Fund Performance

Royce Dividend Value Fund advanced 4.4% for the year-to-date period ended June 30, 2016, doubling the 2.2% return for its benchmark, the Russell 2000 Index, for the same period.

While the year began with an alarming correction that reached into mid-February, the Fund bounced back strongly after a period of underperformance with one of its strongest relative quarterly showings in a number of years, gaining 5.0% versus a loss of 1.5% for the small-cap index in the first quarter.

In this highly volatile period, the portfolio benefited from the long-awaited shift in the small-cap market towards companies with current earnings, below-average risk profiles, and lower valuations, which all fit well with the Fund's strategy.

The second quarter featured an environment that was both more mixed and more challenging for the Fund. While many of the cyclical businesses in sectors as diverse as Industrials, Information Technology, and Materials continued to do well, they ceded overall leadership to defensive areas such as REITs, utilities, and staples.

More pointedly, the Fund suffered most from its significantly higher exposure to capital markets companies, many of which demonstrated little or no recovery in the wake of Brexit. The upshot was a step back for the portfolio, which finished the second quarter with a modest decline of 0.6% while the Russell 2000 rose 3.8%.

We were nonetheless pleased by the Fund's strong first half overall and believe that leadership for small-cap value, which stretches back to the most recent peak for the Russell 2000 on June 23, 2015, should be long lasting. We were also happy that Dividend Value outpaced its benchmark for the one-, 10-year and since inception (5/3/04) periods ended June 30, 2016.

What Worked... And What Didn't

Nine of the Fund's 10 equity sectors finished the first half with net gains—as was also the case for the Russell 2000. Leading the portfolio by a comfortable margin was Materials, followed by strong net gains for Industrials and Financials. The net loss for Telecommunications Services, by contrast was small.

Metals & mining (from Materials) was the leading industry group, followed by machinery and air freight & logistics, both from the Industrials sector. Materials was also home to the Fund's top three contributors for the semiannual period.

Reliance Steel & Aluminum benefited from a sharp rise in steel and other base metals prices. Strong demand from the auto and aerospace sectors, as well as incremental improvement in commercial construction, continues to underpin solid volume trends, while distributor inventories are lean, with extended mill lead times for some products.

Franco-Nevada Corporation is a Toronto-based business that owns royalties and streams in gold mining and other commodity and natural resource investments. The company benefited from a surge in gold prices and paid down debt during the first half while also increasing its dividend and offering upward earnings revisions.

Worthington Industries is a global diversified metals manufacturing company. It was able to keep earnings positive in spite of sales declines earlier in the year and then reaped the benefit of record fiscal fourth quarter earnings per share. We held good-sized positions in all three companies at the end of June.

We have long liked the core businesses of investment processing, management, and operations solutions specialist, SEI Investments. The portfolio's biggest detractor in the first half, it continued to execute well but saw its stock price hurt by market volatility, though its shares were recovering at the end of June.

Staffing and workforce solutions specialist ManpowerGroup saw its shares plummet in the wake of Brexit. Its inability to share in the subsequent recovery was largely related to the company's significant exposure to the European labor market. We chose to hold our shares in the belief that the market overreacted to what remains a business with impressive revenues, positive earnings, and a steady dividend. It was the Fund's seventeenth largest holding at the end of June.

Relative to its benchmark, the Fund was helped most by both its underweight in Health Care and better stock picking in that sector's pharmaceuticals industry. Our larger weighting in Materials, especially in the aforementioned metals & mining group, also boosted outperformance.

Conversely, the portfolio's slight exposure to Utilities and stock selection in Financials hampered relative results.

Current Positioning and Outlook

Portfolio positioning remained largely unchanged at the end of June. We continue to see the most attractive values in cyclically sensitive areas, particularly those involved in capital markets and industrial activity, as our large weightings in Financials and Industrials demonstrate.

Moreover, with Treasury Bond yields at historic lows and interest-rate sensitve stock valuations looking rich, we are comfortable with the portfolio's lack of exposure to defensive areas—the Fund rarely holds REITs and has little exposure to Utilities and Telecommunication Services companies.

Our much larger weighting in capital markets is based on our belief that asset managers, investment banks, and niche vendors are potentially profitable investments because of their high returns on invested capital and ability to differentiate themselves.

In addition, their often complex business models and the companies' cyclical earnings patterns often lead to them being misunderstood—and thus mispriced—by investors, which we believe can create opportunities for us.

Average Annual Total Returns Through 6/30/16 (%)

* Not Annualized

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

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