Royce Micro-Cap Trust Manager Commentary
article 02-24-2016

Royce Micro-Cap Trust Manager Commentary

Our own research and regular meetings with management teams have made us comfortable with a contrarian, pro-cyclical bias for the portfolio. Moreover, we suspect that the protracted leadership of growth over value stocks is likely to reverse in 2016 and believe that companies with better balance sheets will do well in an environment of elevated corporate bond spreads.


Fund Performance

Royce Micro-Cap Trust (NYSE: RMT) was down 11.7% on an NAV (net asset value) basis and fell 16.1% on a market price basis in 2015. These results trailed those for each of its unleveraged benchmarks, the small-cap Russell 2000 Index, which lost 4.4%, and the Russell Microcap Index, which declined 5.2% for the same period.

The Fund struggled versus its benchmarks throughout the year. For the year-to-date period ended June 30, 2015, RMT was down 0.5% on an NAV basis and fell 4.2% based on its market price while the Russell 2000 Index gained 4.8% and the Russell Microcap Index increased 6.0% for the same period.

During the widespread correction in the third quarter, the Fund lost 13.8% on an NAV basis and lost 14.0% on a market price basis, compared to declines of 11.9% for the Russell 2000 and 13.8% for the Russell Microcap. Stock prices then revived somewhat in the fourth quarter, when RMT increased 2.9% on an NAV basis and 1.8% on a market price basis versus respective gains of 3.6% and 3.7% for the Russell 2000 and Microcap Indexes.

For a sense of how challenging the year was for small and micro-cap stocks (and the active managers who pick them), consider that the Russell 2000 lost 10.1% on an equal-weighted basis in 2015. This shows just how hard it was to find stocks that grew appreciably by year-end, especially in the more economically sensitive, cyclical areas of the market that have been our primary focus over the last few years. In this climate, we continued to focus on companies that in our analyses showed a combination of attractive valuation, balance sheet strength, and/or promising growth prospects.

The Fund outperformed the Russell 2000 on an NAV basis for the 15-, 20-year, and since inception (12/14/93) periods ended December 31, 2015 while also beating the Russell Microcap on an NAV basis for the 10- and 15-year periods ended December 31, 2015. (Returns for the Russell Microcap only go back to 2000.) RMT’s average annual NAV total return since inception was 10.3%.

What Worked... And What Didn't

On a sector basis, net gains and losses were split down the middle, with four making contributions and four detracting from calendar-year results. The most significant net gains came from Industrials and Financials while the largest net losses by far could be found in Information Technology.

There was a similar pattern on an industry group basis. Three posted notable contributions—textile, apparel & luxury goods, road & rail, and capital markets, while three areas showed good-sized net losses—electronic equipment, instruments & components, multiline retail, and metals & mining.

Two of the portfolio's top four detractors came from the Consumer Discretionary sector. Malaysia's Parkson Retail Asia has been hit by a slowdown in consumer spending in Southeast Asia and an expansion into Vietnam that encountered setbacks with local partners. Its shares were also hampered by political scandal and a slowdown in the Malaysian economy that further reduced consumer demand. Confident that the firm can bounce back, we continued to hold shares at year-end.

Brazil's T4F Entretenimento operates at all levels of the global entertainment industry, including venue operation, ticketing, food & beverage, merchandise sales, and corporate sponsorships. Its business continued to perform well in 2015, but as U.S. investors our position was compromised by ongoing weakness in the Brazilian real. It was the Fund’s fourteenth-largest position at year-end.

"We expect reversals in a number of trends that should benefit many portfolio holdings over the next few years… We also expect the combined effects of these reversals to put the market's focus squarely on the attributes we emphasize, which we think are overdue for recovery."

Imdex is an Australian business that provides drilling fluids and down hole instrumentation to the mining, oil & gas, water well, and civil engineering industries worldwide. Continued weakness in the mining and oil industries has slowed demand for its equipment. Liking the way in which the company has worked on deleveraging its balance sheet, we think it's well positioned for any recovery and held a stake at the end of 2015.

We thought otherwise about SuperCom, which we exited in November as mounting skepticism about the company's growth prospects seemed to come to a head when the CFO departed, leading to a steep decline in its stock. Based in Israel, the company makes electronic identity solutions including electronic monitoring, identification, and security products.

Ireland's Trinity Biotech was caught up in the sell-off with the rest of the biotech sector in the third quarter. However, we like its product pipeline, so we held a large stake in the company, which provides products for the point-of-care, self-testing, and clinical laboratory segments of the diagnostic market.

There were notable successes as well. Headquartered in Japan, TRANCOM offers distribution information, logistic management service, freight transportation, and system development services. The company continues to gain market share as a growing number of customers are outsourcing their transportation needs. Taiwan PAIHO saw strong growth in demand for sports apparel and shoes translate into strong demand for its fasteners.

On a relative basis, the Fund suffered from ineffective stock selection in the Information Technology and, to a lesser degree, Consumer Discretionary sectors. Conversely, we benefited from successful stock selection in Financials and Industrials.

Top Contributors to Performance
For 2015 (%)1

Trancom 0.87
Taiwan Paiho  0.81
GFT Technologies 0.62
Pantheon Resources plc 0.53
Relo Holdings  0.51
1 Includes dividends

Top Detractors from Performance
For 2015 (%)2

Parkson Retail Asia -0.75
Imdex -0.69
SuperCom -0.46
T4F Entretenimento  -0.39
Trinity Biotech ADR Cl. A -0.34
2 Net of dividends

Current Positioning and Outlook

Europe and Japan have seen underlying improvements in their respective economies, though growth has so far been modest. While these markets rallied in 2015, we still see a large number of mispriced opportunities in the micro-cap space. Canadian stocks sold off dramatically in 2015, which was largely the result of the steep decline in oil prices, though it did not spare our related holdings in technology, manufacturing, and services.

Along with plummeting share prices, the greatly weakened Canadian dollar has presented what we see as a large number of opportunities. The overall environment in developing markets remains challenging as growth rates in these countries have cooled considerably. While there may be a little bit more downside in these markets, we think they should recover nicely once they bottom, as they have done historically.

Canada, Germany, and Hong Kong were the portfolio's largest overweights by country at year-end, though Japan accounted for the largest percentage of net assets. On a sector basis, we had greater exposure to Consumer Discretionary and Information Technology (the Fund’s two largest sectors) with comparable exposure to Industrials. We were also underweight Financials, Health Care, Materials, Consumer Staples, and Energy at year-end.

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

Royce Micro-Cap Trust NAV 3.21 -11.72 9.73 7.43 6.12 9.30 10.01 10.33 12/14/1993
Russell 2000 3.59 -4.41 11.65 9.19 6.80 7.28 8.03 8.56 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 invests primarily in securities of small- and micro-cap companies, which may involve considerably more risk than investing in larger-cap companies. The Fund’s broadly diversified portfolio does not ensure a profit or guarantee against loss. 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 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, Dundee Corporation was 0.5% of the Fund’s net assets, Fifth Street Asset Management was 0.3%, Frontier Services Group was 0.2%, Integrated Electrical Services was 2.0%, and Universal Truckload Services was 0.4%.

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 portfolio 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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