article 06-30-2015

Royce Total Return Fund Manager Commentary

Our belief that we will see both continued economic expansion in the U.S. and an earnings-led rally for small-caps has led us over the past few years to favor more cyclical sectors such as Industrials, Consumer Discretionary, and Materials.

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Fund Performance

We were once again left with mixed feelings about the performance of Royce Total Return Fund. For the year-to-date period ended June 30, 2015, the Fund advanced a modest 0.7%, lagging its small-cap benchmark, the Russell 2000 Index, which gained 4.8% for the same period. The Fund trailed its benchmark during both the first quarter, when it was up 1.8% compared to 4.3%, and the second, when it slipped 1.0% versus a 0.4% gain for the small-cap index.

This was all unquestionably disappointing, but not entirely unexpected in the context of the current small-cap market cycle. Yearto- date returns for the Russell 2000 were the result of what looked to us like a seriously disjointed small-cap marketplace. First-half performance for the index came overwhelmingly from the Health Care sector, led by biotech stocks. This sort of narrow, growth-driven environment is not conducive to strong relative results for a portfolio populated with dividend-paying small-caps chosen primarily for their sterling fundamentals, solid profitability, and attractive valuations. When lower overall levels of volatility are factored in, recent results become even easier to understand.

Which is not to say that we are happy with recent relative performance, only that these results make sense considering the dynamics of the current small-cap market, one in which Total Return has achieved solid absolute returns even as it has trailed the Russell 2000. We have been anticipating a shift away from this environment and toward one in which interest rates are rising, overall equity returns are lower, and volatility is higher, which should benefit the sort of conservatively capitalized dividend payers that we prefer. We remain proud of the Fund's longer-term relative advantages and its strong absolute performance. Total Return outperformed the Russell 2000 for the 15-, 20-year, and since inception (12/15/93) periods ended June 30, 2015. The Fund's average annual total return since inception was 11.0%.

What Worked... And What Didn't

Portfolio net gains and losses at the level of sector, industry, and position tended to be moderate. The Fund paid a relatively steep price for its underweight in Health Care and, to a lesser degree, Information Technology. The first of these sectors led the equity markets as a whole, including small-cap. Biotech companies, which do not fit the Fund's valuation or fundamental criteria, were by far the dominant industry. Financials, the Fund's largest sector at the end of the first half, was also its top contributor. Three of the portfolio's best four performing industry groups came from the sector—capital markets, insurance (its two largest), and banks. The first of these groups had an appreciably larger net gain than its counterparts, driven by strong results for two asset management businesses we think very highly of. Value Partners Group is a Hong Kong-based firm that has focused on Asian markets for more than two decades. Increased performance and management fees helped to boost net profits. When the Chinese equity markets plummeted in June, we were pleased that the firm's stock held up well. The share price of AllianceBernstein Holding—Total Return's second-largest position at the end of June—also cooled off a bit near the end of the first half, but held on to most of its net gain from earlier in the year.

Long-time holding and top-10 position ManpowerGroup was the Fund's top net gainer for the first half. The company has a global business providing staffing and other workforce solutions. Two consecutive quarters of better-than-expected earnings, fueled by an improved labor market, pushed up its shares. The Fund's largest position at the end of June—and another long-term holding—was specialty insurer Markel Corporation. Robust underwriting and investment operations led to steady earnings improvement and a consistently rising share price in the first half.

As for positions that detracted from performance, Tidewater provides marine service vessels to offshore energy companies. Its stock fell with the decline in energy prices and bottomed out in April of this year following a fiscal third-quarter loss reported in February that was nonetheless not as severe as most analysts had been expecting. We have been pleased with the way Tidewater has executed during a highly challenging period for energy companies. Balchem Corporation specializes in making performance ingredients for the food, feed, and medical sterilization industries. Its price fell in late June as insider sales seemed to shift Wall Street's opinion. The Energy, Materials, and Utilities sectors posted net losses in the first half while those that finished in the black included Health Care, Consumer Staples, Consumer Discretionary, and Industrials.


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

ManpowerGroup 0.22
Value Partners Group 0.20
Markel Corporation 0.17
AllianceBernstein Holding L.P. 0.17
GameStop Corporation Cl. A 0.17
1 Includes dividends

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

Tidewater -0.18
Balchem Corporation -0.16
Greif Cl. A -0.16
E-L Financial -0.13
Vishay Intertechnology -0.12
2 Net of dividends

Current Positioning and Outlook

We continue to believe consistent dividend-paying small-cap companies can offer long-term advantages. At the end of the first half, the Fund's sector weightings remained close to the range they have been in since the end of 2013. Our belief that we will see both continued economic expansion in the U.S. and an earnings-led rally for small-caps has led us over the past few years to favor more cyclical sectors such as Industrials, Consumer Discretionary, and Materials. We were overweight in the first and third of these sectors at the end of June while also being overweight in Financials.

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

QTR* YTD* 1 YR 3 YR 5 YR 10 YR 15 YR 20 YR SINCE INCEPT. DATE
Total Return -1.01 0.74 -0.63 14.18 13.70 7.42 9.94 10.85 10.97 12/15/93
Russell 2000 0.42 4.75 6.49 17.81 17.08 8.40 7.50 9.15 9.23 N/A
Annual Operating Expenses: 1.19%

* 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 RTR’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. 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 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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