Fund Performance

Royce International Micro-Cap Fund advanced 6.3% in 2016, outperforming its benchmark, the Russell Global ex-U.S. Small Cap Index, which was up 5.0% for the same period. We were pleased that this solid performance came in the context of sector results that were choppier than those of domestic micro-caps, with the benchmark's two cyclical, commodity-based sectors, Energy and Materials, doing best, followed by strong results for defensive Utilities. This stood in sharp contrast to the U.S. small- and micro-cap markets, in which cyclical leadership was more pronounced.

During the first half of the calendar year, the Fund gained 0.2% versus 1.0% for its benchmark. The second half was more of a tale of two quarters. The third quarter saw International Micro-Cap advance 9.2% versus 7.9% for the benchmark as many stocks rebounded following the Brexit vote.

During the fourth quarter, however, most international small- and micro-caps declined. The Fund fell 2.8% compared to a decline of 3.6% for the Russell Global ex-U.S. Small Cap. A lot of this was due to currency effects as the growing strength of the U.S. dollar affected holdings based in the U.K., where the British pound declined significantly in 2016.

What Worked... And What Didn't

Five of the portfolio's nine equity sectors made contributions to 2016 performance, led by Information Technology and Consumer Discretionary. Detractors made a far lower impact and were led by Energy (the best-performing sector in the benchmark) and Consumer Staples.

The leading industries by contribution were media (Consumer Discretionary), semiconductors & semiconductor equipment (Information Technology), and metals & mining (Materials). As with sectors, detracting industries had much less of an effect on results, with oil, gas & consumable fuels (Energy), commercial services & supplies, and building products (both from Industrials) the leaders.

The Fund's top contributor at the position level was Brazil’s T4F Entretenimento. The company operates at multiple levels of the entertainment industry, including venue operation, ticketing, food & beverage, merchandise sales, and corporate sponsorships. T4F participated in a strong rally that saw Brazilian small-caps rise approximately 60% in 2016. After a few difficult years in which profitability suffered from heightened competition, T4F increased its profits for the second consecutive year. We reduced our stake as its shares climbed.

Manappuram Finance, one of India's leading Non-Bank Financial Companies (NBFC), has been enjoying robust market conditions for its specialized lending focus which offers loans against gold collateral. A stable gold market coupled with healthy demand helped Manappuram to continue its mid-double-digit growth rate. We sold the last of our shares in October.

Imdex is an Australian company with a global business providing drilling fluids and leading downhole instrumentation to the mining, water well, and civil engineering industries. A summer earnings announcement showed stable profitability and offered a more favorable outlook boosted by the company shedding an unprofitable business segment. The combination helped to send shares soaring between June and year-end.

Turning to detractors, Banca Sistema is an Italian bank specializing in financing and managing trade receivables owed by the Italian Public Administrations. Despite its unique business model and attractive growth profile, it was initially caught up in the widespread downdraft for Italian banks, considered one of the more vulnerable areas of European finance in the aftermath of Brexit. However, the company continued to execute effectively and delivered strong earnings growth. We think that it is well positioned to take advantage of the large opportunity set in front of it.

We also held shares of Ardmore Shipping, which owns and operates shipping tankers, primarily for chemicals. With shipping index volumes bouncing along all-time lows during the first half of the year, its stock was not spared. However, the fact that it was trading at about half its book value or lower through most of the second half made it worth holding as we await a recovery for its industry. Zealand Pharma is a Danish biotechnology company whose share price decline was mostly driven by the sell-off in its industry. Seeing what we thought was better value elsewhere, we sold the last of our shares in May.

Companies headquartered in Canada and Australia had the largest positive impact on performance while those based in the U.K. and Italy detracted most. Relative to its benchmark, the Fund had significant stock selection advantages in Consumer Discretionary, especially in the media industry, and Information Technology. Conversely poor stock picks in oil, gas & consumable fuels hurt relative performance, as did our substantial underweight in the Materials sector.

Current Positioning and Outlook

We continue to find attractive opportunities in international microcap companies as valuations in many parts of the world remain compelling to us. With three times as many small- and micro-cap companies headquartered outside the U.S., we continue to see ample opportunity to uncover well-run, underfollowed micro-cap companies trading at attractive valuations.

Of our four largest sectors at yearend—three were overweighted versus the benchmark, Information Technology, Industrials, and Consumer Discretionary.

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

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

Important Performance and Disclosure Information