Fund Performance

Royce Total Return Fund was down 7.2% in 2015, underperforming its small-cap benchmark, the Russell 2000 Index, which was down 4.4% for the same period. The year began with a strong run for Health Care stocks. 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.

During the sweeping correction that shook markets in the third quarter, Total Return lost less than the Russell 2000, down 9.6% versus a decline of 11.9%. When small-caps rebounded in the fourth quarter, however, sentiment swung back to growth, primarily to Health Care and more growth-oriented technology. For the quarter, Total Return advanced 1.9% versus a 3.6% gain for the small-cap index.

It was undoubtedly a difficult year. In fact, 2015 marked the first calendar year in its more-than-20 year history that Total Return lost to the small-cap index when the latter was in negative territory. Taking great pride in the Fund’s long history of both low volatility and sterling down market returns, we found the year’s results particularly tough to digest.

Yet the context is critical. The portfolio trailed its benchmark when returns were positive and outpaced it when small-caps reversed—consistent with its history. For example, from the 2015 small-cap high on June 23 through year-end, the Fund lost 10.7% versus a slide of 11.6% for the Russell 2000. In addition, the Fund maintained a relative edge for longer-term periods.

Total Return outpaced the Russell 2000 for the 15-, 20-year, and since inception (12/15/93) periods ended December 31, 2015. Its average annual total return since inception was 10.3%, a notable result that makes us quite proud.

What Worked... And What Didn't

Six of the Fund’s 10 equity sectors posted net losses in 2015, with three posting markedly large net losses—Industrials, Energy, and Consumer Discretionary. The first of these is a broad and diverse group that remains one of the Fund’s mainstays. Seven of the 12 industry groups in which we held positions finished the year in the red, with machinery and commercial services & supplies detracting most.

For the portfolio as a whole, however, the energy equipment & services group posted the biggest net losses on an industry basis. Many Industrial companies were challenged in 2015 by concerns over the slowing pace of global economic growth while Energy was hampered by consistently soft commodity prices that received no support from producers determined to keep pumping oil. Uncertainty over near-term global economic prospects only made it easier for investors to avoid these sectors.

Aiming to high-grade those holdings with commodity exposure, we parted ways with Tidewater, which provides marine service vessels to offshore energy companies in October. While initially pleased with the way it had been executing through this rough period for the energy business, we grew increasingly concerned about the depth of its ongoing losses and chose to sell.

The same impulse toward higher quality led us to increase our stake in longtime favorite SEACOR Holdings, which provides marine transportation equipment and logistics services primarily for energy companies. SEACOR has a history of opportunistic purchases in prior down markets and, while it too has endured losses of late, we have been pleased with the way the company has managed its business during this time.

Within Consumer Discretionary, holdings in the specialty retail category detracted most, led by two companies with which we are very familiar. The Buckle is a mall-based casual clothing retailer that struggled with reduced store traffic and consequent lower sales. Having owned shares for more than a decade, we were confident in its long-term prospects. We had a similar estimate of specialty footwear retailer DSW and department store operator Dillard’s (from the multiline retail group).

On the positive side, insurance was the portfolio’s top-performing industry, led by number-two holding and top contributor Markel Corporation. A longstanding favorite, insurance was home to the Fund’s three largest positions at year-end.

Information Technology, Health Care, and Financials detracted most on a relative basis for the year. For Information Technology, the issues were underweighting the strongly performing software industry and disappointing stock selection in the communications equipment group.

In Health Care, our underweight was a negative factor while in Financials the situation was more nuanced. We were hurt by our underweight in banks, an overweight in capital markets, and poor stock selection in diversified financial services and thrifts & mortgage finance companies. In contrast, Consumer Staples and Materials were the strongest relative contributors, driven in both cases by superior stock selection.

Current Positioning and Outlook

We expect reversals in a number of trends that should help benefit many portfolio holdings over the next few years. Our own research and regular meetings with confident 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 that companies with better balance sheets will do well in an environment of elevated corporate bond spreads. 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.

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

* Not Annualized

Current month-end performance may be obtained at our Prices and Performance page.

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