article 12-31-2016

Royce Global Financial Services Fund Manager Commentary

Lead Portfolio Manager Chuck Royce and Portfolio Manager Chris Flynn believe we are on the road back to a more historically normal market environment. They think this bodes well for small-cap stocks in general, as well as for many of their preferred financial services companies.


Fund Performance

Royce Global Financial Services Fund gained 12.9% in 2016. Although this result was significantly higher than its long-term returns, it still lagged both its small-cap benchmark, the Russell 2000 Index, and the financial services component of the Russell 2500 Index, which advanced 21.3% and 22.6%, respectively, for the same period.

Two related factors contributed to calendar-year underperformance: First was the portfolio's significantly larger weighting in capital markets companies. This category lagged several other industries in the Financials sector (the second-best performer in the small-cap index) within the Russell 2000. The second factor was the presence of many non-U.S. stocks in this group, which collectively underperformed their domestic counterparts in 2016.

For the first half of 2016, the Fund increased 0.5% compared to a gain of 2.2% for the Russell 2000 and 5.0% for the financial services companies in the Russell 2500. Global Financial's results showed marked improvement on an absolute basis in the second half, though it could not keep pace with the two indexes. In the second half of 2016, the Fund rose 12.4% versus respective gains of 18.7% and 16.8% for the Russell 2000 and the financial services component of the Russell 2500, thanks largely to the beneficial effect the steepening yield curve had on banks and thrifts & mortgage finance companies.

What Worked..And What Didn't 

We have long seen the capital markets industry as home to many niche companies with talented management, differentiated business models, and attractive financial profiles, which are among the key attributes that we seek. While we remain confident in their long-term prospects, many capital markets holdings did not advance as much as others in the sector. Nonetheless, the overall effect for the group on 2016’s performance was positive. Banks were also a significant contributor to calendar-year results.

The Fund's top three contributors were also top-10 holdings at the end of the year. Ares Management is a global alternative asset manager specializing in credit, private equity and real estate investing. Strong fund performance, improved fee-related earnings, and a bright outlook for future growth seemed to draw investors to its shares in 2016.

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 general, and many of our preferred types of financial companies specifically. In addition, we think an accelerating U.S. economy and increased business confidence can help many capital markets businesses both in and outside the U.S.

MBIA provides financial guarantee insurance and other forms of credit protection. The firm has a meaningful exposure to Puerto Rican bonds, which has weighed down its stock price in recent years. Promising signs of a successful resolution to the Puerto Rican debt crisis contributed to a sharp fourth-quarter rally for MBIA's stock.

Popular is a bank holding company that provides commercial banking services through branches in the U.S., Puerto Rico, the British Virgin Islands, and the Dominican Republic. Its shares advanced more or less steadily throughout the year as investors saw more evidence of a turnaround in its U.S. business, as well as progress in Puerto Rico in addressing lingering issues that would enable the bank to capitalize on its leading position in that market.

As for positions that detracted, four of the top five positions came from the capital markets industry. Value Partners Group is a Hong Kong-based asset manager that emphasizes value approaches similar to some of our own. Subpar short-term performance, net outflows, and a CEO resignation all contributed to investors' concerns. Because we remain confident in its long-term prospects, particularly in China, as well as in its Chairman, who has assumed CEO responsibilities, we were comfortable holding our stake at the end of 2016.

Och-Ziff Capital Management Group is an institutional alternative asset manager that offers multi-strategy, credit, equity, and real estate funds. Its stock declined as the company worked through poor short-term investment performance in key funds and an ongoing Department of Justice investigation into certain international fundraising activities. Although the firm settled in September, its assets under management continued to decline, which influenced our decision to sell our shares in December.

Stifel Financial provides wealth management, investment banking, and related financial services. Global volatility hit the advisory fee end of its business particularly hard at the end of 2015 and early in 2016, leading us to sell our position in February.

Top Contributors to Performance
For 2016 (%)1

Ares Management L.P. 1.16
MBIA 1.14
Popular 1.03
Franco-Nevada Corporation 0.90
1 Includes dividends

Top Detractors from Performance
For 2016 (%)2

Value Partners Group -0.55
Och-Ziff Captial Management Group LLC Cl. A -0.55
Stifel Financial -0.38
Jupiter Fund Management -0.32
Clarkson -0.31
2 Net of dividends

Current Positioning and Outlook

Using our proprietary industry classification model, the Fund's three largest industry weighting were in banks, which we expect to continue benefitting from a steepening yield curve and perhaps increased loan demand, specialist vendors, where we often find niche businesses with what we see as sustainable competitive advantages, and alternative asset managers, with a current preference for private credit managers, where we see strong asset growth and undervaluation due to the complexity of the business models.

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 general, and many of our preferred types of financial companies specifically. In addition, we think an accelerating U.S. economy and increased business confidence can help many capital markets businesses both in and outside the U.S.

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

Global Financial Services 4.80 12.93 3.64 13.80 5.02 N/A 7.72 12/31/03
Russell 2500 Fnl Svc 10.94 22.64 12.06 17.14 5.53 N/A 7.71 N/A
Russell 2000 8.83 21.31 6.74 14.46 7.07 8.25 8.53 N/A
Annual Operating Expenses: Gross 1.85% Net 1.69

*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 Gross operating expenses reflect the Fund's gross total annual operating expenses for the Service Class and include management fees, 12b-1 distribution and service fees, other expenses, and acquired fund fees and expenses. Net operating expenses reflect contractual fee waivers and/or expense reimbursements. All expense information is reported as of the Fund’s most current prospectus. Royce & Associates has contractually agreed to waive fees and/or reimburse expenses to the extent necessary to maintain the Fund's net annual operating expenses (excluding brokerage commissions, taxes, interest, litigation expenses, acquired fund fees and expenses, and other expenses not borne in the ordinary course of business) at or below 1.49% through April 30, 2016. 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, Ares Management was 2.3% of the Fund's net assets, MBIA was 2.0%, Popular was 2.5%, BM&FBOVESPA was 1.4%, Franco-Nevada Corporation was 1.8%, Value Partners Group was 1.1%, Och-Ziff Capital Management Group was 0.0%, Stifel Financial was 0.0%, Jupiter Fund Management was 1.3%, and Clarkson was 1.2%.

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 Russell 2500 index represents the smallest 2,500 companies in the Russell 3000 index. The returns for the Russell 2500—Financial Sector represent those of the financial services companies within the Russell 2500 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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