Royce Opportunity Fund Manager Commentary
article 02-22-2016

Royce Opportunity Fund Manager Commentary

2015 was a tough year for Portfolio Managers Buzz Zaino and Bill Hench, but by year-end valuations for the majority of their holdings looked attractive to them and seemed poised to benefit from ongoing U.S. economic growth.


Fund Performance

Royce Opportunity Fund was down 13.6% in 2015, behind its small-cap benchmark, the Russell 2000 Index, which declined 4.4% for the same period. The Fund finished the year-to-date period ended June 30, 2015 with a gain of 0.7% versus an increase of 4.8%.

This period looked stronger than it was for small-caps considering how narrow market leadership was—most of its strength came from Health Care, specifically biotech. When the market began to subsequently correct in the third quarter, however, the decline was more far reaching, and the Fund fell 15.5% while its benchmark was down 11.9%. Stocks recovered a bit in the year’s final quarter, in which the portfolio advanced 1.6% compared to a 3.6% increase for the Russell 2000, capping of a difficult year.

We are, however, confident as we look forward to 2016. We were also pleased that Opportunity Fund outpaced the small-cap index for the 15-year and since inception (11/19/96) periods ended December 31, 2015. The Fund’s average annual total return since inception was 11.4%, a long-term record that gives us great pride.

What Worked... And What Didn't

Eight of the portfolio’s 10 equity sectors finished the year in the red, with Consumer Discretionary, Industrials, Materials, and Information Technology detracting most. With exception of Materials, these are typically our largest sector weightings, as they were at the end of 2015.

At the industry level, four groups accounted for a large share of the Fund’s net losses. Metals & mining stocks detracted most, with Century Aluminum, which produces the metal, and Noranda Aluminum Holding, another producer that focuses on building construction, architectural, and transportation uses, showing the largest net losses. China’s decision to export its excess capacity has kept aluminum prices low.

In the specialty retail group, individual company losses were more diffuse, as they were for electronic equipment, instruments & components companies and machinery stocks. The first of these groups has had to cope with declining mall traffic and a highly selective U.S. consumer.

“We expect the increased spending and business tax credit plans passed in anticipation of the 2016 elections to boost the pace of growth in the U.S., which should help areas such as nonresidential construction, defense, consumer, and technology.”

UniSys Corporation was another significant detractor. In our view a long-term turnaround candidate, the company brought on new management late in 2014 who were charged with restructuring its IT services business that focuses on systems integration, outsourcing, infrastructure, server technology, and consulting. We built our position through much of 2015.

Online lender Enova International offers short-term consumer and installment loans in the U.S., U.K., Australia, and Canada. Having survived a period of government scrutiny into its industry it looks poised to benefit from a rising interest rate environment. Northwest Pipe makes large-diameter, high-pressure steel pipe products used for water transmission. It also moved into the oilfield country tubular goods market close to the time energy prices began to plummet, which hurt growth and revenues. It’s moving out of that business and concentrating on what we think it does best, making us confident in its recovery potential.

On the positive side, there were 16 portfolio companies that were acquired in 2015, which is good news not only for the premiums we received but also for the message that our valuation analyses were sound. 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.

Better-than-expected revenues helped the stock price of RF and mixed-signal integrated circuit specialist MaxLinear to climb in 2015 while earnings strength drove the rising share price of NeoPhotonics Corporation, which makes hybrid photonic integrated optoelectronic modules and subsystems for high-speed communications networks.

A welcome fourth-quarter rebound was not enough to keep the Information Technology sector from detracting most on a relative basis for the calendar year, primarily due to stock selection in IT services and electronic equipment, instruments & components companies.

The Fund suffered versus the benchmark from both our overweight and stock selection misses in Materials and from ineffective stock selection in Consumer Discretionary. A sizable disadvantage also came from its underweight in Health Care while lack of exposure to Energy provided an advantage.

Top Contributors to Performance
For 2015 (%)1

RTI International Metals 0.36
MaxLinear Cl.  0.34
NeoPhotonics Corporation 0.32
U.S. Concrete  0.29
Central Garden & Pet  0.27
1 Includes dividends

Top Detractors from Performance
For 2015(%)2

Century Aluminum -0.66
Unisys Corporation  -0.49
Enova International  -0.49
Northwest Pipe  -0.38
Noranda Aluminum Holding Corporation -0.37
2 Net of dividends

Current Positioning and Outlook

Our large weights in Information Technology, Industrials, and Consumer Discretionary are consistent with our view that valuations for the majority of our portfolio holdings look attractive to us and are poised to benefit from ongoing U.S. economic growth.

We expect the increased federal spending and business tax credit plans passed in anticipation of the 2016 elections to boost the pace of growth in the U.S., which should help areas such as nonresidential construction, defense, consumer, and technology. With so much recent attention on China, we think it’s important to point out that the U.S. remains by far the world’s largest economy.

We expect improvements here at home to ultimately ripple out to other parts of the globe. However, we think the greater domestic focus of most small-cap stocks, specifically many that we hold, will be a positive while we wait for a stronger, steadier pace of economic growth.

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

Opportunity 1.60 -13.57 7.27 5.66 6.08 9.19 11.43 11/19/96
Russell 2000 3.59 -4.41 11.65 9.19 6.80 7.28 7.81 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 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, Century Aluminum was 0.3% of the Fund’s net assets, Noranda Aluminum Holding was 0.01%, UniSys Corporation was 0.7%, Enova International was 0.4%, Northwest Pipe was 0.4%, RTI International Metals was 0.0%, MaxLinear was 0.9%, and NeoPhotonics Corporation 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 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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