Royce Global Financial Services Fund Manager Commentary
article 02-24-2016

Royce Global Financial Services Fund Manager Commentary

Our strategy with the Fund rests on four propositions that grow out of our somewhat unique take on the financial services sector.


Fund Performance

Royce Global Financial Services Fund fell 4.7% in 2015, compared to a loss of 4.4% for its small-cap benchmark, the Russell 2000 Index, and a gain of 3.1% for the financial services component of the Russell 2500 Index for the same period.

The first half of the year was better than the second. For the year-to-date period ended June 30, 2015, the Fund advanced 7.2%, easily outperforming both its small-cap benchmark, which was up 4.8%, and the Russell 2500 Financial Services Index, which was up 3.1% for the same period.

A sweeping correction hit the equity markets in the third quarter, when Global Financial Services was down 10.2% versus a loss of 11.9% for the Russell 2000. The financial services companies in the Russell 2500, however, lost only 3.7% in the third-quarter downturn, helped in part by banks and REITs, which defended better than most other areas.

The Fund's substantial weighting in capital markets companies, a perennial area of investment focus, hurt relative results versus small- and mid-cap financial companies. Equities rebounded in the fourth quarter, but the Fund did not participate, falling 1.1% versus an increase of 3.6% for the Russell 2000 and 3.8% for the Russell 2500 Financial Services Index. Stock selection in the capital markets and diversified financial services group detracted most from relative performance in the year's last three months.

What Worked..And What Didn't 

Our strategy with the Fund rests on four propositions that grow out of our somewhat unique take on the financial services sector: Select areas of financial services, along with their suppliers, look more likely to us to grow faster than the overall economy over the long term. Certain business models in the sector, including those of asset managers, investment banks, niche lenders, exchanges, and specialist service providers, are attractive because of their high returns on invested capital and ability to differentiate themselves. Their often complex business models and the companies' cyclical earnings patterns also often lead to them being misunderstood—and thus mispriced—by investors, which can create opportunities for active managers. Our many years of experience as an asset manager provide ample insight into the particular dynamics of these businesses.

"During the year, we increased exposure to alternative asset managers, primarily those involved in private equity, private credit, and real estate. We believe that several are well positioned to take advantage of how major regulatory legislation has reshaped the financial services landscape."

We were disappointed in overall results for the capital markets group in 2015, though we still think highly of the recovery potential and long-term prospects for a number of our holdings in the industry. Eight of the portfolio's 10 most significant detractors came from the group, which also accounted for five of our 10 largest contributors.

At the position level, Medley Management posted the largest net losses. This Manhattan-based asset manager focuses on yield-oriented products for institutional and retail investors. Its shares suffered most in the year's second half as third-quarter earnings, energy exposure, and a reduced management fee for one of its business development companies all disappointed investors.

Dundee Corporation is a holding company based in Toronto that is involved in investment advisory, corporate finance, energy, resources, agriculture, real estate, and infrastructure. The company also holds investment portfolios in these areas. Its stock was hurt most by significant exposure to the weakened commodity markets in 2015. We held small positions in both companies at year-end.

Turning to the positive side, two asset managers led the Fund's list of contributors by an impressive margin— Diamond Hill Investment Group, an independent investment advisor located in Columbus, OH., and ETF specialist Wisdom Tree Investments.

Top Contributors to Performance
For 2015 (%)1

Diamond Hill Investment Group 0.67
WisdomTree Investments 0.65
MarketAxess Holdings 0.46
MSCI 0.40
Xoom Corporation  0.39
1 Includes dividends

Top Detractors from Performance
For 2015 (%)2

Medley Management Cl. A -0.84
Dundee Corporation Cl. A  -0.75
Fifth Street Asset Management Cl. A -0.73
U.S. Global Investors Cl. A -0.67
Coronation Fund Managers -0.56
2 Net of dividends

Current Positioning and Outlook

Effective June 15, 2015, we renamed the Fund while simultaneously expanding its ability to invest in non-U.S. financial services companies, which have become an area of increasing interest and opportunity for us over the last several years.

At year-end the Fund's most significant exposure outside the U.S. was in the U.K., Canada, and Switzerland. While more than half of the portfolio is categorized in the capital markets industry, investors should be aware that we see considerable diversity within this group, which encompasses both traditional and alternative asset managers and institutional and retail brokerage firms based in the U.S., as well as international asset management, wealth management, and investment banking firms.

As a result, the portfolio’s industry emphasis is very different from that of the financial services companies in the Russell 2500, and we would expect the Fund to remain periodically out of sync with it and to often move in a different direction than the Russell 2000.

During the year, we increased exposure to alternative asset managers, primarily those involved in private equity, private credit, and real estate. We believe that several are well positioned to take advantage of how major regulatory legislation has reshaped the financial services landscape.

We also added selectively to specific situations where leading niche financial companies saw their stock prices decline for what we see as temporary causes. Finally, we added to certain holdings where we view management as making steady, profitable progress, while trimming others where we came to the opposite conclusion.

Average Annual Total Returns Through 12/31/15 (%)

Global Financial Services -1.08 -4.71 -4.71 11.86 8.43 6.07 N/A 7.30 12/31/03
Russell 2500 Fnl Svc 3.82 3.13 3.13 14.37 11.68 5.22 N/A 6.55 N/A
Russell 2000 3.59 -4.41 -4.41 11.65 9.19 6.80 8.03 7.53 N/A
Annual Operating Expenses: Gross 1.93% Net 1.74

*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. Gross operating expenses reflect the Fund’s gross total annual operating expenses for the Service Class and include management fees, 12b-1 distribution and service fees, other expenses, and acquired fund fees and expenses. Net operating expenses reflect contractual fee waivers and/or expense reimbursements. All expense information is reported as of the Fund’s most current prospectus. Royce & Associates has contractually agreed to waive fees and/or reimburse expenses to the extent necessary to maintain the Fund’s net annual operating expenses (excluding brokerage commissions, taxes, interest, litigation expenses, acquired fund fees and expenses, and other expenses not borne in the ordinary course of business) at or below 1.49% through April 30, 2016. 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. 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 December 31, 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 December 31, 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.

As of 12/31/15, Medley Management was 0.6% of the Fund’s net assets, Dundee Corporation was 0.4%, Diamond Hill Investment Group was 1.3%, and WisdomTree Investments was 0.5%.

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 equity securities that are "principally" engaged in the financial services industry. The Fund is not a complete investment program. It is designed for long-term investors who can accept the risks of investing in a fund with common stock holdings primarily in small-cap and mid-cap financial services companies. Therefore, the Fund is subject to certain risks associated with the industry, including, among other things, changes in government regulations, interest rate levels, and general economic conditions. The Fund invests primarily in small-cap and/or 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.) The Fund may invest up to 50% 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 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 Russell 2500 index represents the smallest 2,500 companies in the Russell 3000 index. The returns for the Russell 2500—Financial Sector represent those of the financial services companies within the Russell 2500 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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