article 05-13-2014

The origin of the market's current shift goes back further than the March 4, 2014 small-cap high...

2014 appears poised to become the fifth consecutive year in which a number of equity investors have paused not to smell the blooming flowers of spring but instead to ponder the state of the global economy. Several have also been selling, no doubt concerned that the dynamic bull market that ran virtually correction-free through 2013 is about to, or already has, reached its peak.

The 2014 high for small-caps, as measured by the Russell 2000 Index, occurred on March 4, 2014. Since then, the market has stumbled while also turning to more economically sensitive areas of the market, which have begun to work after years of lagging their more defensive and/or fast-growing counterparts. And while the success of certain cyclical sectors such as Energy has been clear since the March 4, 2014 small-cap high, it's also true that the origin of the market's current shift goes back a bit further.

In fact, looking at 12-month returns from the May 2, 2013 low for the 10-year Treasury yield, which marked the beginning of a rising interest-rate environment, reveals some interesting results for certain Royce Funds.

12-Month Cumulative Returns from May 2, 2013 for Royce Featured Funds

Fund Fund Return Index1 Index Return
Pennsylvania Mutual 23.55 Russell 2000 21.68
Micro-Cap 19.15 Russell Microcap Index 26.30
Premier 27.07 Russell 2000 21.68
Low-Priced Stock 18.88 Russell 2000 21.68
Total Return 18.98 Russell 2000 21.68
Heritage 16.65 Russell 2000 21.68
Opportunity 28.94 Russell 2000 21.68
Special Equity 16.11 Russell 2000 21.68
Value 22.44 Russell 2000 21.68
Value Plus 21.28 Russell 2000 21.68
100 20.10 Russell 2000 21.68
Dividend Value 18.75 Russell 2000 21.68
Global Value 12.04 Russell Global Small Cap Index 15.20
International Smaller-Cos 11.09 Russell Global ex-U.S. Small Cap 11.78
Special Equity Multi-Cap 21.32 Russell 1000 20.82

1 Each index listed is the corresponding Fund's primary benchmark.

Royce Featured Funds Average Annual Total Returns as of Quarter-End 3/31/14 (%)

Average Annual Total Returns Annual Expenses
Fund QTR YTD 1 YR 5 YR 10 YR 15 YR Since
Incept.
Date Gross
Operating
Expenses
Net
Operating
Expenses
Pennsylvania Mutual 0.34 0.34 23.18 23.36 9.36 12.20 14.532 N/A 0.93 0.93
Micro-Cap -0.78 -0.78 17.49 19.98 7.86 12.62 12.48 12/31/1991 1.56 1.56
Premier 1.76 1.76 21.85 22.07 10.99 13.11 12.61 12/31/1991 1.09 1.09
Low-Priced Stock 2.06 2.06 13.67 17.62 6.44 11.92 11.61 12/15/1993 1.65 1.99
Total Return 0.55 0.55 20.65 21.61 8.70 10.89 11.60 12/15/1993 1.18 1.18
Heritage 0.49 0.49 15.94 22.44 9.48 13.23 13.83 12/27/1995 1.49 1.49
Opportunity 3.54 3.54 31.13 31.62 9.69 14.99 13.86 11/19/1996 1.17 1.17
Special Equity -0.76 -0.76 18.15 19.98 8.86 12.01 10.13 5/1/1998 1.13 1.13
Value 1.04 1.04 25.22 20.33 10.18 N/A 11.61 6/14/2001 1.48 1.48
Value Plus 3.43 3.43 25.28 20.79 8.60 N/A 12.90 6/14/2001 1.49 1.49
100 0.20 0.20 17.99 21.05 10.56 N/A 11.72 6/30/2003 1.51 1.51
Dividend Value 0.17 0.17 19.57 23.55 N/A N/A 10.16 5/3/2004 1.52 1.52
Global Value 4.31 4.31 10.02 18.44 N/A N/A 5.84 12/29/2006 1.84 1.70
International Smaller-Cos 2.25 2.25 11.71 18.83 N/A N/A 7.13 6/30/2008 2.08 1.70
Special Equity Multi-Cap 0.60 0.60 24.31 N/A N/A N/A 16.46 12/31/2010 1.46 1.24
Russell 2000 Index 1.12 1.12 24.90 24.31 8.53 8.91 N/A N/A N/A N/A
Russell 1000 Index 2.05 2.05 22.41 21.73 7.80 4.94 N/A N/A N/A N/A
Russell Microcap Index 3.01 3.01 33.24 25.86 6.63 N/A N/A N/A N/A N/A
Russell Global Small Cap Index 2.34 2.34 17.58 21.53 8.51 8.88 N/A N/A N/A N/A
Russell Global ex-U.S. Small Cap Index 3.21 3.21 13.55 20.20 8.92 9.12 N/A N/A N/A N/A
2 For Pennsylvania Mutual, the average annual total return shown is for the 40-year period ended as of the date shown above rather than since the Fund's inception.

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 180 days of purchase may be subject to a 1% redemption fee payable to the Fund (2% for Royce Global Value and International Smaller-Companies Funds). Redemption fees are not reflected in the performance shown above; if they were, performance would be lower. Current month-end performance may be higher or lower than performance quoted and may be obtained here. All performance and expense information reflects results of the Fund's oldest share Class (Investment Class or Service Class, as the case may be). Gross operating expenses reflect each Fund's gross total annual operating expenses, including management fees, any 12b-1 distribution and service fees, other expenses, and any applicable 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 operating expenses through April 30, 2015 to the extent necessary to maintain net annual operating expenses, other than acquired fund fees and expenses, to no more than 1.24% for the Service Class of Royce Special Equity Multi-Cap Fund, to no more than 1.49% for the Service Class of Royce Low-Priced Stock Fund, and to no more than 1.69% for the Service Class of Royce International Smaller-Companies Fund. Royce & Associates has contractually agreed to waive fees and/or reimburse operating expenses through April 30, 2024 to the extent necessary to maintain net annual operating expenses, other than acquired fund fees and expenses, to no more than 1.99% for the Service Class of Royce International Smaller-Companies Fund. Acquired fund fees and expenses reflect the estimated amount of the fees and expenses incurred indirectly by any applicable Fund through its investments in mutual funds, hedge funds, private equity funds, and other investment companies. Shares of a Fund's Service, Consultant, R, and K Classes bear an annual distribution expense that is not borne by the Fund's Investment Class.

This has been a welcome development for us—over the last five years we have been active in cyclical sectors, finding more companies with the balance sheet strength, free cash flow generation, and other signs of financial well-being that have traditionally populated our portfolios.

And in the current uncertain climate, a few things seem clear, at least to us. Namely that rising interest rates are here to stay, even if the increases come by fits and starts. This appears to be ushering in a more historically familiar environment for stocks, one that favors patient and disciplined stock selection—a hallmark here at Royce.

Important Disclosure Information

Francis Gannon is Co-Chief Investment Officer and a Managing Director of Royce & Associates, LLC, investment adviser for The Royce Funds. Mr. Gannon's thoughts and opinions in this piece are solely his own and may differ from those of other Royce investment professionals, or the firm as a whole. There can be no assurance with regard to future market movements.

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. Investments in securities of small-cap companies may involve considerably more risk than investments in securities of larger-cap companies. (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 Microcap Index includes 1,000 of the smallest securities in the small-cap Russell 2000 Index, along with the next smallest eligible securities as determined by Russell. The Russell 1000 index is an unmanaged, capitalization-weighted index of domestic large-cap stocks. It measures the performance of the 1,000 largest publicly traded U.S. companies in the Russell 3000 index. The Russell Global Small Cap Index is an unmanaged, capitalization-weighted index of global small-cap stocks. Index returns include net reinvested dividends and/or interest income. The Russell Global ex-U.S. Small Cap Index is an unmanaged, capitalization-weighted index of global small-cap stocks, excluding the United States. The performance of an index does not represent exactly any particular investment, as you cannot invest directly in an index.

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