including, among other things, changes in government regulations, interest rate levels, and general economic conditions. The Fund invests primarily in small-cap and/or mid-cap stocks, which may involve considerably more risk than investing in larger-cap stocks. (Please see "Primary Risks for Fund Investors" in the prospectus.) As of 12/31/14 the Fund invested 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 of these stocks would cause the Fund's overall value to decline to a greater degree.The Fund may invest up to 35% 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 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 Russell 2500 index represents the smallest 2,500 companies in the Russell 3000 index. The returns for the Russell 2500—Financial Sector represent those of the financial services companies within the Russell 2500 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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