article 06-30-2016

2016 Semiannual Manager Commentary for Royce Premier Fund

We continue to see the greatest values in leading companies in cyclically sensitive areas, particularly those within the industrial part of the economy. 

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Fund Performance

Royce Premier Fund was up 6.5% for the year-to-date period ended June 30, 2016, more than doubling the 2.2% gain for the Russell 2000 Index, its small-cap benchmark, for the same period.

Particularly in the volatile first quarter, the Fund benefited from long-awaited market reversals in favor of companies with positive earnings, better balance sheets, and higher profitability, all of which fit well with the Fund's strategy. Premier gained 4.4% in the first quarter compared to a decline of 1.5% for the small-cap index.

The second quarter saw a brief but powerful burst of high volatility in the aftermath of the Brexit vote. Following a few very bearish session, the U.S. equity markets resumed their previously placid bullish pace.

The Fund delivered positive returns, but lagged the index in the second quarter, up 2.0% for the period compared to a 3.8% gain for the Russell 2000. Longer-term results remained strong—and encouraging given our belief that the capital markets are slowly but surely returning to what we regard as normal.

The Fund outperformed its benchmark for the one-, 10-, 15-, 20-year, and since inception (12/31/91) periods ended June 30, 2016. Premier's average annual total return since inception was 11.1%—a long-term record in which we take great pride.

What Worked... And What Didn't

Notwithstanding the high volatility in the first half, seven of the Fund’s eight equity sectors finished the semiannual period with net gains. Only Energy detracted, and its net loss was modest. Industrials led by a wide margin, more than doubling the contribution from Consumer Discretionary, the portfolio's second-best performing sector.

Three of the top-five contributing industry groups came from Industrials—commercial services & supplies, machinery, and construction & engineering—as did three of the portfolio's best performing positions.

Ritchie Bros. Auctioneers is a long-time holding that we first bought in Premier's portfolio in 2000. This leading auctioneer of used industrial equipment continued to benefit from management's ongoing efforts to improve profitability as well as robust auction volumes from its construction segment and market share gains in newer target areas such as transportation and agriculture. Although we took some gains as its shares rose, it was the Fund’s second-largest position at the end of June.

Copart was the portfolio's largest holding and another top contributor from the Industrials sector. The company has what we think is a strong niche providing vehicle suppliers, primarily insurance companies, with services to process and sell salvage vehicles through auctions. During the first half, it benefited from favorable industry tailwinds, including aging vehicle fleets and the increased cost and complexity of car repairs due to the greater number of computerized parts, that created higher salvage volumes.

Valmont Industries makes specialty metal products and coatings for lighting, communication, and utility markets as well as agricultural irrigation products. We like the way its management has reduced costs in the face of prolonged depressed demand, which should allow the company to see improved operating margins this year, though we are keeping an eye on the potential partial offset of rising steel prices.

Speaking of steel, and moving outside Industrials, 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.

The Industrials sector was also home to the Fund's biggest detractor in the first half. The Advisory Board provides best practice research and analysis to the health care industry. We reduced our position as business in its core healthcare segment decelerated, with below-rate subscriptions signings likely to impact the company through the end of the year.

Jones Lang LaSalle provides real estate brokerage and property management services. It continues to execute well but a deceleration in commercial real estate transaction volumes—mostly related to volatile capital markets in the first half—have hurt its results. We think the market's reaction was extreme and we held shares at the end of June.

Relative to the Russell 2000, the Fund was helped most by its underweight and stock selection in Health Care, with the latter factor strongest in life sciences tools & services and health care equipment & supplies.

The Industrials sector was also a major source of outperformance, thanks to our overweight and effective stock picks in commercial services & supplies and marine. Conversely, our lack of exposure to REITs and the Utilities sector negatively affected first-half performance as these interest-rate sensitive stocks rallied as bond yields fell.


Top Contributors to Performance
For 2016 (%)1

Ritchie Bros. Auctioneers 0.96
Reliance Steel & Aluminum  0.70
Copart 0.70
Cognex Corporation  0.68
Valmont Industries  0.64
1 Includes dividends

Top Detractors from Performance
For 2016 (%)2

The Advisory Board -0.83
Jones Lang LaSalle -0.62
Myriad Genetics  -0.48
Westlake Chemical  -0.45
Stifel Financial  -0.44
2 Net of dividends

Current Positioning and Outlook

Portfolio positioning remains largely intact, although in Industrials we lowered our exposure to machinery and increased it in construction & engineering. We continue to see the greatest values in leading companies in cyclically sensitive areas, particularly those within the industrial part of the economy, which can be seen in our largest sector weightings in Industrials and Information Technology.

Moreover, while the Fund rarely has holdings among REITs, Utilities, and Telecommunication Services stocks, with Treasury Bond yields at historic lows, we are very comfortable with the Fund's lack of exposure in those areas.

Average Annual Total Returns as of Quarter-End 6/30/16 (%)

  QTR 1YR 3YR 5YR 10YR 20YR SINCE
INCEPT.
DATE
Premier 2.01 6.51 -5.61 4.05 4.28 6.61 10.44 11.08 12/31/91
Russell 2000 3.79 2.22 -6.73 7.09 8.35 6.20 7.61 9.13 N/A
Annual Operating Expenses: 1.13%

* 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. All performance and risk information reflects results of the Investment Class (its oldest class). Operating expenses reflect the Fund’s total annual operating expenses for the Investment Class as of the Fund’s most current prospectus and include management fees and other expenses. Shares of RPR’s Service, Consultant, R, and K Classes bear an annual distribution expense that is not borne by the Investment Class. 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.

As of 6/30/16, Ritchie Bros. Auctioneers was 2.9% of the Fund's net assets, Copart was 2.9%, Valmont Industries was 2.6%, Reliance Steel & Aluminum was 2.2%, The Advisory Board was 0.6%, and Jones Lang LaSalle was 0.8%.

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.

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 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 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.) The Fund may invest up to 25% 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 Index 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 performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.

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