article 12-31-2014

Royce Smaller-Companies Growth Fund Manager Commentary

Royce Smaller-Companies Growth Fund (formerly Royce Value Plus Fund) gained 3.9% in 2014, trailing its small-cap benchmark, the Russell 2000 Index, which gained 4.9% for the same period. Smaller-Companies Growth finished the first half of 2014 with an advantage over the small-cap benchmark, up 4.1% versus 3.2%. Holding this gain through the third quarter, when small-cap stock prices began to slip rapidly following a high for the Russell 2000 on July 3, the Fund was down 6.5% while the small-cap index declined 7.4%. When small-caps rallied through much of the fourth quarter, however, the Fund could not match the benchmark's pace. Smaller-Companies Growth increased 6.8% in the final quarter of 2014, a fine result on an absolute basis, but still behind the 9.7% advance for the Russell 2000. This had its effect on certain intermediate- and long-term results, many of which fell short of what we would like on a relative basis even as they were strong on an absolute basis. The Fund outperformed the Russell 2000 for the since inception (6/14/01) period ended December 31, 2014. The Fund's average annual total return since inception was 12.2%.

What Worked... And What Didn't

Health Care had a robustly positive effect on calendar-year results, leading all of the Fund's sectors by a large margin. Two of these holdings were takeover targets in 2014. Furiex Pharmaceuticals first saw strong results in phase III clinical trials for an IBS treatment before being acquired at a healthy premium. The announcement in April prompted us to sell our shares. In February the stock price of InterMune soared on news of positive phase III trial results for a drug that treats IPF (idiopathic pulmonary fibrosis), a chronic and ultimately fatal condition that leads to a decline in lung function. It shot up again in August on news that Roche was buying the firm. Elsewhere in the sector, Myriad Genetics was a top contributor after detracting from 2013 results. The company faced several headwinds that year: reimbursement change concerns from payers, a Supreme Court decision in June that held that human genes cannot be patented, and new competition in the breast cancer gene testing market. This led its stock to fall, though the company retained some of its patents on certain genetic testing processes. Its shares then came back strong in the first half. The reimbursement issues were resolved at a rate that was more favorable than many investors were expecting, and the firm has demonstrated an impressive rate of growth. Additionally, competition, especially in the breast cancer genetic screening area, has not materialized to the degree many were anticipating. For example, it has retained about 90% of its market share in breast cancer genetic screening. It was the Fund's third-largest holding at year end.

We also had success with holdings involved in big data and machine-to-machine (M2M) technology, sometimes known as "the Internet of Things." The latter typically involves using technology on one piece of equipment that captures and relays information through a wireless or wired network. This information then goes to a computer, which translates it into meaningful data that makes machines work better. Sierra Wireless, a wireless data communications equipment company with a global business providing M2M communications and mobile components, was one beneficiary of solid fundamentals and burgeoning investor interest in this important area. It was the Fund's fourteenth-largest holding at the end of 2014.

Net losses at the sector level were relatively modest. Energy led the detractors followed by Materials, Consumer Staples, and Financials. After increasing our exposure to Energy in the first half, we began to trim as share prices were climbing, a fortuitous shift in light of the rapid decline in oil prices. With Energy, our preference is for service businesses rather than E&P (exploration & production) companies. Triangle Petroleum is involved in several facets of energy, including fracking and well services as well as production. Its shares plummeted with the second-half plunge in commodity prices. As with the Fund's other holdings in the sector, we like its longer-term potential to recover in an improved business climate for the industry.

E2open initially looked to us like a broken SaaS business ("software as a service," a software licensing and delivery model in which software is licensed on a subscription basis) that had terrific rebound potential. Three lost customers later, we concluded that its growth potential looked likely to remain untapped for longer than we were willing to wait and sold our shares despite some positive product feedback. SciQuest provides procurement and spending management software on a subscription basis primarily to universities, hospitals, and local and state governments. Its planned expansion into more commercial sectors did not materialize along the lines we had been anticipating. The firm also exhibited an earnings pattern that had grown too consistently inconsistent and was made worse by some recent misses. All of this led us to take our losses and move on, selling the last of our shares in October.

Top Contributors to Performance
For 2014 (%)

InterMune 1.65
Furiex Pharmaceuticals 1.44
Sierra Wireless 1.33
Myriad Genetics 0.95
U.S. Silica Holdings 0.93
1 Includes dividends

Top Detractors from Performance
For 2014 (%)

E2open -1.31
SciQuest -0.90
Triangle Petroleum -0.62
Worthington Industries -0.53
Medicines Company (The) -0.74
1 Net of dividends

Current Positioning and Outlook

We sought to bring sector weightings more into balance with one another during 2014, reducing some (such as Energy) and adding to others, such as Health Care. Looking forward, the latter sector and Consumer Discretionary are areas of particular interest. While we slightly reduced our overall exposure to Information Technology, the big data and Internet of Things themes remain focal points.

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

Smaller-Companies Growth 6.79 3.89 16.64 11.32 7.11 12.18 6/14/2001
Russell 2000 9.73 4.89 19.21 15.55 7.77 8.20 N/A
Annual Operating Expenses: 1.49%

* 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 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 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 the Fund's Consultant and R Classes 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. (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 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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