article 06-30-2016

2016 Semiannual Manager Commentary for Royce Global Financial Services Fund

Portfolio Manager Chuck Royce and Assistant Portfolio Manager Chris Flynn have constructed a portfolio of what they consider to be differentiated franchises with attractive business models and low capital requirements in a specialized area where they think our experience gives us an analytical advantage. They believe the long-term outlook for these companies is promising.

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Fund Performance

Royce Global Financial Services Fund advanced 0.5% for the year-to-date period ended June 30, 2016, compared to a gain of 2.2% for its small-cap benchmark, the Russell 2000 Index, and an increase of 5.0% for the financial services component of the Russell 2500 Index for the same period.

The year began on a distinctly bearish note, with small-cap share prices in a dizzying decline through their year-to-date low on February 11. Stocks then rallied through the end of the first quarter.

The Fund acquitted itself well through this volatile period, with a 1.9% gain that outpaced both the Russell 2000, which fell 1.5%, and the Russell 2500 financial services companies, which were up 0.3%. 

The second quarter saw an extension of the rally, but with some important sector and industry leadership shifts within small-cap. REITs and Utilities—two of the more resilient and successful areas within the Russell 2000 over the last couple of years—maintained their strong runs as other areas either decelerated or failed to participate at all.

The Fund fell behind both indexes in the second quarter, down 1.4% versus respective gains of 3.8% and 4.7% for the Russell 2000 and the financial services component of the Russell 2500. This was primarily due to poor second-quarter results for capital markets, by far the portfolio's largest industry and a perennial area of investment focus, which were disproportionately affected by Brexit. Its effects elsewhere in the U.S. equity market were otherwise more quickly shaken off.

What Worked..And What Didn't 

The Fund's significant overweight in capital markets was therefore the biggest factor in relative underperformance. We view the capital markets industry as highly diverse, which is one reason we frequently find attractive opportunities there.

The portfolio's holdings in this industry include both domestic and international traditional asset managers, alternative asset managers, investment banks, wealth management firms, and specialist vendors to the industry. While we remain confident in the long-term prospects of our holdings, shorter-term periods, especially volatile ones, can affect these stocks disproportionately.

Discount brokerage leader The Charles Schwab Corporation was the Fund's biggest detractor in the first half, mostly the result of the post-Brexit expectation that interest rates will remain low for an extended period, which could create a challenge for Schwab as its profits could be expected to improve with rising rates.

"During the first half, we reduced our weighting in traditional asset managers in favor of credit-focused alternative asset managers, trimmed our exposure to U.S.-based wealth managers, and increased our investments in selected real estate-related firms headquartered outside the U.S. We have constructed a portfolio of what we consider to be differentiated franchises with attractive business models and low capital requirements in a specialized area where we think our experience gives us an analytical advantage."

Based in the United Kingdom, Jupiter Fund Management is an asset manager with a focus on retail investors. Its shares fell sharply after the Brexit vote, though that did little to alter our view of Jupiter as one of the U.K.'s better asset management firms.

Och-Ziff Capital Management Group is an institutional alternative asset manager that offers multi-strategy, credit, equity, and real estate funds. Its stock declined as the company worked through poor short-term investment performance in key funds and an ongoing Department of Justice investigation into certain international fundraising activities. We believe that investment performance will rebound and that the DOJ investigation will conclude with manageable civil fines.

The Fund's best performer in the first half was Franco-Nevada Corporation, a Canadian gold-focused royalty company with a large and diversified portfolio of cash-flow producing assets. The company paid down debt, increased its dividend, and offered upward earnings revisions, all as gold prices surged during the first half.

Two stock exchange operators were among the top first-half contributors. Brazil's BM&FBOVESPA is a top-10 holding that bought rival Cetip in April, creating the largest exchange in Latin America, with a presence from Mexico to Chile. Its stock rose on the news as well as on fiscal first quarter revenue, margin, and earnings improvements.

TMX Group owns and operates the Toronto Stock Exchange. The company reported decent earnings and offered evidence of transforming its business model to a lower cost base with a broader base of revenue streams.


Top Contributors to Performance
For 2016 (%)1

Franco-Nevada Corporation 1.05
BM&FBOVESPA 0.95
TMX Group  0.70
U.S. Global Investors Cl. A 0.65
FirstService Corporation 0.56
1 Includes dividends

Top Detractors from Performance
For 2016 (%)2

The Charles Schwab Corporation -0.52
Jupiter Fund Management -0.50
Och-Ziff Capital Management Group LLC Cl. A -0.39
Stifel Financial -0.33
Financial Engines -0.33
2 Net of dividends

Current Positioning and Outlook

At the end of the semiannual period, the U.S., Canada, and the U.K. were our largest country exposures, accounting for about 75% of net assets.

However, highlighting the geographic reach of the portfolio, we held positions located in another 20 countries, none of which individually amounted to 3% of net assets. Based on our proprietary classification we held about two-thirds of the portfolio in five categories: traditional asset managers, alternative asset managers, specialist vendors, exchanges, and banks.

During the first half, we reduced our weighting in traditional asset managers in favor of credit-focused alternative asset managers, trimmed our exposure to U.S.-based wealth managers, and increased our investments in selected real estate-related firms headquartered outside the U.S.

We have constructed a portfolio of what we consider to be differentiated franchises with attractive business models and low capital requirements in a specialized area where we think our experience gives us an analytical advantage. We believe the long-term outlook for these companies is promising.

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

  QTR YTD 1YR 3YR 5YR 10YR 20YR SINCE
INCEPT.
DATE
Global Financial Services -1.35 0.50 -10.68 5.77 7.98 5.19 N/A 7.04 12/31/03
Russell 2500 Fnl Svc 4.69 5.01 5.01 10.79 12.20 4.97 N/A 6.70 N/A
Russell 2000 3.79 2.22 -6.73 7.09 8.35 6.20 7.61 7.41 N/A
Annual Operating Expenses: Gross 1.85% Net 1.69

*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, 2017. 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 2016.

The thoughts expressed in this piece concerning recent market movements and future prospects for small company stocks are solely the opinion of Royce at June 30, 2016, 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 June 30, 2016 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 6/30/16, The Charles Schwab Corporation was 1.6% of the Fund’s net assets, Jupiter Fund Management was 1.7%, Och-Ziff Capital Management Group was 0.5%, Franco-Nevada Corporation was 1.3%, BM&FBOVESPA was 2.4%, and TMX Group was 0.0%.

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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