Fund Performance

Royce International Small-Cap Fund (formerly Royce International Smaller-Companies Fund) enjoyed a strong first half on an absolute basis even as it came up short on a relative scale. For the year-to-date period ended June 30, 2015, the Fund advanced 4.5% compared to a 7.7% increase for its benchmark, the Russell Global ex-U.S. Small Cap Index, for the same period. After a bearish finish to 2014, fortunes for many non-U.S. equity markets reversed in 2015's first quarter. During these volatile first three months, the Fund was unable to gain an advantage over its benchmark, falling 0.5% in the first quarter versus a 3.7% gain for the index.

The Fund found its footing in the second quarter, improving on both an absolute and relative basis. We were pleased to see International Small-Cap outperform the Russell Global ex-U.S. Small Cap in the bullish April and relatively more muted May. The Fund was even with the benchmark in the markedly bearish June, when markets were rocked largely by the Greek default and anxiety over China's plunging stock market. The Fund thus outpaced the index in the second quarter, climbing 5.0% compared to the non-U.S. smallcap index's 3.9% gain. The Fund outperformed the Russell Global ex-U.S. Small Cap for the since inception (6/30/08) period ended June 30, 2015.

What Worked... And What Didn't

Six of the Fund's eight equity sectors contributed to performance in the first half, with net gains from Financials making the largest positive impact, followed by Industrials and Health Care. When sector impacts are compared to the Fund's benchmark, only the first of the three made a positive impact. Based on country exposure, the top contributors were the U.K., Japan, and Hong Kong while the largest detractors from results were Brazil (by a wide margin), India, and Germany.

The portfolio's strength in the Financials sector came primarily from two of its top performers, each of which was a top-10 holding at the end of June. Value Partners Group is a Hong Kong-based firm that has focused on Asian markets for more than two decades. Its shares often closely parallel movements in the Hong Kong and Shanghai markets. Each climbed precipitously into May before cooling off with the bear market for Chinese stocks. Its value orientation having an understandable appeal to us, the company saw growth in its assets under management and improved performance and management fees, all of which helped its earnings. VZ Holding provides financial services to individual and corporate clients in Switzerland and Germany. The Swiss National Bank's surprise decision in mid-January to delink from the euro resulted in rapid appreciation for the Swiss franc, which in turn led VZ Holding's stock to decline as the Swiss market as a whole reacted negatively to the currency inflation. We took this opportunity to add shares, as we believe this is a high-quality company with a domestic business that has historically been largely unaffected by currency movements. When the company subsequently reported sterling 2014 results in March, its stock marched to new highs. Another top contributor and top-10 holding, e2v Technologies makes high-tech electronic components including radio frequency, microwave, and sensing components. While recent revenue growth was modest, the company continued to offer optimistic full-year guidance. Along with an earlier assurance that it planned on doubling EBIT by 2020, the news kept investors very interested in the stock through the end of June.

Industrials was a mixed bag on two levels—the sector did well in the portfolio but had a modest negative impact vis-à-vis the benchmark. In addition, while eight companies from the sector were among the Fund's top-20 contributors in the first half, it was also home to a pair of its largest detractors, including the top detractor for the first half, Brazil's Kepler Weber. The company manufactures food storage equipment including grain silos, conveyors, and animal feed mills. Ongoing weakness in the Brazilian economy, combined with a global commodity price decline, led to a sell off. Execution issues continued to hurt results for India's KPIT Technologies, which provides product engineering and application and consulting services to a number of industries. Its shares tanked after the company reported disappointing earnings for its fiscal fourth quarter as revenues fell and margins contracted. Seeing what we thought were better opportunities elsewhere, we exited both positions in April. One of 2014's top contributors, India's Shriram Transport Finance lends to the used truck market and was a significant detractor in the first half as it experienced a steep decline in profits based on increased costs associated with bad loans.

Current Positioning and Outlook

Effective May 1, 2015, Dilip Badlani and Jim Harvey became the Fund's portfolio managers (Dilip having served previously as assistant portfolio manager since 2013). Mark Rayner continues to serve as assistant portfolio manager. Our portfolio holdings emphasize our preference for high-quality, wealth-compounding businesses, particularly in sectors such as Industrials and Consumer Discretionary—two areas in which we were overweight versus the benchmark at the end of June.

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

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

Important Performance, Expense, and Disclosure Information