article 06-30-2015

Royce Opportunity Fund Manager Commentary

Many holdings that we built or first began to buy in the first half fall under our Turnarounds investment theme, an area that we think should generally do well as the pace of economic growth picks up, as we suspect it will.

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Fund Performance

Royce Opportunity Fund Fund finished the year-to-date period ended June 30, 2015 with a gain of 0.7% versus an increase of 4.8% for its small-cap benchmark, the Russell 2000, for the same period.

The Fund first lost a chunk of ground to its benchmark during a bearish January, which hurt its early results. For the first quarter, Opportunity rose 1.1% compared to 4.3% for the Russell 2000. The second quarter saw another relative disadvantage, made worse by a very difficult June. On the second-to-last day of the month, news of the Greek default wreaked havoc on stock prices and the Fund lost more than the Russell 2000. For the second quarter the Fund was down 0.4% while the small-cap index was up 0.4%. 2015's firsthalf results notwithstanding, Opportunity maintained longer-term advantages over its benchmark. The Fund outpaced the Russell 2000 for the 10-, 15-year, and since inception (11/19/96) periods ended June 30, 2015. Opportunity's average annual total return since inception was 12.7%. We take great pride in the Fund's nearly two decades of strong long-term results.

What Worked... And What Didn't

Typically a strong performer in any bull market, Opportunity was hurt by the very narrow leadership within small-cap over the last 12 months, a period in which biotech dominated returns for both the asset class and domestic equities as a whole. Hewing to the timetested idea that broad diversity across industries and positions works best in the Fund, we were not too surprised by the portfolio's first-half performance results. Our theme-driven, opportunistic value approach emphasizes very inexpensive stocks—as determined by low price-to-book and price-to-sales ratios—so we had no exposure to biotech or pharmaceuticals companies, which sport very rich valuations. This lack of exposure was the most significant factor in the Fund's relative disadvantage in the semiannual period. So while Health Care finished the first half as the portfolio's second-best contributing sector, its net gains were modest on an absolute level as well as compared to the benchmark and came mostly from companies in the life sciences tools & services group and health care equipment & supplies industry.

The Fund's largest sector at the end of June was Information Technology. The size and diversity of this sector have for many years made it a regular source of investment opportunity for us. In the first half, its diversity could perhaps best be seen by the starkly different results for its industry groups within the portfolio (this could also be seen within the Russell 2000). Two of the Fund's best-performing industries came from IT. Net gains for the semiconductors & semiconductor equipment group were strong enough to not only lead on an industry basis by a wide margin, but were also appreciably higher than those for each of the Fund's equity sectors. Conversely, three of the portfolio's four largest-detracting industry groups also came from Information Technology—electronic equipment, instruments & components stocks (where net losses nearly rivalled the gains achieved by the semiconductor industry), IT services companies, and the technology hardware storage & peripherals group.

Within Materials, the metals & mining group was home to the Fund's biggest contributor and two of its most significant detractors. Fading aluminum prices stymied results for both Century Aluminum and Noranda Aluminum Holding Corporation, though the latter company put shares on sale at a sizable discount prior to the commodity price decline, exacerbating its losses. Our confidence in an eventual rebound for industrial metals led us to increase our stake in both companies. RTI International Metals specializes in titanium and other metals and sells primarily to the aerospace industry. Its shares shot up quickly in March when Alcoa announced an agreement to buy the company.

TRC Companies is an engineering, environmental consulting, and construction management firm. In spite of having virtually no Wall Street coverage, its improved earnings and expanding margins drew enough attention to its stock for it to advance significantly in the first half. We trimmed our position as its price rose. Interface produces modular carpet tiles for a variety of industries. It is one of many companies we own in the non-residential construction space, though it is also involved in the residential area running Flor, which sells carpet squares. Improved results in its corporate, hospitality, and retail flooring businesses, as well as its status as an environmentally conscious business, keyed an increase for its shares.


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

RTI International Metals 0.42
TRC Companies 0.31
Interface 0.31
EarthLink Holdings 0.30
NeoPhotonics Corporation 0.26
1 Includes dividends

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

Century Aluminum -0.42
Silicon Graphics International -0.29
McClatchy Company (The) Cl. A -0.27
Noranda Aluminum Holding Corporation -0.24
Identiv -0.23
2 Net of dividends

Current Positioning and Outlook

We have been pleased by the number of bargains that we have found within several industries, including a number of positions in Information Technology, Industrials, and Consumer Discretionary. At the end of June we were substantially overweight in the first two sectors and overweight in the third. Many holdings that we built or first began to buy in the first half fall under our Turnarounds investment theme, an area that we think should generally do well as the pace of economic growth picks up, as we suspect it will. Non-residential construction remains an area of focus, as the industry is beginning to enjoy what we anticipate should be a long-term recovery.

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

QTR* YTD* 1 YR 3 YR 5 YR 10 YR 15 YR SINCE INCEPT. DATE
Opportunity -0.44 0.67 -2.75 16.58 15.62 8.58 10.40 12.67 11/19/96
Russell 2000 0.42 4.75 6.49 17.81 17.08 8.40 7.50 8.57 N/A
Annual Operating Expenses: 1.15%

* 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 Investment Class (its oldest class). Operating expenses reflect the Fund’s total annual operating expenses for the Investment Class as of the Fund’s most current prospectus and include management fees, other expenses, and acquired fund fees and expenses. 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. Shares of ROF’s Service, Consultant, R, and K Classes bear an annual distribution expense that is not borne by the Investment 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 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 small-cap stocks, which may involve considerably more risk than investing in larger-cap stocks. (Please see "Primary Risks for Fund Investors" in the prospectus.) The Fund’s broadly diversified portfolio does not ensure a profit or guarantee against loss. 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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