Royce International Micro-Cap Fund Manager Commentary | Royce Funds
article 06-30-2015

Royce International Micro-Cap Fund Manager Commentary

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.


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.

Top Contributors to Performance
Year-to-Date Through 6/30/15 (%)1

Taiwan Paiho 1.02
Trancom 0.92
I.T 0.68
Magellan Aerospace 0.54
AirBoss of America 0.53
1 Includes dividends

Top Detractors from Performance
Year-to-Date Through 6/30/15 (%)2

Imdex -0.59
Parkson Retail Asia -0.50
Western Forest Products -0.33
Zuiko Corporation -0.32
Bufab Holding -0.27
2 Net of dividends

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 (%)

International Micro-Cap 5.60 7.45 -2.75 10.82 2.40 12/31/2010
Russell Glo x US SC 3.93 7.74 -3.46 11.35 3.67 N/A
Annual Operating Expenses: Gross 3.47% Net 1.65%

* 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. 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 1.64% through April 30, 2016 and at or below 1.99% though April 30, 2025. 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 year-to-date performance for 2015.

The thoughts expressed in this piece concerning recent market movements and future prospects for small company stocks are solely the opinion of Royce at June 30, 2015, 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 June 30, 2015 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 micro-cap stocks, which may involve considerably more risk than investing in larger-cap stocks. 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.) As of 6/30/15, 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. (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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