article 12-31-2016

Royce Dividend Value Fund Manager Commentary

Lead Portfolio Manager Chuck Royce and Portfolio Manager Jay Kaplan firmly believe that we have turned the page on the anomalous 2011-2015 period and in their view, we are on the road back to a more historically normal market environment, and think this bodes well for small-cap stocks.


Fund Performance

Royce Dividend Value Fund advanced 16.4% in 2016, trailing its small-cap benchmark, the Russell 2000 Index, which gained 21.3% for the same period. Three factors had an outsized effect on calendar-year underperformance: At the end of 2016 a significant percentage of the Fund’s assets were invested in mid-cap stocks, which meaningfully underperformed their small-cap peers (the Russell Midcap Index rose 13.8% in 2016); 23.4% of the Fund’s net assets were invested in international stocks, which significantly trailed their domestic counterparts; and the Fund had a high weighting in capital markets companies, a number of which were non-U.S., and the group as a whole underperformed relative to the Russell 2000. However, we were pleased to see value recapture leadership from growth in 2016 and cyclicals beat defensives.

Based on history and reversion to the mean, we believe that these two developments should have staying power, in particular because the previous five years (2011-2015) were so odd, with unprecedented levels of monetary policy intervention and little, if any, in the way of fiscal stimulus. Finally, we were intrigued by the number of holdings that entered 2017 with what we thought were very attractive valuations.

During the first half of 2016, Dividend Value increased 4.4% compared to 2.2% for the small-cap index. During the third quarter the Fund lost some ground, gaining 4.4% versus 9.0% for the benchmark. The Fund also lagged for the fourth quarter, up 6.7% versus 8.8% for the Russell 2000. The Fund's average annual total return since inception was 8.5%.

What Worked... And What Didn't

Nine of the Fund's 11 equity sectors showed net gains for 2016. Industrials and Financials led by a sizable margin, followed by a solid contribution from Materials. Telecommunication Services detracted most, albeit modestly, while Health Care saw a very small loss. At the industry level, machinery (Industrials), metals & mining (Materials), capital markets (Financials), and banks (Financials) were the leaders.

The biggest detractors among the portfolio's industry groups were diversified telecommunication services (a low weighting in one of the Fund's smallest sectors, Telecommunication Services), technology hardware, storage & peripherals (Information Technology), and marine (Industrials).

We were pleased to see value recapture leadership from growth in 2016 and cyclicals beat defensives. Based on history and reversion to the mean, we believe that these two developments should have staying power. We were also intrigued by the number of holdings that entered 2017 with what we thought were very attractive valuations.

The portfolio's top contributor at the position level was Worthington Industries, a metals manufacturing company that earlier in the year was able to improve margins and keep earnings positive in spite of some sales declines. Its stock was then galvanized by postelection optimism for significant infrastructure spending before pulling back a bit toward the end of the year. We reduced our position in November.

Top-10 holding and long-time Royce favorite Reliance Steel & Aluminum distributes metals. Its shares rose through much of the year and gained a similar boost following the election. Not long after Parker Hannifin announced plans to buy the company in December, we began to sell our shares of CLARCOR, which makes replacement filters for trucks and construction equipment.

Detracting most on the position level was SEI Investments, an asset manager that also provides technology solutions. We have long liked its core businesses and were happy to hold a good-sized position at the end of 2016 owing to our confidence in its long-term prospects and its previous record of success. London-based Inmarsat has a global business providing satellite broadband services on land, at sea, and in the air. Sales declines were driven by the recession in the commercial shipping industry along with ongoing weakness in international trade. However, the firm also saw better-than-expected growth in its government and aviation businesses before the end of the year, which aided our decision to hold our shares.

In spite of its stock price volatility through much of the year, we held on to top-10 position Diebold Nixdorf, which makes software-based self-service delivery and security systems. The company announced an expensive acquisition that, while making the combined company the world’s largest maker of automated teller machines, also sported a price tag which worried other investors.

Relative to the Russell 2000, the calendar year's largest detractor was Financials where, in addition to the previously mentioned overweight and stock selection missteps in capital markets, our underweight in banks created a significant lag. Stock selection in Industrials was also a factor in underperformance. Helping relative results most was our appreciably lower exposure to Health Care—the only sector in the Russell 2000 to show a net loss in 2016.

Top Contributors to Performance
For 2016(%)1

Worthington Industries 1.02
Reliance Steel & Aluminum 0.90
Quaker Chemical 0.66
TD Ameritrade Holding Corporation 0.62
1 Includes dividends

Top Detractors from Performance
For 2016 (%)2

SEI Investments -0.47
Inmarsat -0.35
Diebold Nixdorf -0.24
Westwood Holdings Group -0.21
MTS Systems -0.21
2 Net of dividends

Current Positioning and Outlook

We firmly believe that we have turned the page on the anomalous 2011-2015 period, in which extraordinary monetary accommodations caused financial markets to behave in odd and unprecedented ways. In our view, we are on the road back to a more historically normal market environment.

We think this bodes well for small-cap stocks. In our view cyclicals look well-positioned for ongoing leadership. In addition to our usual cyclical tilt, we are looking in some defensive areas such as healthcare. It is very much on a stock-by-stock basis, with a focus on individual companies that combine attractive valuations with strong fundamentals.

Average Annual Total Returns Through 12/31/16 (%)

Dividend Value 6.74 16.36 2.40 10.42 6.76 N/A 8.46 05/03/04
Russell 2000 8.83 21.31 6.74 14.46 7.07 8.25 8.61 N/A
Annual Operating Expenses: 1.39

* Not Annualized

Important Performance and Expense Information

All performance information 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 at Operating expenses reflect the Fund’s gross total annual operating expenses for the Service Class as of the Fund’s most current prospectus and include management fees, 12b-1 distribution and service fees, other expenses, and acquired fund fees and expenses. Acquired fund fees and expenses reflect the estimated amount of the fees and expenses incurred indirectly by the Fund through its investments in mutual funds, hedge funds, private equity funds, and other investment companies.

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

Important Performance and Disclosure Information

The thoughts expressed in this piece concerning recent market movements and future prospects for small company stocks are solely the opinion of Royce at December 31, 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 December 31, 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. 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 12/31/16, Worthington Industries was 1.4% of the Fund's net assets, Reliance Steel & Aluminum was 2.0%, CLARCOR was 0.8%, Quaker Chemical was 1.6%, TD Ameritrade Holding Corporation was 1.5%, SEI Investments was 1.2%, Inmarsat was 0.5%, Diebold Nixdorf was 1.9%, Westwood Holdings Group was 0.0%, and MTS 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. Smaller-cap stocks may involve considerably more risk than larger-cap stocks. (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 2000 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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