Fund Performance

Royce Premier Fund gained 23.0% in 2016, outperforming its small-cap benchmark, the Russell 2000 Index, which was up 21.3% for the same period. The Fund benefited from three key reversals in 2016—positive returns for small-cap stocks, a leadership rotation back to value, as well as quality, and significantly improved results for many cyclical businesses.

Each contributed to strength for companies with positive earnings, better balance sheets, and higher profitability—the sort of companies that are our primary focus in the portfolio. In many ways, we saw 2016's performance as a validation of our determinedly active, small-cap quality approach following a dismal 2015.

Premier outpaced its benchmark during the more volatile first half of the calendar year, up 6.5% versus 2.2% for the Russell 2000. Much of its relative advantage in 2016 was the result of better performance when shares were tumbling, as they did most notably in January and the first half of February and again in October.

In the third quarter, Premier ceded a bit of ground, advancing 6.7% compared to 9.0% for the small-cap index. The Fund then slightly trailed in fourth quarter, up 8.2% versus 8.8% for the Russell 2000. We were also pleased that Premier was ahead of its benchmark for the one-, 10-, 15-, 20-, 25-year, and since inception (12/31/91) periods ended December 31, 2016. (Having just marked a quarter century of history, its 25-year and since inception results are the same.) The Fund's average annual total return since inception was 11.5%, a long-term record in which we take great pride.

What Worked... And What Didn't

Eight of the portfolio's nine equity sectors finished 2016 in the black. The Fund's two largest contributors, Industrials and Information Technology, led by significant margins. Consumer Discretionary and Financials also made noteworthy positive impacts. Health Care made a small contribution while Real Estate was the Fund's only sector with a loss in 2016.

At the industry level, machinery, our largest weighting in Industrials, led comfortably, followed by electronic equipment, instruments & components (Information Technology) and commercial services & supplies (Industrials). Detractions at the industry level were far less impactful and were led by professional services (Industrials), real estate management & development (Real Estate), and biotechnology (Health Care).

The Fund's top contributor at the position level was Cognex Corporation, the market leader in machine vision technology that captures and analyzes visual information to automate tasks that previously relied on human eyesight. This technology is a major driver of industrial and process automation. Sales to the auto industry accelerated, its consumer electronics segment proved better than expected, and it gained share among logistics services providers.

MKS Instruments provides components and subsystems that measure and analyze semiconductor performance. The company has been benefiting from a technology inflection point in both chip design and manufacture that requires more spending on capital equipment. Long-time Royce favorite Lincoln Electric Holdings is a global leader in welding equipment and supplies. The company looks poised to benefit from the expectation of accelerating U.S. economic growth in part driven by infrastructure spending. Having effectively managed expenses over the last few years in the face of relatively subpar global growth, the company may also see earnings grow at a faster pace than revenues.

Turning to detractors, The Advisory Board, a specialist in performance improvement software and solutions to the health care and higher education industries, saw spending decelerate in its healthcare business, which caused it to lower long-term growth goals. We significantly reduced our stake in 2016.

The franchise breast cancer genetic test for Myriad Genetics lost more share in the face of aggressive and competitive pricing during 2016. In addition, its remaining portfolio of genetic tests and international expansion have not ramped revenue fast enough to offset this, resulting in decelerating top line growth. Finally, the company also increased leverage with an acquisition of an earlier stage, unprofitable company. All of these influenced our decision to exit the stock.

Outperformance versus the benchmark in 2016 was driven by underweighting the lagging Health Care sector, an area that has looked highly valued to us for some time, as well as positive stock selection. Also aiding relative performance was savvy stock picking in Consumer Discretionary, where Thor Industries was the standout.

The Fund's underweighting in banks led it to trail in Financials, making that sector the portfolio's leading relative detractor. Poor stock selection in real estate management & development, where Jones Lang LaSalle notably detracted, caused the Real Estate sector to underperform.

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.

In addition, the fact that the market seems to be acting in a more historically familiar way should play a large role in keeping investors focused on high quality, conservatively capitalized companies that are making progress in improving their competitive positions and their profitability. We welcome the renewed attention on these fundamentals.

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

* 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 www.roycefunds.com. 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.

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

Important Performance and Disclosure Information