Fund Performance

Royce Small-Cap Value Fund advanced 6.0% for the year-to-date period ended June 30, 2016, ahead of its small-cap benchmark, the Russell 2000 Index, which was up 2.2% for the same period.

The Fund held up well through a volatile first half, especially during the first quarter when small-caps experienced long-awaited reversals in favor of companies with positive earnings, better balance sheets, and higher profitability, all of which fit well with the Fund's strategy. Small-Cap Leaders gained 5.2% in the first quarter compared to a decline of 1.5% for the small-cap index.

Late in the second quarter, the Brexit decision generated a quick surge of high volatility for markets across the globe. Yet after a few bearish sessions, the U.S. equity markets resumed their previously slow steady pace of growth.

The Fund delivered a modest positive return in the second quarter, up 0.8% compared to 3.8% for the Russell 2000. We remain encouraged about the potential for the Fund's quality-centric approach, which focuses on what we think are leading small-cap companies that have strong business models and competitive positions, superior balance sheets, and attractive prospects for growth.

Small-Cap Leaders' average annual total return for the since inception (6/30/03) period ended June 30, 2016 was 8.7%.

What Worked... And What Didn't

Industrials and Information Technology were well out in front, leading seven of the Fund's eight equity sectors that finished the first half in the black. Three industry groups posted notable net gains—electronic equipment, instruments & components, semiconductors & semiconductor equipment, both Information Technology areas, and thrifts & mortgage finance from Financials.

That third industry is home to Genworth MI Canada, that country's leading residential mortgage insurance provider. Its stock rebounded with consecutive quarters of strong results which were driven by a loss ratio that remains below the low end of its guidance. This has eased investor anxieties about the impact of lower oil prices in resource-rich Alberta, where about 20% of its policies are written. The recovery in oil prices also helped its shares to surge. Even with its recovery, the company was still recently priced below tangible book value and has a nearly 5% dividend yield, factors that contributed to it being the Fund's largest holding at the end of June.

Other top performers included Minerals Technologies, a beneficiary of improved investor sentiment toward global industrials following the Russell 2000's first-half low on February 11. The company continues to build a pipeline of exclusive deals to supply precipitated calcium carbonate to paper producers, primarily in China, while the recent pick-up in steel prices bodes well for its refractories sales. Management also continues to do an exceptional job managing costs and improving the profitability of several acquired businesses.

Negative sentiment toward the end of 2015 weighed down the prices of trucking stocks, including less-than-truckload provider Saia, a top-10 holding. The company has subsequently delivered better-than-industry results thanks to its ongoing rate improvement and fleet management moves.

Fabrinet is one of the few contract manufacturers focused exclusively on optical networking communications equipment. The company has reported excellent results as its key customers—telecomm service providers and data center operators—are upgrading their infrastructure with optical components to handle the explosive growth in Internet data traffic.

Three asset managers headed the list of positions that detracted. Virtus Investment Partners had to cope with the departure of a key portfolio manager from one of its best-performing and asset-attracting funds. While no doubt a loss, the magnitude of outflows may prove less severe than the market has priced in. We think the portfolio at issue remains in highly capable hands—the right-hand man of the departed manager—along with a strong analytical team. We added shares in the first half.

Both the downdraft early in 2016 and the Brexit-bred volatility in late June pressured the shares of Lazard as increased uncertainty about global growth slowed the pace of merger and acquisition activity that is one of its key specialties. Investors also seemed sensitive to the firm's greater exposure to international and, more specifically, emerging market funds.

The same waves of volatility hurt Artisan Partners Asset Management, stoking concerns about the impact on earnings of slower or negative net fund flows and reduced assets under management. We like each company's long-term prospects.

The Fund's relative advantages versus the Russell 2000 included our significant underweight in Health Care and superior stock selection in that sector's life sciences tools & sciences group. We were also helped by better stock picking in our two leading industries in Information Technology and the road & rail group in Industrials.

Conversely, we were hurt in the first half by our much larger weighting in capital markets. Also hampering relative returns was our lack of exposure to REITs and the Utilities sector as these interest-rate sensitive stocks rallied as bond yields fell.

Current Positioning and Outlook

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

Our largest sector weightings in Industrials and Information Technology reflect this view. 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 here.

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

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

Important Performance, Expense, and Disclosure Information