article 12-31-2014

Royce Opportunity Fund Manager Commentary

Fund Performance

Royce Opportunity Fund posted a loss of 0.5% in 2014, underperforming its small-cap benchmark, the Russell 2000 Index, which increased 4.9% for the same period. After a number of strong calendar-year performances on both an absolute and relative basis, Opportunity finished further behind its benchmark than we would prefer. And while a year in the red, even slightly, is far from ideal, we remain confident in the Fund's distinctive opportunistic approach, especially over long-term periods.

For the first half, the Fund narrowly trailed the Russell 2000, up 3.0% versus 3.2%. The bulk of Opportunity's difficulties, on both a relative and absolute basis, were in the bearish third quarter when small-caps began to slide following a high on July 3. For the quarter, the Fund fell 9.0% compared to a loss of 7.4% for the small-cap index. This did not worry us; Opportunity has historically had a mixed record of success in short-term downdrafts versus the Russell 2000. And while the Fund also underperformed in the bullish fourth quarter, rising 6.1% while the Russell 2000 climbed 9.7%, the quarter included the end of the downturn, which bottomed out on October 13. From that date through the end of December, Opportunity narrowly outpaced the small-cap index, advancing 15.4% versus 15.2%. The calendar year did little to dent Opportunity's longer-term advantage. The Fund outpaced the small-cap index for the three-, 10-, 15-year, and since inception (11/19/96) periods ended December 31, 2014 (and trailed by only 24 basis points for the five-year period). Opportunity's average annual total return since inception was 13.0%. We take great pride in the Fund's nearly two decades of strong long-term results.

What Worked... And What Didn't

The market hates uncertainty. In that sense, the second half of 2014 reminded us a little of 2011, when political discord made the market nervous and led to a largely negative second half. Although 2014 was a much better year than 2011, we once again saw an exogenous event—the collapse of oil prices—sow the seeds of uncertainty, rattle investors, and help to create both higher volatility and steep losses, at least among certain small-caps and most energy companies. Opportunity's exposure to Energy was slight, though not small enough to prevent the sector from detracting most—by a good-sized margin—from 2014's results. Two holdings from the sector were among the Fund's loss leaders. Swift Energy is an onshore and offshore exploration & production ("E&P") company. Offshore has higher costs, which meant being hurt first and hardest in the decline. We reduced our position in December, as we did with Approach Resources, a Texasbased E&P business.

Outside Energy, we held shares of Quiksilver, which makes and distributes youth-oriented branded apparel, footwear, and accessories. The company operates under its own brand name as well as Roxy and DC. Its turnaround is taking longer than we anticipated, but we like the management team that came on board in 2013 and the strong presence of its brands in high-pOpportunityile spots such as Macy's. Our confidence in the likelihood of infrastructure improvements led us to build our position in General Cable, which makes copper, aluminum, and fiber optic wire and cable products for the energy, industrial, construction, specialty, and communications markets. Its international exposure hurt results, but we think it's well positioned to recover when industrial activity picks up.

The rising stock price of Century Aluminum prompted us to sell shares through most of 2014. The company produces the metal for sale in the U.S. and Iceland. Earnings recovered in the second half in part the result of the increased use of aluminum-steel hybrids in the aerospace and automotive industries. In February 2014, RF Micro Devices and TriQuint Semiconductor agreed to merge, which seemed to help the shares of each semiconductor business to climb in 2014. We sold the last of our shares of TriQuint in May while holding RF Micro Devices at year end. One of 2013's top contributors extended its net gains through 2014—SunEdison produces electronic-grade polysilicon used for electronics, solar cells, and film devices while also developing solar power projects. The demand for solar technology keeps heating up, the result of improved technological efficiency that's helping to lower costs and support for its long-term environmental benefits.

Top Contributors to Performance
For 2014 (%)

Century Aluminum 0.61
RF Micro Devices 0.47
SunEdison 0.36
Spansion Cl. A 0.35
Planar Systems 0.35
1 Includes dividends

Top Detractors from Performance
For 2014 (%)

Quiksilver -0.42
Swift Energy -0.36
General Cable -0.34
Approach Resources -0.31
Extreme Networks -0.28
1 Net of dividends

Current Positioning and Outlook

In many ways a restocking year, 2014 saw us trimming or selling positions that had established momentum while looking to find or add to companies that will ideally furnish the next few years with strong performance. Looking ahead, we are constructive on several consumer and technology areas, as well as housing and non-residential construction. Lower energy prices and improved employment rates should help to keep the U.S. consumer active and confident, as was the case in the closing months of 2014 when auto sales remained strong, and holiday sales were robust for many retailers. We anticipate that housing sales should gain momentum in the weeks and months following the Super Bowl, as is often the case, and also expect non-residential construction and infrastructure activity to increase in 2015.

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

Opportunity 6.15 -0.48 20.52 15.31 8.14 11.60 13.00 11/19/1996
Russell 2000 9.73 4.89 19.21 15.55 7.77 7.38 8.53 N/A
Annual Operating Expenses: 1.17%

* 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 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 Opportunity's Service, Consultant, R, and K Classes bear an annual distribution expense that is not borne by the Investment 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 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. 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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