article 06-30-2015

Royce Smaller-Companies Growth Fund Manager Commentary

We continue to selectively build positions in Health Care, focusing on areas such as biotech, pharmaceuticals, and behavioral health services, which we continue to see as a vibrant theme.

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It was a terrific first-half result for the Growth-at-a-Reasonable-Price approach we use in Royce Smaller-Companies Growth Fund (formerly Royce Value Plus Fund). The Fund increased 8.9% for the year-to-date period ended June 30, 2015, ahead of its small-cap benchmark, the Russell 2000 Index, which rose 4.8% for the same period.

Along with much of the rest of the small-cap market, the Fund stumbled a bit out of the gate, enduring a bearish January. Its rebound in February was impressive, however, as it finished the month well ahead of its benchmark. For the first quarter Smaller-Companies Growth advanced 4.8%, edging ahead of the Russell 2000, which climbed 4.3% for the same period. The Fund's relative advantage was both more decisive and more evenly spread out in the second quarter— it beat the small-cap index in the slightly bearish April, the more bullish May, and volatile June. The Fund finished the quarter with a 4.0% gain compared to a 0.4% increase for the Russell 2000. The portfolio's strong first half helped long-term results on both an absolute and relative basis. Smaller-Companies Growth outperformed the Russell 2000 for the one-, 10-year, and since inception (6/14/01) periods ended June 30, 2015. The Fund's average annual total return since inception was 12.4%.

What Worked... And What Didn't

The portfolio was slightly overweight in Health Care during the first half, when overall market leadership came overwhelmingly from biotech stocks. Within the Russell 2000, pharmaceuticals and health care providers & services also posted notable net gains. We were very pleased, then, that stock selection and the Fund's overweight, which included greater average exposure to both biotech and pharmaceuticals, made positive impacts on first-half returns vis-à-vis the small-cap index. Shares of Anacor Pharmaceuticals appreciated steadily based on the ongoing successful launch of its first commercial product, Kerydin, a topical antifungal medication. The market was also anticipating positive clinical results for its lead development compound, Crisaborole, a topical treatment for atopic dermatitis. We took advantage of its rising stock price to reduce our position somewhat. However, we remain optimistic about the prospects for both products, and Anacor remained a core holding in the Fund at the end of June. Cambrex Corporation is a life sciences company that provides active pharmaceutical ingredients ("APIs") for the pharmaceuticals industry. We think very highly of this business— pharmaceuticals companies typically outsource around 50% of their API business, and Cambrex has one of the best reputations in this attractive niche. Its shares grew particularly healthy in February after the company reported terrific results for the fourth quarter and fiscal 2015. Among other developments, investors especially liked its expanded partnership with Gilead Science to provide APIs for the Big Pharma firm's hepatitis C drug, Harvoni, which was approved for use in the U.S. and Europe late in 2014.

Four other sectors posted strong-to-solid net gains in the semiannual period, including Consumer Discretionary and Information Technology—the Fund's two largest at the end of June. Gentherm hails from the first of these sectors and is a leader in the manufacture of variable temperature climate control devices primarily for the automotive markets. We like the ways the firm is positioning itself for future growth: First, it has been penetrating further into the automotive markets by offering cooling seats, as well as heated and cooling steering wheels, back seats, and cup holders, in addition to cooling compartments. Second, it is moving into other industries, such as mattresses. Shares of Paylocity Holding Corporation rallied after the company reported strong revenue growth for the first quarter and raised guidance for the full year. We continue to see ample growth potential for this cloud-based software provider specializing in payroll and human resources.

Net losses for the semiannual period were comparatively modest at the sector, industry, and position levels. The Materials, Energy, and Consumer Staples sectors detracted from returns, as did one of 2014's top contributors, Sierra Wireless, which provides wireless data communications equipment for M2M (machine-to-machine) communications and mobile components. Its shares fell due to a slowdown in its wireless solutions business—which typically acts as a key driver of sales for its components. We see this as a temporary issue and view Sierra as a well-managed, quality business with a long runway for future growth. We reduced our position in retailer Zumiez, which sells sports-related apparel, footwear, and other equipment, after tiring of recent losses.


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

Anacor Pharmaceuticals 1.39
Cambrex Corporation 1.24
Genthem 0.78
Paylocity Holding Corporation 0.77
Boot Barn Holdings 0.77
1 Includes dividends

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

Sierra Wireless -0.67
Zumiez -0.46
Horsehead Holding Corporation -0.37
Rogers Corporation -0.32
Container Store Group (The) -0.28
2 Net of dividends

Current Positioning and Outlook

We continue to selectively build positions in Health Care, focusing on areas such as biotech, pharmaceuticals, and behavioral health services, which we continue to see as a vibrant theme. The portfolio was also substantially overweight in Consumer Discretionary at the end of June, which reflects our confidence in the ongoing health of consumer spending against a backdrop of higher employment and lower energy prices.

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

  QTR* YTD* 1 YR 3 YR 5 YR 10 YR SINCE INCEPT. DATE
Smaller-Companies Growth 3.96 8.92 8.73 17.73 13.98 8.63 12.41 6/14/2001
Russell 2000 0.42 4.75 6.49 17.81 17.08 8.40 8.26 N/A
Annual Operating Expenses: 1.45%

* 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 Service Class (its oldest class). Operating expenses reflect the Fund’s total annual operating expenses for the Service Class as of the Fund’s most current prospectus and include management fees, 12b-1 distribution and service fees, other expenses, and acquired fund fees and expenses. Acquired fund fees and expenses reflect the estimated amount of 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 RVP’s Consultant and R Classes bear an annual distribution expense that is higher than that of the Service 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. he Fund invests primarily in small-cap and mid-cap stocks, which may involve considerably more risk than investing in larger-cap stocks. (Please see "Primary Risks for Fund Investors" in the prospectus.) In addition, 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. The Fund may invest up to 25% of its net assets in foreign securities (measured at the time of investment), which may involve political, economic, currency, and other risks not encountered in U.S. investments. (Please see "Investing in Foreign Securities" 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 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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