Fund Performance

Royce Micro-Cap Opportunity Fund advanced 3.2% for the year-to-date period ended June 30, 2016, outperforming its benchmark, the Russell Microcap Index, which lost 1.7% for the same period.

The positive low returns for the first half of 2016 belie the wildly volatile nature of the small-cap market during this time. As micro- and small-cap stocks entered bear territory in mid-February before coming back strong to finish the first quarter, market leadership shifted more definitively from growth to value. These dramatic moves helped the Fund to outperform its benchmark in the first quarter (-0.9% versus -5.4%), as investors moved away from the narrow areas that were successful in 2015 and began to focus on areas that had been mostly overlooked.

The second quarter offered its own drama in the form of Brexit, but the modestly bullish pace of returns was impeded only briefly before resuming through the end of June. The Fund gained a bit more ground on its micro-cap benchmark in this period, gaining 4.1% compared to 4.0% for the Russell Microcap.

We remain confident in the portfolio's theme-driven deep value approach as we look out to the rest of 2016 and beyond. We were also pleased with the Fund's 9.9% average annual total return since inception (8/31/10).

What Worked... And What Didn't

Four of the Fund's nine equity sectors finished the first half in the black. Information Technology—the portfolio’s largest sector—posted net gains well in excess of Industrials, the next-best performer.

Of the five sectors in the red at the end of June, only Health Care detracted meaningfully from first-half performance. The electronic equipment, instruments & components group led all of the portfolio's industries by a sizable margin, followed by semiconductors & semiconductor equipment (both from Information Technology), and aerospace & defense (Industrials).

Health Care was home to three of the Fund's four biggest detracting industry groups—health care providers & services, health care equipment & supplies, and biotechnology. Software rounded out the top four. Net losses at the industry level were comparatively modest.

Amber Road, the Fund's top performing—and largest—holding in the first half, is a software company with a compelling niche. It develops single platforms to automate and streamline global trades, offering import and export, global logistics, and trade agreement management solutions. We first bought shares in 2014 on the understanding that its turnaround would take time and patience. In the first half of 2016, investors seemed to be anticipating greater acceptance of its product, driving up the value of its shares.

Newport Corporation became one of several acquisition targets in the portfolio when MKS Instruments announced in February that it would be buying the business of this specialty electronic component maker for a significant premium. We sold our shares shortly after the announcement.

KEYW Holding Corporation is another top-10 position that enjoyed a strong first half. The company makes software that collects, processes, and analyses intelligence data and information in cyberspace. We see cybersecurity as a major growth area and were pleased to see this largely underfollowed company command attention as it sold off a business to better focus on what we see as its core strength.

As for positions that detracted from performance, the most impactful was SunEdison, which makes semiconductors and solar energy technology. After the company suffered through months of disappointing developments dating back to 2015, we decided to sell our position during February and March of this year.

We had the opposite view about the long-term prospects for Civitas Solutions, which provides home and community based health and human services to people with intellectual, developmental, physical or behavioral disabilities, and other special needs. We thought its valuation looked highly attractive when we gradually began to build our position in the spring of 2015. Its share price proceeded to appreciate through the second half of 2015 before correcting dramatically earlier this year, giving us a buying opportunity. We like its niche in what we see as a healthcare segment with ample growth potential.

Relative to the Russell Microcap, the Fund benefited significantly from superior stock selection in Information Technology, particularly in the aforementioned electronic equipment, instruments & components group and in communications equipment. Better stock picking also helped in Industrials, especially in the overweighted aerospace & defense and machinery groups.

In addition, the Fund's lower exposure to biotechnology stocks was a source of relative outperformance in Health Care, where stock selection also helped. Ineffective stock selection hampered relative results in two areas of Consumer Discretionary—hotels, restaurants & leisure and household durables—while the portfolio's lack of exposure to Utilities also hurt.

Current Positioning and Outlook

The Fund's largest weightings at the end of June were Information Technology and Industrials. We also had relatively larger weightings in Consumer Discretionary and Materials.

These positions were consistent with our belief that the U.S. economy will continue to grow, and our industry focus has been on areas such as residential and non-residential construction, defense, and discrete consumer industries, where we think positive trends in employment and wage growth should ultimately prove rewarding for these companies.

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

* Not Annualized

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

Important Performance, Expense, and Disclosure Information