Fund Performance

For the year-to-date period ended June 30, 2015 Royce International Micro-Cap Fund was up 7.5%, trailing its benchmark, the Russell Global ex-U.S. Small Cap, which advanced 7.7% for the same period. While we were pleased with the Fund's absolute result, its relative showing was disappointing.

After finishing 2014 in the red (and behind their domestic counterparts), non-U.S. equities continued the downward trend in the first month of 2015, this time joined by most U.S. stocks. There was, however, a spirited global rally in February before many non-U.S. issues corrected again in March. This made for a volatile opening period that, thanks to the strength of returns in February, left most non-U.S. stocks in the black. For the first quarter International Micro-Cap was up 1.8%, lagging the benchmark, which gained 3.7% for the same period. The upward trend for non-U.S. stocks continued into the second quarter, with April having the most pronounced positive effect. Although the Fund trailed the benchmark in the opening month of the second quarter, its 4.9% return was more than respectable. The Fund outperformed its benchmark in the quieter May and more volatile and bearish June. For the second quarter, International Micro-Cap advanced 5.6% compared to the Russell Global ex-U.S. Small Cap's 3.9% gain. The Fund also outperformed its benchmark for the one-year period ended June 30, 2015.

What Worked... And What Didn't

Industrials was the Fund's largest contributor at the sector level during the first half—more than doubling the respective net gains from Consumer Discretionary, Information Technology, and Health Care, International Micro-Cap's second-, third-, and fourth-largest contributors. We were also pleased that net gains for this sector were strong relative to those for the sector in its benchmark as well. Eight of the portfolio's top-20 (and two of its top-five) contributors at the position level came from this group, including its biggest position at the end of June, Trancom, one of the largest distribution and logistics companies in Japan. The company continued to take market share in the first half while its stock participated in the rally for Japanese equities. Its shares received an additional boost in the second quarter after Trancom reported better-than-expected earnings. Along with growing annual operating profits, we thought we had a number of good reasons to hold a large position at the end of June. At the country level, the largest positive impacts came from Japan, which led by a wide margin, and Taiwan and Germany. Net losses aggregated to country were far more modest, with Australia, Brazil, Malaysia, and Singapore detracting most.

Three portfolio sectors that finished the semiannual period in the black—Consumer Discretionary, Consumer Staples, and Information Technology—nonetheless had a negative impact compared to sector results within the Russell Global ex-U.S. Small Cap. Still, the Fund's top contributor to first-half performance came from the first of these groups. Taiwan Paiho is in the arguably pedestrian business of manufacturing fasteners for shoes, supplying customers such as Nike and Adidas. Introducing new products at higher price points helped lead to margin expansion, which seemed to send investors running to the stock. Liking both its management and recent product innovations, we held on to our stake.

Holdings more sensitive to commodity-price pressure, especially in the energy and metals & mining industries, tended to struggle in the first half—Energy was the Fund's only sector with a sizable net loss. Imdex, a Western Australian business that provides drilling fluids and downhole instrumentation, saw its shares hurt by the ongoing difficulties faced by businesses exposed to mining as well as oil and gas. Malaysia's Parkson Retail Asia has been hit by a slowdown in consumer spending in Southeast Asia and an expansion into Vietnam that encountered setbacks with local partners. Liking the respective long-term prospects for each business, we held a sizable position in both companies at the end of June. Weakness in lumber prices, which has not been offset by a decline in the value of the Canadian dollar, hurt results for Western Forest Products, leading us to exit the position in March.

Current Positioning and Outlook

At the end of June we maintained substantial overweights in Industrials, Consumer Discretionary, and Information Technology. At the country level, we had the greatest exposure to Japan, Canada, and Germany. We anticipate an ongoing expansion in the global economy while we continue to seek profitable, conservatively capitalized companies capable of compounding their wealth, ideally even when faced with economic headwinds.

Average Annual Total Returns as of Quarter-End 6/30/15 (%)

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

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