2016 Semiannual Manager Commentary for Royce Micro-Cap Trust
article 06-30-2016

2016 Semiannual Manager Commentary for Royce Micro-Cap Trust

Going forward, we remain confident that earnings and low leverage will matter more to investors through what we expect should be a long-running cycle. We have been researching and investing in micro-cap stocks for more than two decades and believe that our experience in this asset class can be a differentiator as the markets also continue to normalize.


Fund Performance

Royce Micro-Cap Trust "RMT" increased 5.4% on a net asset value ("NAV") basis and 5.8% on a market price basis for the year-to-date period ended June 30, 2016, ahead of both of its unleveraged benchmarks: the small-cap Russell 2000 Index was up 2.2% while the Russell Microcap Index declined 1.7% for the same period.

RMT was solid in a first quarter that was challenging for micro-cap stocks, up 0.1% on an NAV basis and down 1.2% based on market price, compared to first-quarter declines of 1.5% for the Russell 2000 and 5.4% for the Russell Microcap. 

The second quarter was mostly a period of gradual recovery that favored more defensive areas, such as REITs and utilities while cyclical areas within Materials, Industrials, and Energy continued to do well, in sharp contrast to what we experienced in 2015.

The wave of volatility that hit the markets in the wake of the Brexit vote wound up doing little to impede this low-key bullish phase. Although it had little exposure to defensive stocks, the Fund excelled in the second quarter, advancing 5.3% on an NAV basis and 7.1% on a market price basis, outpacing the Russell 2000 (+3.8%) and the Russell Microcap (+4.0%).

On an NAV basis RMT outpaced the Russell Microcap for the one-, three-, 10-, and 15-year periods ended June 30, 2016 while also beating the Russell 2000 for the one-, 15-, 20-year, and since inception (12/14/93) periods on an NAV basis. (Returns for the Russell Microcap Index only go back to 2000.) RMT's average annual NAV total return for the since inception period ended June 30, 2016 was 10.3%.

What Worked... And What Didn't

Eight of the Fund's 10 equity sectors were in the black at the end of June, led by Materials, Information Technology, and Financials, with the net losses posted by Health Care and Consumer Discretionary more modest in comparison.

RMT's leading industry group by a wide margin was metals & mining (Materials), where we were significantly overweight relative to the Russell 2000.

We hold what we think is an effective balance in this group between industrial metals companies and precious metals and mining companies. It contributed two of the portfolio's top five net gainers in the first half.

Major Drilling Group International performs contract drilling for companies involved in mining and mineral exploration. In a challenging environment for miners early in 2016, the company increased revenues and margins, helping its shares to climb.

Exeter Resource mines for gold primarily in Argentina and Chile and benefited mostly from increased gold prices. We were drawn to its large cash reserves and promising mining properties.

ASA Gold and Precious Metals is a closed-end fund that invests primarily in gold mining companies that was also rewarded by the rebound in precious metals prices. Electronic equipment, instruments & components is another key industry overweight that made a large contribution to first-half results.

Its top performer was Newport Corporation, a photonics technology specialist whose shares climbed by more than 50% in February after the company agreed to be acquired by MKS Instruments.

As for those holdings that detracted from performance, we held our position in ZAIS Group Holdings, an investment manager focused on specialized credit strategies—an asset management segment with what we think is ample long-term potential. Its shares fell with a quarterly loss reported in March and were mostly down through the end of June.

A falling stock price in the first half and our confidence in its long-term prospects led us to add shares of Fenix Parts, which recycles and resells original equipment manufacturer automotive parts and products. Consecutive quarterly losses drove investors away, but we like its business and the acquisitions it made in 2015, which have not diluted its balance sheet to a worrisome level.

Relative to the Russell 2000, the Fund benefited most from both its overweight and effective stock picking in metals & mining (Materials), the combination of an underweight and stock picking success in biotechnology (Health Care), our larger weighting and savvy stock picks in electronic equipment, instruments & components, and the same mix in the energy equipment & services group.

Conversely, first-half results were hampered most by our underweight in REITs (Financials) and lack of exposure to the Utilities sector.

Top Contributors to Performance
For 2016 (%)1

Major Drilling Group International 0.74
Newport Corporation 0.50
ASA Gold and Precious Metals 0.48
Care.com 0.41
Exeter Resource 0.37
1 Includes dividends

Top Detractors from Performance
For 2016 (%)2

ZAIS Group Holdings Cl. A -0.53
Fenix Parts -0.35
Avalanche Biotechnologies -0.35
Liberty Tax Cl. A  -0.33
SeaChange International -0.32
2 Net of dividends

Current Positioning and Outlook

While the corporate earnings picture is a phenomenon we continue to watch quite carefully, we are cautiously optimistic about RMT's near- and long-term prospects, basing our belief primarily on two factors—the growing performance advantage of both small- and micro-cap value versus growth and the relatively attractive valuation and earnings picture for many cyclical stocks.

We continue to believe that an extended period of slow growth should be enough to keep profitable cyclicals climbing, especially after factoring in the ways in which low expectations and—for some industries—oversold conditions depressed the stock prices of so many small-caps that we see as attractive—that is, solidly profitable— businesses.

In many cases, it appears that the market has just begun to reward steady earnings and high profitability and is only gradually recognizing how low valuations had become for many cyclicals.

Going forward, we remain confident that earnings and low leverage will matter more to investors through what we expect should be a long-running cycle. We have been researching and investing in micro-cap stocks for more than two decades and believe that our experience in this asset class can be a differentiator as the markets continue to normalize.

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

Royce Micro-Cap Trust NAV 5.34 -6.47 7.07 7.90 5.51 10.35 12/14/1993
Russell 2000 3.79 -6.73 7.09 8.35 6.20 N/A 12/29/1978

* Not Annualized

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

Important Performance, Expense, and Disclosure Information

All performance information reflects past performance, is presented on a total return basis, and reflects the reinvestment of distributions. Past performance is no guarantee of future results. Current performance may be higher or lower than performance quoted. Returns as of the most recent month-end may be obtained here. The market price of the Fund's shares will fluctuate, so that shares may be worth more or less than their original cost when sold. The Fund invests primarily in securities of small- and micro-cap companies, which may involve considerably more risk than investing in larger-cap companies. The Fund’s broadly diversified portfolio does not ensure a profit or guarantee against loss. Regarding the "Top Contributors" and "Top Detractors" tables, 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, Major Drilling Group International was 1.4% of the Fund’s net assets, Exeter Resource was 0.5%, ASA Gold and Precious Metals was 0.8%, Newport Corporation was 0.0%, ZAIS Group Holdings was 0.2%, and Fenix Parts was 0.5%.

The Fund is a closed-end registered investment company whose shares of common stock may trade at a discount to their net asset value. Shares of the Fund's common stock are also subject to the market risks of investing in the underlying portfolio securities held by the Fund. This Fund is a closed-end fund whose shares of common stock trade on the NYSE. Royce Fund Services, Inc. ("RFS") is a member of FINRA and has filed this material with FINRA on behalf of the Fund. RFS does not serve as a distributor or as an underwriter to the Fund. 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 Index is an 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 Microcap Index includes 1,000 of the smallest securities in the small-cap Russell 2000 Index, along with the next smallest eligible securities as determined by Russell. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.



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