article 12-31-2014

Royce International Smaller-Companies Fund Manager Commentary

Fund Performance

Non-U.S. small-cap indexes trailed their domestic peers once again in 2014, and Royce International Smaller-Companies Fund was unable to resist the trend. The Fund was down 7.3% in 2014 while its benchmark, the Russell Global ex-U.S. Small Cap Index, lost 3.6% for the same period. Although the Fund also trailed its benchmark in the first half of 2014, its results were both nicely positive and strong on an absolute basis. For the year-to-date period ended June 30, 2014, International Smaller-Cos advanced 6.6% versus 7.5% for the non- U.S. small-cap index.

The Fund's fortunes began to change when a downdraft hit smallcaps across the globe. International Smaller-Cos fell 7.0% in the third quarter while the Russell Global ex-U.S. Small Cap declined 6.2%. All of the Fund's nine equity sectors detracted from performance in the quarter, with Health Care, Industrials, and Materials registering the largest negative impact. At the country level, companies headquartered in France, the United Kingdom, and Japan were the biggest detractors in aggregate from third-quarter performance.

While U.S. small-caps rallied in the fourth quarter, elsewhere in the world smaller companies in general managed only to lose less than they had in the third quarter. International Smaller-Cos was down 6.4% in the final quarter of 2014 compared to a 4.5% loss for the benchmark. Holdings in the U.K. and Japan were once again significant detractors, as were positions headquartered in Malaysia and Brazil. We remain disappointed with the Fund's intermediate and long-term relative results. International Smaller-Cos outperformed the Russell Global ex-U.S. Small Cap for the since inception (6/30/08) period ended December 31, 2014.

What Worked... And What Didn't

For the calendar year, all but one of the Fund's eight equity sectors were in the red. Consumer Discretionary made the largest negative impact by a good-sized margin, with Energy and Materials also posting sizable net losses. Industrials was the Fund's only sector to post net gains, in part due to the strong showing for the machinery industry. At the country level, India was the top contributor to returns for the year (as was the case in the semiannual period, when in May probusiness Bharatiya Janata Party candidate Narenda Modi was elected Prime Minister by a landslide victory). In fact, four of the Fund's top-five contributors to 2014 performance were Indian companies, two of them machinery stocks. AIA Engineering manufactures chromium grinding balls used by the mining and cement industries. In May the firm reported an increase in after-tax profit year-over-year for its fiscal fourth quarter, leading us to take more gains as its stock advanced. A strong balance sheet and rising profits initially drew us to rolling-bearings manufacturer FAG Bearings India. We sold our shares between May and August as its stock price began to reach our sell target. Shriram Transport Finance is India's leading lender to the used truck market and another beneficiary of the country's improved business conditions. We took gains as its shares rose. Magellan Aerospace is an Ontario-based company that serves the civil aerospace and defense markets. Its shares benefited from a strong aerospace and defense capital spending cycle as well as weakness in the Canadian dollar, which significantly increased its competitiveness versus U.S. suppliers. We trimmed our stake in December, though it was a top- 15 holding at the end of 2014.

Globaltrans Investment GDR endured a difficult year, seeing further share price declines in the second half. The company is a leading private freight rail transportation group operating in Russia, the CIS (the Commonwealth of Independent States, including Ukraine), and the Baltics. Globaltrans lost about 70% of its value by year end, hurt by tensions in Ukraine and the weakening ruble. With more than 85% of freight transported by rail in Russia, we believe the company can improve its competitive position in the next couple of years. We like its corporate governance and constructive attitude towards capital allocation. EnQuest is a London-based oil and gas development and production company. A nearly 50% decline in oil prices in the second half keyed the company's plummeting share price. Brasil Brokers Participacoes is one of Brazil's two leading real estate brokerages. A weak real estate market and low consumer sentiment contributed to the company's fading share price, which was also hampered by political uncertainty through the first nine months of the year. As we anticipated, the re-election of president Dilma Rousseff has not yet led to a more business-friendly environment in Brazil. We sold some shares in October and December. The strength of the U.S. dollar also played a role in the performance of non-U.S. holdings.

Top Contributors to Performance
For 2014 (%)

AIA Engineering 0.64
Shriram Transport Finance 0.60
FAG Bearings India 0.55
Thomas Cook (India) 0.53
Magellan Aerospace 0.46
1 Includes dividends

Top Detractors from Performance
For 2014 (%)

Globaltrans Investment GDR -0.98
EnQuest -0.67
Brasil Brokers Participacoes -0.62
New World Department Store China -0.56
Societe Internationale de Plantations d'Heveas -0.50
1 Net of dividends

Current Positioning and Outlook

Though out of favor at the end of 2014, we continue to believe that the international small-cap market is home to many high-quality companies. We see the most potential for growth in developed nations such as Japan, the U.K., and France as well as in certain emerging markets such as India and Brazil. Our focus remains on some of the more economically sensitive areas of the market, such as Industrials and Consumer Discretionary, though International Smaller-Cos was also overweight in Health Care at year end. We have been populating the portfolio with companies that we believe can remain competitive in a highly challenging environment for non-U.S. small-cap stocks.

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

International Smaller-Cos -6.43 -7.29 7.66 5.10 4.69 6/30/2008
Russell Glo x US SC -4.45 -3.63 10.31 6.40 3.18 N/A
Annual Operating Expenses: Gross 2.08% Net 1.7%

* 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 2% 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 total gross annual operating expenses 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 any applicable 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 expense reimbursements. All expense information is reported as of the Fund's most current prospectus. Royce & Associates has contractually agreed to waive its fees and/or reimburse operating 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 1.69% through April 30, 2015 and at or below 1.99% through April 30, 2024. 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 may invest a significant portion of its assets in foreign companies, which may be subject to different risks than investments in securities of U.S. companies, including adverse political, social, economic, currency or other developments that are unique to a particular country or region. These risk factors may affect the prices of foreign securities issued by companies headquartered in developing countries more than those headquartered in developed countries. (Please see "Investing in Foreign Securities" in the prospectus.) Therefore, the prices of the securities of foreign companies in particular countries or regions may, at times, move in a different direction than those of the securities of U.S. companies. (Please see "Primary Risks for Fund Investors" in the prospectus.) In addition, 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 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.) 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 Global ex-U.S. Small Cap Index is an unmanaged, capitalization-weighted index of global small-cap stocks, excluding the United States. Index returns include net reinvested dividends and/or interest income. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.



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