article 06-30-2016

2016 Semiannual Manager Commentary for Royce International Premier Fund

In the wake of Brexit, our core discipline, which emphasizes companies with notable strengths in industry structure, competitive positioning, operational efficiency, financial track record, and corporate governance, remains unchanged. We believe that the U.K. is more likely to move, however slowly and fitfully, toward Norway's model—with negotiated access to the common market. In addition, after initial stumbles, political matters in the country are coming together more effectively. So while volatility—both in the U.K. and the eurozone— seems likely to remain high in the short run, our confidence in the long-term prospects for our European (and other) holdings remains strong.

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Fund Performance

Royce International Premier Fund gained 0.8% for the year-to-date period ended June 30, 2016, slightly trailing its benchmark, the Russell Global ex-U.S. Small Cap Index, which rose 1.0% for the same period. During the first quarter, results for non-U.S. small-caps were mixed, though mostly muted.

Those in developed Europe—the strongest international small-cap group in 2015—corrected most steeply. Considering that more than half of the portfolio's net assets were invested in companies headquartered in this region, we were not surprised to see the Fund fall behind its international small-cap benchmark for the quarter, when International Premier lost 1.2% versus an advance of 0.9% for the benchmark.

The first quarter also saw a rebound in commodity prices that helped certain emerging markets, where the Fund has few investments.

The second quarter was moving along in a less volatile, more bullish fashion until the Brexit decision upended many markets, particularly those in the eurozone. By the end of June, most had still not recovered, unlike many of their counterparts in other regions of the globe.

The Fund managed well during this highly volatile period, outpacing the Russell Global ex-U.S. Small Cap in the second quarter, up 2.0% compared to a 0.1% advance for its benchmark. We were also pleased that the portfolio held on to its longer-term relative performance edge. International Premier outperformed the Russell Global ex-U.S. Small Cap for the one-, three-, five-year, and since inception (12/31/10) periods ended June 30, 2016.

What Worked... And What Didn't

Five of the Fund's eight equity sectors made positive contributions to first-half results. Health Care led by a wide margin, followed by a strong net gain for Financials while the Materials, Consumer Discretionary, and Energy sectors were the detractors.

Two industry groups in Health Care made outsized net gains—health care equipment & supplies and health care providers & services. Among the industry groups that detracted, the biggest net losses came from pharmaceuticals (also in Health Care), chemicals (Materials), and oil, gas & consumable fuels (Energy).

"In the wake of Brexit, our core discipline, which emphasizes companies with notable strengths in industry structure, competitive positioning, operational efficiency, financial track record, and corporate governance, remains unchanged. We believe that the U.K. is more likely to move, however slowly and fitfully, toward Norway's model—with negotiated access to the common market. In addition, after initial stumbles, political matters in the country are coming together more effectively. So while volatility—both in the U.K. and the eurozone— seems likely to remain high in the short run, our confidence in the long-term prospects for our European (and other) holdings remains strong."

Health Care was the Fund's second-largest sector weighting at the end of June. A large and diverse area, it is also home to many companies that fit the most desirable of our four business models—what we call "perennials," businesses with high levels of recurring revenues and reasonable to attractive valuations.

OdontoPrev is a dental benefits and technology company in Brazil, which has one of the largest dentistry markets in the world. Its business was helped by strong earnings and increased membership, as well as the recovery of Brazil's stock market and currency during the first half. We took some gains in June as its price climbed.

Carl Zeiss Meditec is a German medical technology company with a global business that focuses on ophthalmological treatments and therapeutic systems. Currency tailwinds and strong growth in its surgical ophthalmology segment helped its shares to rise in the first half. We reduced our stake in the second quarter.

Virbac is a French firm that makes vaccines, antibiotics, and other veterinary medications. Its shares suffered mostly from the negative results of a 2014 FDA investigation of its U.S. plant in St. Louis that were released earlier this year. We were confident that the company had dealt effectively with these issues—it was the portfolio's fifteenth-largest positon at the end of June.

Gaztransport Et Technigaz is a French engineering company that specializes in cargo containment systems and land storage for liquefied natural gas carriers. Its shares looked less attractive when the Fair Trade Commission of South Korea—a major hub of its business—announced it would investigate whether or not the company was in violation of fair trade laws, which led us to sell our shares in the first quarter.

We also parted ways with Motherson Sumi Systems, an Indian business that makes mirrors, wiring harnesses, and other automotive components due to what we saw as more compelling opportunities elsewhere.

The Fund's most significant disadvantage versus its benchmark was its lack of exposure to the metals & mining group while we had stock selection advantages in the two aforementioned healthcare industries, capital markets (Financials), and electronic equipment, instruments & components (Information Technology). The countries with the greatest positive impact on first-half results were Switzerland, Brazil, and Japan; holdings in France and the U.K. detracted most.


Top Contributors to Performance
For 2016 (%)1

OdontoPrev 1.29
Carl Zeiss Meditec 0.68
MISUMI Group  0.62
Partners Group Holding 0.50
Fidessa Group 0.45
1 Includes dividends

Top Detractors from Performance
For 2016 (%)2

Virbac  -0.77
Gaztransport Et Technigaz -0.67
Motherson Sumi Systems -0.51
Victrex -0.50
Azimut Holding -0.46
2 Net of dividends

Current Positioning and Outlook

At the end of June, our largest country exposures were to Japan, the U.K., Switzerland, and Germany, and our biggest sector weightings were in Industrials, Health Care, Information Technology, and Financials.

In the wake of Brexit, our core discipline, which emphasizes companies with notable strengths in industry structure, competitive positioning, operational efficiency, financial track record, and corporate governance, remains unchanged.

We believe that the U.K. is more likely to move, however slowly and fitfully, toward Norway's model—with negotiated access to the common market.

In addition, after initial stumbles, political matters in the country are coming together more effectively. So while volatility—both in the U.K. and the eurozone—seems likely to remain high in the short run, our confidence in the long-term prospects for our European (and other) holdings remains strong.

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

  QTR YTD 1YR 3YR 5YR 10YR 20YR SINCE
INCEPT.
DATE
International Premier 2.06 0.92 3.26 6.99 4.80 N/A N/A 5.12 12/31/10
Russell Glo x US SC 0.09 1.01 -5.77 4.06 1.91 3.82 N/A 1.89 N/A
Annual Operating Expenses: Gross 1.38% Net 1.19

* 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 2% 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 Service Class (its oldest class). Gross operating expenses reflect total gross annual operating expenses and include management fees, 12b-1 distribution and service fees, and other 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 its fees and/or reimburse operating 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 1.54% through April 30, 2017 and at or below 1.99% through April 30, 2025. 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, OdontoPrev was 2.7% of the Fund’s net assets, Carl Zeiss Meditec was 2.3%, Virbac was 2.2%, Gaztransport Et Technigaz was 0.0%, and Motherson Sumi Systems 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 may invest a significant portion of its assets in foreign companies which may be subject to different risks than investments in securities of U.S. companies, including adverse political, social, economic, or other developments that are unique to a particular country or region. These risk factors may affect the prices of foreign securities issued by companies headquartered in developing countries more than those headquartered in developed countries. (Please see "Investing in Foreign Securities" in the prospectus.) Therefore, the prices of the securities of foreign companies in particular countries or regions may, at times, move in a different direction than those of the securities of U.S. companies. (Please see "Primary Risks for Fund Investors" in the prospectus.) The Fund invests primarily in small-cap stocks, which may involve considerably more risk than investing in larger-cap stocks. The Fund also generally invests a significant portion of its assets in a limited number of stocks, which may involve considerably more risk than a more broadly diversified portfolio because a decline in the value of any one of these stocks would cause the Fund's overall value to decline to a greater degree. (Please see "Primary Risks for Fund Investors" 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 Global ex-U.S. Small Cap Index is an unmanaged, capitalization-weighted index of global small-cap stocks, excluding the United States. Index returns include net reinvested dividends and/or interest income. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.

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