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

Royce Micro-Cap Trust Manager Commentary

We continue to believe that economic growth will accelerate, which should help portfolio holdings in these more cyclical sectors.


Fund Performance

For the year-to-date period ended June 30, 2015, Royce Micro-Cap Trust (NYSE: RMT) was down 0.5% on an NAV (net asset value) basis and fell 4.2% on a market price basis, trailing both of its unleveraged benchmarks. The smallcap Russell 2000 Index gained 4.8% while the Russell Microcap Index increased 6.0% for the same period. The Fund got off to a difficult start, losing more than each benchmark during the bearish January and underperforming for the first quarter as a whole—RMT lost 0.8% on an NAV basis and was down 0.6% on a market price basis compared to a gain of 4.3% for the Russell 2000 and an increase of 3.1% for the Russell Microcap in the opening quarter of 2015.

The second quarter was similarly underwhelming. RMT was up 0.3% on an NAV basis but slipped 3.6% based on market price versus respective second-quarter gains of 0.4% and 2.8% for the small-cap and micro-cap indexes. Long-term results offered more encouragement. The Fund outperformed the Russell 2000 on an NAV basis for the three-, 15-, 20-year, and since inception (12/14/93) periods ended June 30, 2015 while also beating the Russell Microcap for the 10- and 15-year periods ended June 30, 2015. (Returns for the Russell Microcap only go back to 2000.) RMT's average annual NAV total return since inception was 11.2%.

What Worked... And What Didn't

When comparing the Fund's results for the semiannual period to those of its benchmarks, three sectors stand out as problem areas—Consumer Discretionary, Health Care, and Information Technology. Only the first of these sectors, however, posted a net loss in the portfolio, mostly due to dismal results for five industries: the diversified consumer services, media, specialty retail, household durables, and textile, apparel & luxury goods groups. Health Care cut both ways in the first half. It led all of the portfolio's 10 equity sectors by a good-sized margin, yet its performance paled before that area's results within the Russell 2000 and Microcap indexes. Much of this can be traced to the Fund being significantly underweight the sector as a whole as well as having very little exposure to biotech stocks, which dominated first-half results for both of RMT's benchmarks. Most biotech companies, however, lack the fundamental attributes we seek in our holdings. While Information Technology showed a net gain in the Fund for the first half, it also came up short versus that same sector's results in the small-cap and micro-cap indexes. Two industry groups—Internet software & services and software— fared poorly versus the indexes. As was the case with Consumer Discretionary, we were overweight Information Technology at the end of June and believed that many holdings in both sectors can continue to rebound in concert with a more robustly recovering economy.

The Industrials sector posted respectable net gains on both an absolute and relative basis, keyed by a terrific performance from the Fund's top contributor, Frontier Services Group. The Hong Kongbased company provides logistical services in Africa and benefited from a large capital gain on a portfolio investment and investor perception that its enhanced liquidity position will help fund FSG's plan to expand its logistics network. Two of RMT's top-10 holdings also made solid contributions. Shares of Ohio-based investment management firm Diamond Hill Investment Group climbed over much of the last few years, boosted most recently by strong earnings and growing revenues. Nautilus offers branded health and fitness products such as Schwinn, Bowflex, and Nautilus itself. Its stock gained strength after the firm reported double-digit earnings growth for its fiscal first quarter, part of a multi-year turnaround that kicked off when new management came on board four years ago. New products and operational discipline helped to improve profitability.

As for those positions that detracted from results, we added shares of LeapFrog Enterprises early in the year when its stock was falling. The company makes technology-based educational platforms with curriculum interactive software content and standalone products. Around the same time the firm reported a fiscal third-quarter loss (caused primarily by poor sales and late product shipments), a class action suit was announced. We like its solid brand and think its business has value. EZCORP owns and operates pawn shops. Its stock fell sharply in the first quarter as the firm revised earnings downward before it declined further on news in April that it would delay its fiscal second-quarter earnings release because of an ongoing review of a loan portfolio. We reduced our position in March. Value Line produces investment-related periodical publications and also provides investment advisory services to mutual funds, institutions, and individuals. While the company remained solidly profitable and pays a dividend, its shares trended downward through much of the first half. We were happy to hold shares at the end of June.

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

Frontier Services Group 0.97
Diamond Hill Investment Group 0.39
Nautiuls 0.27
Smith & Wesson Holding Corporation 0.24
GTT Communications 0.22
1 Includes dividends

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

LeapFrog Enterprises Cl. A -0.32
EZCORP Cl. A -0.24
Value Line -0.22
Qumu Corporation -0.20
Graham Corporation -0.20
2 Net of dividends

Current Positioning and Outlook

The Fund had a significant overweight in Industrials and was also overweight in Consumer Discretionary, Information Technology, and Materials at the end of the semiannual period. We continue to believe that economic growth will accelerate, which should help portfolio holdings in these more cyclical sectors.

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

RMT -3.63 -4.19 -4.94 17.11 16.55 6.30 10.45 11.11 10.22 12/14/1993
XOTCX 0.28 -0.52 -0.05 17.94 16.05 8.25 10.15 11.16 11.20 12/14/1993
Russell 2000 0.42 4.75 6.49 17.81 17.08 8.40 7.50 9.15 9.23 N/A

* Not Annualized

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

Important Performance, Expense, and Disclosure Information

All performance information reflects past performance, is presented on a total return basis, and reflects the reinvestment of distributions. Past performance is no guarantee of future results. Current performance may be higher or lower than performance quoted. Returns as of the most recent month-end may be obtained here. The market price of the Fund’s shares will fluctuate, so that shares may be worth more or less than their original cost when sold. The Fund normally invests in micro-cap companies, which may involve considerably more risk than investments in securities of larger-cap companies. The Fund’s broadly diversified portfolio does not ensure a profit or guarantee against loss. From time to time, the Fund may invest a significant portion of its net assets in foreign securities, which may involve political, economic, currency and other risks not encountered in U.S. investments. Regarding the "Top Contributors" and "Top Detractors" tables, 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.

The Fund is a closed-end registered investment company whose shares of common stock may trade at a discount to their net asset value. Shares of the Fund's common stock are also subject to the market risks of investing in the underlying portoflio securities held by the Fund. This Fund is a closed-end fund whose shares of common stock trade on the NYSE. Royce Fund Services, Inc. ("RFS") is a member of FINRA and has filed this material with FINRA on behalf of the Fund. RFS does not serve as a distributor or as an underwriter to the Fund. 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 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 Russell Microcap Index includes 1,000 of the smallest securities in the small-cap Russell 2000 Index, along with the next smallest eligible securities as determined by Russell. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.



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