<PAGE>
THE ROYCE FUND
STATEMENT OF ADDITIONAL INFORMATION
THE ROYCE FUND (the "Trust"), a Massachusetts business trust, is a
professionally managed, open-end registered investment company, which offers
investors the opportunity to invest in eight portfolios or series ("Funds").
Each Fund has distinct investment objectives and/or policies, and a
shareholder's interest is limited to the Fund in which the shareholder owns
shares. The eight Funds are:
ROYCE VALUE FUND
ROYCE PREMIER FUND
ROYCE EQUITY INCOME FUND
ROYCE MICRO-CAP FUND (FORMERLY NAMED ROYCE OTC FUND)
ROYCE LOW-PRICED STOCK FUND
ROYCE TOTAL RETURN FUND
ROYCE GLOBAL SERVICES FUND
REVEST GROWTH AND INCOME FUND
This Statement of Additional Information relates to all of the Funds other than
REvest Growth and Income Fund, which is covered by its own separate Statement of
Additional Information.
The Trust is designed for long-term investors, including those who wish
to use shares of any Fund as a funding vehicle for certain tax-deferred
retirement plans (including Individual Retirement Account (IRA) plans), and not
for investors who intend to liquidate their investments after a short period of
time.
This Statement of Additional Information is not a prospectus, but
should be read in conjunction with the Trust's current Prospectuses dated May 2,
1995 for Royce Value Fund, Royce Premier Fund, Royce Equity Income Fund, Royce
Micro-Cap Fund, Royce Low-Priced Stock Fund and Royce Total Return Fund, and
dated December 15, 1994 for Royce Global Services Fund. Please retain this
document for future reference. The audited financial statements included in the
Annual Reports to Shareholders of such Funds for the fiscal year or period ended
December 31, 1994 are incorporated herein by reference. To obtain an additional
copy of the Prospectus or Annual Report for any of the Funds, please call
Investor Information at 1-800-221-4268.
INVESTMENT ADVISER TRANSFER AGENT
Quest Advisory Corp. ("Quest") State Street Bank and Trust Company
c/o National Financial Data Services
DISTRIBUTOR CUSTODIAN
Quest Distributors, Inc. ("QDI") State Street Bank and Trust Company
MAY 2, 1995
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
INVESTMENT POLICIES AND LIMITATIONS.......................................... 2
RISK FACTORS AND SPECIAL CONSIDERATIONS...................................... 4
MANAGEMENT OF THE TRUST...................................................... 8
PRINCIPAL HOLDERS OF SHARES................................................. 10
INVESTMENT ADVISORY SERVICES................................................. 12
DISTRIBUTOR.................................................................. 14
CUSTODIAN.................................................................... 16
INDEPENDENT ACCOUNTANTS...................................................... 17
PORTFOLIO TRANSACTIONS....................................................... 17
CODE OF ETHICS AND RELATED MATTERS........................................... 18
PRICING OF SHARES BEING OFFERED.............................................. 19
REDEMPTIONS IN KIND.......................................................... 19
TAXATION .................................................................... 19
DESCRIPTION OF THE TRUST..................................................... 23
PERFORMANCE DATA............................................................. 23
</TABLE>
<PAGE>
INVESTMENT POLICIES AND LIMITATIONS
The following investment policies and limitations supplement those set
forth in the Funds' Prospectuses. Unless otherwise noted, whenever an investment
policy or limitation states a maximum percentage of a Fund's assets that may be
invested in any security or other asset, or sets forth a policy regarding
quality standards, the percentage limitation or standard will be determined
immediately after giving effect to the Fund's acquisition of the security or
other asset. Accordingly, any subsequent change in values, net assets or other
circumstances will not be considered in determining whether the investment
complies with the Fund's investment policies and limitations.
A Fund's fundamental investment policies cannot be changed without the
approval of a "majority of the outstanding voting securities" (as defined in the
Investment Company Act of 1940 [the "1940 Act"]) of the Fund. Except for the
fundamental investment restrictions set forth below, the investment policies and
limitations described in this Statement of Additional Information are operating
policies and may be changed by the Board of Trustees without shareholder
approval. However, shareholders will be notified prior to a material change in
an operating policy affecting their Fund.
NO FUND MAY, AS A MATTER OF FUNDAMENTAL POLICY:
1. Issue any senior securities;
2. Purchase securities on margin or write call options on its
portfolio securities;
3. Sell securities short;
4. Borrow money, except that each of the Funds other than Royce
Value Fund may borrow money from banks as a temporary measure
for extraordinary or emergency purposes in an amount not
exceeding 5% of such Fund's total assets;
5. Underwrite the securities of other issuers;
6. Invest more than 10% of its total assets in the securities of
foreign issuers (except for Royce Global Services Fund, which is
not subject to any such limitation);
7. Invest in restricted securities (except for Royce Global
Services Fund, which may invest up to 15% of its net assets in
illiquid securities, including restricted securities) or in
repurchase agreements which mature in more than seven days;
8. Invest more than 10% (15% for Royce Global Services Fund) of its
assets in securities without readily available market quotations
(i.e., illiquid securities);
9. Invest, with respect to Royce Value and Royce Equity Income
Funds, more than 5% of such Fund's assets in the securities of
any one issuer (except U.S. Government securities) or, with
respect to 75% of the other Funds' total assets, more than 5% of
such Fund's assets in the securities of any one issuer (except
U.S. Government securities);
10. Invest more than 25% of its assets in any one industry;
11. Acquire more than 10% of the outstanding voting securities of
any one issuer;
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12. Purchase or sell real estate or real estate mortgage loans or
invest in the securities of real estate companies unless such
securities are publicly-traded;
13. Purchase or sell commodities or commodity contracts;
14. Make loans, except for purchases of portions of issues of
publicly-distributed bonds, debentures and other securities,
whether or not such purchases are made upon the original
issuance of such securities, and except that Royce Equity
Income, Low-Priced Stock, Total Return and Global Services Funds
may loan up to 25% of their respective assets to qualified
brokers, dealers or institutions for their use relating to short
sales or other securities transactions (provided that such loans
are fully collateralized at all times);
15. Invest in companies for the purpose of exercising control of
management;
16. Purchase portfolio securities from or sell such securities
directly to any of the Trust's Trustees, officers, employees or
investment adviser, as principal for their own accounts;
17. Invest in the securities of other investment companies (except
for Royce Global Services Fund, which may invest in the
securities of other investment companies to the extent permitted
by the 1940 Act); or
18. Purchase any warrants, rights or options, except that (i) all of
the Funds other than Royce Value Fund, may, if no value is
assigned thereto, acquire warrants in units with or attached to
debt securities or non-convertible preferred stock, and (ii)
Royce Low-Priced Stock, Total Return and Global Services Funds
may also invest up to 5% of their respective net assets in
warrants, valued at the lower of cost or market, provided that
warrants that are not listed on the New York or American Stock
Exchanges shall not exceed 2% of such Funds' respective net
assets.
NO FUND MAY, AS A MATTER OF OPERATING POLICY:
1. Invest more than 5% of its total assets in securities of
unseasoned issuers, including their predecessors, which have
been in operation for less than three years;
2. Invest in oil, gas or other mineral leases or development
programs;
3. Invest more than 5% of its net assets in lower-rated (high-risk)
non-convertible debt securities; or
4. Enter into repurchase agreements with any party other than the
custodian of its assets or having a term of more than seven
days.
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ROYCE GLOBAL SERVICES FUND
The Global Services Fund may invest in the securities of a company that is
engaged in securities related activities as a broker, a dealer, an underwriter,
an investment adviser registered under the Investment Advisers Act of 1940 or an
investment adviser to an investment company, subject to the following
limitations in the case of a company that, in its most recent fiscal year,
derived more than 15% of its gross revenues from such activities:
(a) The purchase cannot cause more than 5% of the Global Services Fund's
assets to be invested in the securities of the company;
(b) For an equity security, the purchase cannot result in the Global
Services Fund owning more than 5% of the company's outstanding securities
of that class; and
(c) For a debt security, the purchase cannot result in the Global Services
Fund owning more than 10% of the principal amount of the company's
outstanding debt securities.
In applying the gross revenues test, a company's gross revenues from its
own securities related activities and from its ratable share of the securities
related activities of enterprises of which it owns 20% or more of the voting or
equity interest are considered in determining the degree to which the company is
engaged in securities related activities. The limitations apply only at the time
of the Global Services Fund's purchase of the securities of such a company. When
the Global Services Fund is considering purchasing or has purchased warrants or
convertible securities of a securities related business, the required
determination is made as though such warrants or conversion privileges had been
exercised.
The Global Services Fund is not permitted to acquire a general partnership
interest or a security issued by its investment adviser or principal underwriter
or any affiliated person of its investment adviser or principal underwriter.
The Global Services Fund may, under the 1940 Act, invest up to 10% of its
assets in the securities of other investment companies, provided that not more
than 5% of its assets are invested in the securities of any one such company and
that the Global Services Fund does not invest in more than 3% of the total
outstanding voting stock of any one such company. It does not currently intend
to purchase securities of other investment companies, except in the open market
where no commission other than the ordinary broker's commission is paid, or to
purchase or hold securities issued by other open-end investment companies. These
limitations do not apply to securities received as dividends, through offers of
exchange or as a result of a reorganization, consolidation or merger.
RISK FACTORS AND SPECIAL CONSIDERATIONS
FUNDS' RIGHTS AS STOCKHOLDERS
As noted above, no Fund may invest in a company for the purpose of
exercising control of management. However, a Fund may exercise its rights as a
stockholder and communicate its views on important matters of policy to
management, the board of directors and/or stockholders if Quest or the Board of
Trustees determine that such matters could have a significant effect on the
value of the Fund's investment in the company. The activities that a Fund may
engage in, either individually or in conjunction with others, may include, among
others, supporting or opposing proposed changes in a company's corporate
structure or business activities; seeking changes in a company's board of
directors or
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management; seeking changes in a company's direction or policies; seeking the
sale or reorganization of a company or a portion of its assets; or supporting or
opposing third party takeover attempts. This area of corporate activity is
increasingly prone to litigation, and it is possible that a Fund could be
involved in lawsuits related to such activities. Quest will monitor such
activities with a view to mitigating, to the extent possible, the risk of
litigation against the Funds and the risk of actual liability if a Fund is
involved in litigation. However, no guarantee can be made that litigation
against a Fund will not be undertaken or liabilities incurred.
A Fund may, at its expense or in conjunction with others, pursue litigation
or otherwise exercise its rights as a security holder to seek to protect the
interests of security holders if Quest and the Trust's Board of Trustees
determine this to be in the best interests of a Fund's shareholders.
SECURITIES LENDING
Royce Equity Income, Low-Priced Stock, Total Return and Global Services
Funds may lend up to 25% of their respective assets to brokers, dealers and
other financial institutions. Securities lending allows the Fund to retain
ownership of the securities loaned and, at the same time, to earn additional
income. Since there may be delays in the recovery of loaned securities or even a
loss of rights in collateral supplied should the borrower fail financially,
loans will be made only to parties that participate in a Global Securities
Lending Program monitored by the Funds' custodian and who are deemed by it to be
of good standing. Furthermore, such loans will be made only if, in Quest's
judgment, the consideration to be earned from such loans would justify the risk.
Quest understands that it is the current view of the staff of the
Securities and Exchange Commission that a Fund may engage in such loan
transactions only under the following conditions: (1) the Fund must receive 100%
collateral in the form of cash or cash equivalents (e.g., U.S. Treasury bills or
notes) from the borrower; (2) the borrower must increase the collateral whenever
the market value of the securities loaned (determined on a daily basis) rises
above the value of the collateral; (3) after giving notice, the Fund must be
able to terminate the loan at any time; (4) the Fund must receive reasonable
interest on the loan or a flat fee from the borrower, as well as amounts
equivalent to any dividends, interest or other distributions on the securities
loaned and to any increase in market value; (5) the Fund may pay only reasonable
custodian fees in connection with the loan; and (6) the Fund must be able to
vote proxies on the securities loaned, either by terminating the loan or by
entering into an alternative arrangement with the borrower.
LOWER-RATED (HIGH-RISK) DEBT SECURITIES
Each Fund may invest up to 5% of its net assets in lower-rated (high-risk)
non-convertible debt securities. They may be rated from Ba to Ca by Moody's
Investors Service, Inc. or from BB to D by Standard & Poor's Corporation or may
be unrated. These securities have poor protection with respect to the payment of
interest and repayment of principal and may be in default as to the payment of
principal or interest. These securities are often considered to be speculative
and involve greater risk of loss or price changes due to changes in the issuer's
capacity to pay. The market prices of lower-rated (high-risk) debt securities
may fluctuate more than those of higher-rated debt securities and may decline
significantly in periods of general economic difficulty, which may follow
periods of rising interest rates.
While the market for lower-rated (high-risk) corporate debt securities has
been in existence for many years and has weathered previous economic downturns,
the 1980s brought a dramatic increase in the use of such securities to fund
highly leveraged corporate acquisitions and restructurings. Past
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experience may not provide an accurate indication of the future performance of
the high-yield/high-risk bond market, especially during periods of economic
recession. In fact, from 1989 to 1991, the percentage of lower-rated (high-risk)
debt securities that defaulted rose significantly above prior levels.
The market for lower-rated (high-risk) debt securities may be thinner and
less active than that for higher-rated debt securities, which can adversely
affect the prices at which the former are sold. If market quotations cease to be
readily available for a lower-rated (high-risk) debt security in which a Fund
has invested, the security will then be valued in accordance with procedures
established by the Board of Trustees. Judgment plays a greater role in valuing
lower-rated (high-risk) debt securities than is the case for securities for
which more external sources for quotations and last sale information are
available. Adverse publicity and changing investor perceptions may affect a
Fund's ability to dispose of lower-rated (high-risk) debt securities.
Since the risk of default is higher for lower-rated (high-risk) debt
securities, Quest's research and credit analysis may play an important part in
managing securities of this type for the Funds. In considering such investments
for the Funds, Quest will attempt to identify those issuers of lower-rated
(high-risk) debt securities whose financial condition is adequate to meet future
obligations, has improved or is expected to improve in the future. Quest's
analysis may focus on relative values based on such factors as interest or
dividend coverage, asset coverage, earnings prospects and the experience and
managerial strength of the issuer.
FOREIGN INVESTMENTS
Except for Royce Global Services Fund, which is not subject to any such
limitation, each Fund may invest up to 10% of its total assets in the securities
of foreign issuers. Foreign investments can involve significant risks in
addition to the risks inherent in U.S. investments. The value of securities
denominated in or indexed to foreign currencies and of dividends and interest
from such securities can change significantly when foreign currencies strengthen
or weaken relative to the U.S. dollar. Foreign securities markets generally have
less trading volume and less liquidity than U.S. markets, and prices on some
foreign markets can be highly volatile. Many foreign countries lack uniform
accounting and disclosure standards comparable to those applicable to U.S.
companies, and it may be more difficult to obtain reliable information regarding
an issuer's financial condition and operations. In addition, the costs of
foreign investing, including withholding taxes, brokerage commissions and
custodial costs, are generally higher than for U.S. investments.
Foreign markets may offer less protection to investors than U.S. markets.
Foreign issuers, brokers and securities markets may be subject to less
government supervision. Foreign security trading practices, including those
involving the release of assets in advance of payment, may involve increased
risks in the event of a failed trade or the insolvency of a broker-dealer, and
may involve substantial delays. It may also be difficult to enforce legal rights
in foreign countries.
Investing abroad also involves different political and economic risks.
Foreign investments may be affected by actions of foreign governments adverse to
the interests of U.S. investors, including the possibility of expropriation or
nationalization of assets, confiscatory taxation, restrictions on U.S.
investment or on the ability to repatriate assets or convert currency into U.S.
dollars, or other government intervention. There may be a greater possibility of
default by foreign governments or foreign government-sponsored enterprises.
Investments in foreign countries also involve a risk of local political,
economic or social instability, military action or unrest or adverse diplomatic
developments. There is no assurance that Quest will be able to anticipate these
potential events or counter their effects.
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The considerations noted above are generally intensified for investments in
developing countries. Developing countries may have relatively unstable
governments, economies based on only a few industries and securities markets
that trade a small number of securities.
American Depositary Receipt (ADR) facilities may be established as either
unsponsored or sponsored. While ADRs issued under these two types of facilities
are in some respects similar, there are distinctions between them relating to
the rights and obligations of ADR holders and the practices of market
participants. A depository may establish an unsponsored facility without
participation by (or even necessarily the acquiescence of) the issuer of the
deposited securities, although typically the depository requests a letter of
non-objection from such issuer prior to the establishment of the facility.
Holders of unsponsored ADRs generally bear all the costs of such facilities. The
depository usually charges fees upon the deposit and withdrawal of the deposited
securities, the conversion of dividends into U.S. dollars, the disposition of
non-cash distributions and the performance of other services. The depository of
an unsponsored facility frequently is under no obligation to distribute
shareholder communications received from the issuer of the deposited securities
or to pass through voting rights to ADR holders in respect of the deposited
securities. Sponsored ADR facilities are created in generally the same manner as
unsponsored facilities, except that the issuer of the deposited securities
enters into a deposit agreement with the depository. The deposit agreement sets
out the rights and responsibilities of the issuer, the depository and the ADR
holders. With sponsored facilities, the issuer of the deposited securities
generally will bear some of the costs relating to the facility (such as deposit
and withdrawal fees). Under the terms of most sponsored arrangements,
depositories agree to distribute notices of shareholder meetings and voting
instructions and to provide shareholder communications and other information to
the ADR holders at the request of the issuer of the deposited securities.
REPURCHASE AGREEMENTS
In a repurchase agreement, a Fund in effect makes a loan by purchasing a
security and simultaneously committing to resell that security to the seller at
an agreed upon price on an agreed upon date within a number of days (usually not
more than seven) from the date of purchase. The resale price reflects the
purchase price plus an agreed upon incremental amount which is unrelated to the
coupon rate or maturity of the purchased security. A repurchase agreement
involves the obligation of the seller to pay the agreed upon price, which
obligation is in effect secured by the value (at least equal to the amount of
the agreed upon resale price and marked to market daily) of the underlying
security.
The Funds may engage in repurchase agreements with respect to any U.S.
Government security. While it does not presently appear possible to eliminate
all risks from these transactions (particularly the possibility of a decline in
the market value of the underlying securities, as well as delays and costs to
the Fund in connection with bankruptcy proceedings), it is the policy of the
Trust to enter into repurchase agreements only with its custodian, State Street
Bank and Trust Company, and having a term of seven days or less.
* * *
Quest believes that Royce Value, Micro-Cap, Low-Priced Stock and Global
Services Funds are suitable for investment only by persons who can invest
without concern for current income, and that such Funds and Royce Premier Fund
are suitable only for those who are in a financial position to assume
above-average investment risks in search for long-term capital appreciation.
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MANAGEMENT OF THE TRUST
The following table sets forth certain information as to each Trustee and
officer of the Trust:
<TABLE>
<CAPTION>
Position Held
Name, Address and Age with the Trust Principal Occupations During Past 5 Years
- --------------------- -------------- -----------------------------------------
<S> <C> <C>
Charles M. Royce* (55) Trustee, President, Secretary, Treasurer and sole director and
1414 Avenue of the President and sole voting shareholder of Quest Advisory Corp.
Americas Treasurer ("Quest"), the Trust's principal investment adviser;
New York, NY 10019 Trustee, President and Treasurer of Pennsylvania
Mutual Fund ("PMF"), an open-end diversified
management investment company of which Quest is the
investment adviser; Director, President and Treasurer
of Royce Value Trust, Inc. ("RVT") and, since
September 1993, Royce OTC Micro-Cap Fund, Inc.
("OTCM"), closed-end diversified management investment
companies of which Quest is the investment adviser;
Secretary and sole director and shareholder of Quest
Distributors, Inc. ("QDI"), the distributor of the
Trust's shares; and managing general partner of Quest
Management Company ("QMC"), a registered investment
adviser, and its predecessor.
Richard M. Galkin (56) Trustee Private investor and President of Richard M. Galkin
5284 Boca Marina Circle Associates, Inc., tele-communications consultants.
South
Boca Raton, FL 33487
Stephen L. Isaacs (55) Trustee Attorney; Director of Columbia University Development
60 Haven Street, Fl. B-2 Law and Policy Program; Professor at Columbia
New York, NY 10032 University; President of Stephen L. Isaacs Associates,
Consultants; and counsel to Kaplan & Kilsheimer from
January 1988 to February 1991.
David L. Meister (55) Trustee Consultant to the communications industry since
111 Marquez Place January 1993; Executive officer of Digital Planet
Pacific Palisades, CA Inc. from April 1991 to December 1992; consultant to
90272 the communications and television industry from
August 1990 to April 1991; and Executive Vice
President of Infotechnology, Inc. from December 1986
to July 1990.
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Position Held
Name, Address and Age with the Trust Principal Occupations During Past 5 Years
- --------------------- -------------- -----------------------------------------
Jack E. Fockler, Jr.* (36) Vice President Vice President (since August 1993) and senior
1414 Avenue of the associate of Quest, having been employed by Quest
Americas since October 1989; Vice President of the Trust,
New York, NY 10019 PMF, RVT and OTCM since April 1995; and general
partner of QMC since July 1993.
W. Whitney George* (36) Vice President Vice President (since August 1993) and senior analyst
1414 Avenue of the of Quest, having been employed by Quest since October
Americas 1991; Vice President of the Trust, PMF, RVT and OTCM
New York, NY 10019 since April 1995; and general partner of QMC and its
predecessor since January 1992.
Daniel A. O'Byrne* (33) Vice President Vice President of Quest since May 1994, having been
1414 Avenue of the and Assistant employed by Quest since October 1986; and Vice
Americas Secretary President of the Trust, PMF, RVT and OTCM since July
New York, NY 10019 1994.
Susan I. Grant* (42) Secretary Senior Counsel and Chief Compliance Officer of Quest
1414 Avenue of the and Secretary of the Trust, PMF, RVT and OTCM since
Americas August 1994; and Assistant Counsel of First Investors
New York, NY 10019 Corporation from July 1989 to August 1994.
</TABLE>
- --------------------------------
*An "interested person" under Section 2(a)(19) of the 1940 Act.
All of the Trust's trustees are also trustees of PMF and directors of RVT
and OTCM.
The Board of Trustees has an Audit Committee, comprised of Richard M.
Galkin, Stephen L. Isaacs and David L. Meister. The Audit Committee is
responsible for the selection and nomination of independent auditors for the
Funds and for conducting post-audit reviews of their financial conditions with
such auditors.
For the year ended December 31, 1994, the following trustees received
compensation from the Trust and the three other funds in the group of registered
investment companies comprising The Royce Funds for services as a
trustee/director on such funds' Boards:
<TABLE>
<CAPTION>
Aggregate Compensation Total Compensation
Name from Trust from The Royce Funds
- ----------------- ------------------------ --------------------
<S> <C> <C>
Richard M. Galkin $17,500 $60,000
Stephen L. Isaacs 17,500 60,000
David L. Meister 17,500 60,000
</TABLE>
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PRINCIPAL HOLDERS OF SHARES
As of March 31, 1995, the following persons were known to the Trust to be
the record or beneficial owners of 5% or more of the outstanding shares of
certain of its Funds:
<TABLE>
<CAPTION>
Type of
Fund Number of Shares Ownership Percentage of Outstanding Shares
- ---- ---------------- --------- --------------------------------
<S> <C> <C> <C>
Royce Premier Fund
- ------------------
Charles Schwab & Co. Inc. 12,938,381 Record 37.0%
Attn: Mutual Fund Dept.
101 Montgomery Street
San Francisco, CA 94104
Royce Equity Income Fund
- ------------------------
Charles Schwab & Co. Inc. 6,437,037 Record 50.2%
Attn: Mutual Fund Dept.
101 Montgomery Street
San Francisco, CA 94104
Royce Micro-Cap Fund
- --------------------
Charles Schwab & Co. Inc. 683,748 Record 14.1%
Attn: Mutual Fund Dept.
101 Montgomery Street
San Francisco, CA 94104
Royce Low-Priced Stock Fund
- ---------------------------
Bruce Museum Inc. 20,426 Record 5.5%
Special Program Fund and
Museum Drive beneficial
Greenwich, CT 06830
Charles Schwab & Co. Inc. 71,720 Record 19.3%
Attn: Mutual Fund Dept.
101 Montgomery Street
San Francisco, CA 94104
Charles M. Royce 203,551 Record 54.8%
1414 Avenue of the Americas and
New York, NY 10019 beneficial
W. Whitney George, Trustee 63,640 Record 17.1%
Royce 1992 Generation
Skipping Trust
1414 Avenue of the Americas
New York, NY 10019
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<PAGE>
Type of
Fund Number of Shares Ownership Percentage of Outstanding Shares
- ---- ---------------- --------- --------------------------------
Royce Total Return Fund
- -----------------------
Delaware Charter Guarantee 24,827 Record 6.7%
Trust Co.
FBO Alice M. Harvey
P.O. Box 8963
Wilmington, DE 19899
Integra Trust Company 98,474 Record 26.6%
National Assn.
Trust Securities Sect. 2-032
300 Fourth Avenue
Pittsburgh, PA 15278
James M. Novak 74,340 Record 20.1%
Mark Stadler Trustees
Cindrich & Titus Profit
Sharing Plan
FBO Thomas O. Arbogast
2000 Gateway Center
Pittsburgh, PA 15222
Charles M. Royce, Trustee 47,331 Record 12.8%
N. Holmes Clare Trust
FBO Barbara K. Clare
c/o Quest Advisory Corp.
1414 Avenue of the Americas
New York, NY 10019
State Street Bank & Trust Co. 71,653 Record 19.4%
Custodian for IRA of
Becky L. O'Connor
10 St. James Place
Pittsburgh, PA 15215
Royce Global Services Fund
- --------------------------
Bruce Museum Inc. 19,493 Record 8.5%
Special Program Fund and
Museum Drive beneficial
Greenwich, CT 06830
Integra Trust Company 27,780 Record 12.0%
National Assn.
Trust Securities Sect. 2-032
300 Fourth Avenue
Pittsburgh, PA 15278
Charles M. Royce 170,540 Record 73.9%
1414 Avenue of the Americas and
New York, NY 10019 beneficial
</TABLE>
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As of March 31, 1995, all of the trustees and officers of the Trust as a
group beneficially owned less than 1% of the outstanding shares of each of Royce
Equity Income Fund, Royce Premier Fund and Royce Value Fund, 2.6% of the
outstanding shares of Royce Micro-Cap Fund, 14.8% of the outstanding shares of
Royce Total Return Fund, 54.8% of the outstanding shares of Royce Low-Priced
Stock Fund and 73.9% of the shares of Royce Global Services Fund.
INVESTMENT ADVISORY SERVICES
SERVICES PROVIDED BY QUEST
As compensation for its services under the Investment Advisory Agreements
with the Funds, Quest is entitled to receive the following fees:
<TABLE>
<CAPTION>
Fund Percentage Per Annum of Fund's Average Net Assets
- ---- -------------------------------------------------
<S> <C>
Royce Value Fund 1.00% of first $50,000,000,
.875% of next $50,000,000 and
.75% of any additional average net assets
Royce Premier Fund 1.00%
Royce Equity Income Fund 1.00%
Royce Micro-Cap Fund 1.50%
Royce Low-Priced Stock Fund 1.50%
Royce Total Return Fund 1.00%
Royce Global Services Fund 1.50%
</TABLE>
Such fees, which are payable monthly from the assets of the Fund involved, are
higher (substantially higher, in the case of Royce Micro-Cap, Low-Priced Stock
and Global Services Funds) than those paid by most other mutual funds with
similar investment objectives.
Under the Investment Advisory Agreements, Quest (i) determines the
composition of each Fund's portfolio, the nature and timing of the changes in it
and the manner of implementing such changes, subject to any directions it may
receive from the Trust's Board of Trustees; (ii) provides each Fund with
investment advisory, research and related services for the investment of its
funds; (iii) furnishes, without expense to the Trust, the services of such
members of its organization as may be duly elected executive officers or
Trustees of the Trust; and (iv) pays all executive officers' salaries and
executive expenses and all expenses incurred in performing its investment
advisory duties under the Investment Advisory Agreements.
The Trust pays all administrative and other costs and expenses attributable
to its operations and transactions, including, without limitation, transfer
agent and custodian fees; legal, administrative and clerical services; rent for
its office space and facilities; auditing; preparation, printing and
distribution of its prospectuses, proxy statements, shareholders reports and
notices; supplies and postage; Federal and state registration fees; Federal,
state and local taxes; non-affiliated trustees' fees; and brokerage commissions.
For each of the three fiscal years ended December 31, 1992, 1993 and 1994,
as applicable, Quest received advisory fees from the Funds (net of any amounts
waived by Quest) and waived advisory fees payable to it, as follows:
12
<PAGE>
<TABLE>
<CAPTION>
Advisory Fees Amounts
Received by Quest Waived by Quest
----------------- ---------------
<S> <C> <C>
Royce Value Fund
1992 $1,460,910 -
1993 1,568,398 -
1994 1,503,696 -
Royce Equity Income Fund
1992 $ 322,488 $137,825
1993 488,816 229,166
1994 820,662 53,626
Royce Premier Fund
1992 $ 2,496 $ 12,279
1993 124,020 8,461
1994 1,400,394 -
Royce Micro-Cap Fund
1992 $ 3,473 $ 15,138
1993 83,095 19,063
1994 295,148 20,330
Royce Low-Priced Stock Fund
1993* $ 0 $ 294
1994 0 15,272
Royce Total Return Fund
1993* $ 0 $ 294
1994 0 10,506
Royce Global Services Fund
1994** $ 0 $ 367
</TABLE>
- -------
* December 15, 1993 (commencement of operations) to December 31, 1993
**December 15, 1994 (commencement of operations) to December 31, 1994
PORTFOLIO MANAGEMENT
The Funds' portfolios and the portfolios of Quest's other accounts are
managed by Quest's senior investment staff, including Charles M. Royce, Quest's
Chief Investment Officer, who is primarily responsible for supervising its
investment management activities. Mr. Royce is assisted by Thomas R. Ebright,
Jack E. Fockler, Jr. and W. Whitney George, Vice Presidents of Quest, all of
whom participate in such activities, with their specific responsibilities
varying from time to time. In the event of any significant change in Quest's
senior investment staff, the members of the Trust's Board of Trustees who are
not interested persons of the Trust will consider what action, if any, should be
taken in connection with the Funds' management arrangements.
Certain information concerning Messrs. Royce, Ebright, Fockler and George
is set forth above under "MANAGEMENT OF THE TRUST". Set forth below is certain
information concerning Mr. Ebright.
13
<PAGE>
<TABLE>
<CAPTION>
Name Principal Occupations and Other Affiliations During Last 5 Years
- ---- ----------------------------------------------------------------
<S> <C>
Thomas R. Ebright Vice President and member of the senior investment staff of Quest;
Trustee/Director of PMF, RVT and, since September 1993, OTCM;
President and Treasurer of QDI; general partner of QMC and its
predecessor until June 1994; President, Treasurer and a director
and principal shareholder of Royce, Ebright & Associates, Inc.,
the investment adviser for REvest Growth and Income Fund, since
June 1994; director of Atlantic Pro Sports, Inc. and of the
Strasburg Rail Road Co. since March 1993; and President and
principal owner of Baltimore Professional Hockey, Inc. until May
1993.
</TABLE>
LIMITATION ON FUND EXPENSES
Quest has agreed, in connection with the Trust's qualification of shares of
each Fund for sale in California, to reduce its investment advisory fee for each
Fund monthly to the extent that such Fund's "aggregate annual expenses" (as
defined) exceed 2 1/2% of the first $30 million, 2% of the next $70 million and
1 1/2% of any remaining average net assets of such Fund for any fiscal year. All
or a portion of the distribution fee payable to QDI may be excludable from such
"aggregate annual expenses".
DISTRIBUTOR
QDI, the distributor of the shares of each Fund, has its principal office
at 1414 Avenue of the Americas, New York, New York 10019. It was organized in
November 1982 and is a member of the National Association of Securities Dealers,
Inc. ("NASD").
As compensation for its services and for the expenses payable by it under
the Distribution Agreement with the Trust, QDI is entitled to receive, for and
from the assets of the Fund involved, a monthly fee equal to 1% per annum
(consisting of an asset-based sales charge of .75% and a personal service and/or
account maintenance fee of .25%) of Royce Value Fund's average net assets and
.25% per annum (consisting of an asset-based sales charge) of Royce Low-Priced
Stock, Total Return and Global Services Funds' respective average net assets.
Except to the extent that they may be waived by QDI, these fees are not subject
to any required reductions and, in the case of Royce Value Fund, are higher than
the fees paid by most other mutual funds which use their own assets to promote
the sale of their shares. QDI is also entitled to receive the proceeds of any
front-end sales loads that may be imposed on purchases of shares of Royce Value
Fund and of any contingent deferred sales charges that may be imposed on
redemptions of such Fund's shares. The Distribution Agreement has been
terminated as to Royce Equity Income, Premier and Micro-Cap Funds.
Under the Distribution Agreement, QDI (i) seeks to promote the sale and/or
continued holding of shares of such Funds through a variety of activities,
including advertising, direct marketing and servicing investors and introducing
parties on an on-going basis; (ii) pays sales commissions and other fees to
those broker-dealers, investment advisers and others (excluding banks) who have
introduced investors to such Funds (which commissions and other fees may or may
not be the same amount as or otherwise comparable to the distribution fees
payable to QDI); (iii) pays the cost of preparing, printing and distributing any
advertising or sales literature and the cost of printing and mailing the Funds'
prospectuses to persons other than shareholders of the Funds; and (iv) pays all
other expenses incurred by it in promoting the sale and/or continued holding of
the shares of such Funds and in rendering such services under the Distribution
Agreement. The Trust bears the expense of registering its shares with the
Securities
14
<PAGE>
and Exchange Commission and the cost of qualifying and maintaining the
qualification of its shares for sale under the securities laws of the various
states.
The Trust entered into the Distribution Agreement with QDI pursuant to a
Distribution Plan which, among other things, permits each Fund that remains
covered by the Plan to pay the monthly distribution fee out of its net assets.
As required by Rule 12b-1 under the 1940 Act, the Plan has been approved by the
shareholders of each Fund that remains covered by the Plan and by the Trust's
Board of Trustees (which also approved the Distribution Agreement pursuant to
which the distribution fees are paid), including a majority of the Trustees who
are not interested persons of the Trust and who have no direct or indirect
financial interest in the operation of the Plan or the Distribution Agreement.
In approving the Plan, the Trustees, in accordance with the requirements of
Rule 12b-1, considered various factors (including the amount of the distribution
fees) and determined that there is a reasonable likelihood that the Plan will
benefit each Fund and its shareholders.
The Plan may be terminated as to any Fund by vote of a majority of the
non-interested Trustees who have no direct or indirect financial interest in the
Plan or in the Distribution Agreement or by vote of a majority of the
outstanding voting securities of such Fund. Any change in the Plan that would
materially increase the distribution cost to a Fund requires approval by the
shareholders of such Fund; otherwise, the Plan may be amended by the Trustees,
including a majority of the non-interested Trustees, as described above.
The Distribution Agreement may be terminated as to any Fund at any time on
60 days' written notice and without payment of any penalty, by QDI, by the vote
of a majority of the outstanding voting securities of such Fund or by the vote
of a majority of the Trustees who are not interested persons of the Trust and
who have no direct or indirect financial interest in the operation of the Plan
or in any agreements related thereto.
The Distribution Agreement and the Plan, if not sooner terminated in
accordance with their terms, will continue in effect for successive one-year
periods, provided that each such continuance is specifically approved (i) by the
vote of a majority of the Trustees who are not parties to the Agreement or
interested persons of any such party and who have no direct or indirect
financial interest in the Plan or the Agreement and (ii) either (a) by the vote
of a majority of the outstanding voting securities of the Fund involved or (b)
by the vote of a majority of the entire Board of Trustees.
While the Plan is in effect, the selection and nomination of those Trustees
who are not interested persons of the Trust will be committed to the discretion
of the Trustees who are not interested persons.
The Board of Trustees has adopted resolutions pursuant to which the
proceeds of all contingent deferred sales charges for redeemed shares of Royce
Value Fund received from January 1, 1990 through April 7, 1994 (when the
contingent deferred sales charge was terminated) will be held in separate
reserve accounts for the year involved, to be spent by QDI only upon the
approval of the Board of Trustees for the specific purposes set forth in the
Plan. If the proceeds received in a particular year have not been spent within
the four year period following the close of the year in which they were
received, the proceeds are to be paid by QDI to Royce Value Fund, the
shareholders of which bore such contingent deferred sales charges. See Note 2 of
Notes to Financial Statements of Royce Value Fund contained in such Fund's
Annual Report to Shareholders for the year ended December 31, 1994.
For the year ended December 31, 1994, Royce Value Fund paid distribution
fees to QDI of $1,109,175 (net of $650,642 waived by QDI -- 1% of its average
net assets during such year before
15
<PAGE>
giving effect to such waiver and 0.63% of its average net assets after giving
effect to such waiver). QDI spent the distribution fees paid to it by, and the
proceeds of contingent deferred sales charges released to it for, Royce Value
Fund during 1994 in the following manner:
<TABLE>
<S> <C> <C>
(i) Promotion, Literature & Advertising $ 54,808
(ii) Printing and mailing of prospectuses
to other than current shareholders 5,477
(iii) Compensation paid or to be paid to introducing
brokers, investment advisers and others 1,201,833
(iv) Registration fees, accounting and legal 10,690
(v) Administration and other 11,789
-----------
Total $ 1,284,597
===========
</TABLE>
As of January 1, 1994, $336,642 was held by QDI in such separate reserve
accounts for Royce Value Fund. For the year ended December 31, 1994, $12,992 of
proceeds of contingent deferred sales charges on account of redemptions of
shares of Royce Value Fund during such year were added to such reserve accounts,
and $162,902 was released to QDI from such reserve accounts for Royce Value
Fund. Thus, as of January 1, 1995, $186,732 was held by QDI in such reserve
accounts for Royce Value Fund, and no proceeds of contingent deferred sales
charges on account of redemptions of shares of Royce Value Fund during the year
ended December 31, 1990 remained in the reserve account for such proceeds
because all of the monies in such reserve account had been previously released
by the Board of Trustees to QDI.
QDI has temporarily waived the distribution fees payable to it by Royce
Low-Priced Stock, Total Return and Global Services Funds.
No trustee of the Trust who was not an interested person of the Trust had
any direct or indirect financial interest in the operation of the Plan or the
Distribution Agreement. Charles M. Royce, an interested person of the Trust,
Quest and QDI, had such an interest.
The benefits to Royce Value Fund included the receipt of net proceeds of
$7,367,068 from sales of its shares during the fiscal year ended December 31,
1994. The cost of shares redeemed by such Fund during such year aggregated
$7,591,915.
Under the Rules of Fair Practice of the NASD, the front-end sales loads,
asset-based sales charges and contingent deferred sales charges payable by any
Fund and/or the shareholders thereof to QDI are limited to (i) 6.25% of total
new gross sales occurring after July 7, 1993 plus interest charges on such
amount at the prime rate plus 1% per annum increased by (ii) 6.25% of total new
gross sales occurring after such Fund first adopted the Plan until July 7, 1993,
plus interest charges on such amount at the prime rate plus 1% per annum less
any front-end, asset-based or deferred sales charges on such sales or net assets
resulting from such sales.
CUSTODIAN
State Street Bank and Trust Company ("State Street") is the custodian for
the securities, cash and other assets of each Fund and the transfer agent and
dividend disbursing agent for the shares of each Fund, but it does not
participate in any Fund's investment decisions. The Trust has authorized State
Street to deposit certain domestic and foreign portfolio securities in several
central depository systems and to use foreign sub-custodians for certain foreign
portfolio securities, as allowed by Federal law. State Street's main office is
at 225 Franklin Street, Boston, Massachusetts 02107. All mutual fund transfer,
dividend
16
<PAGE>
disbursing and shareholder service activities are performed by State Street's
agent, National Financial Data Services, at 1004 Baltimore, Kansas City,
Missouri 64105.
State Street is responsible for the calculation of each Fund's daily net
asset value per share and for the maintenance of its portfolio and general
accounting records and also provides certain shareholder services.
INDEPENDENT ACCOUNTANTS
Coopers & Lybrand L.L.P., whose address is One Post Office Square, Boston,
Massachusetts 02109, are the independent accountants of the Trust.
PORTFOLIO TRANSACTIONS
Quest is responsible for selecting the brokers who effect the purchases and
sales of each Fund's portfolio securities. No broker is selected to effect a
securities transaction for a Fund unless such broker is believed by Quest to be
capable of obtaining the best price and execution for the security involved in
the transaction. In addition to considering a broker's execution capability,
Quest generally considers the brokerage and research services which the broker
has provided to it, including any research relating to the security involved in
the transaction and/or to other securities. Such services may include general
economic research, market and statistical information, industry and technical
research, strategy and company research, and may be written or oral. Quest
determines the overall reasonableness of brokerage commissions paid, after
considering the amount another broker might have charged for effecting the
transaction and the value placed by Quest upon the brokerage and/or research
services provided by such broker, viewed in terms of either that particular
transaction or Quest's overall responsibilities with respect to its accounts.
Quest is authorized, under Section 28(e) of the Securities Exchange Act of
1934 and under its Investment Advisory Agreements with the Trust, to pay a
brokerage commission in excess of that which another broker might have charged
for effecting the same transaction, in recognition of the value of brokerage and
research services provided by the broker.
Brokerage and research services furnished by brokers through whom a Fund
effects securities transactions may be used by Quest in servicing all of its
accounts and those of QMC, and not all of such services may be used by Quest in
connection with the Trust or any one of its Funds.
Quest may also place a Fund's brokerage business with firms which promote
the sale of the Fund's shares, consistent with achieving the best price and
execution. In no event will a Fund's brokerage business be placed with QDI.
Even though investment decisions for each Fund are made independently from
those for the other Funds and of the other accounts managed by Quest and its
affiliate, securities of the same issuer are frequently purchased, held or sold
by more than one Fund and the other accounts because the same security may be
suitable for all of them. When more than one Fund and/or such other accounts are
simultaneously engaged in the purchase or sale of the same security, Quest seeks
to average the transactions as to price and allocate them as to amount in a
manner believed to be equitable to each. In some cases, this procedure may
adversely affect the price paid or received by a Fund or the size of the
position obtainable for a Fund.
17
<PAGE>
During each of the three years ended December 31, 1992, 1993 and 1994, the
Funds paid brokerage commissions as follows:
<TABLE>
<CAPTION>
Fund 1992 1993 1994
- ---- ---- ---- ----
<S> <C> <C> <C>
Royce Value Fund $181,211 $123,987 $138,437
Royce Equity Income Fund 145,385 283,374 218,843
Royce Premier Fund 6,079 87,723 465,986
Royce Micro-Cap Fund 14,603 39,013 41,497
Royce Low-Priced Stock Fund - 632* 12,946
Royce Total Return Fund - 0* 6,231
Royce Global Services Fund - - 382**
</TABLE>
- -----------------
* For the period from December 15, 1993 (commencement of operations) to December
31, 1993.
**For the period from December 15, 1994 (commencement of operations)
to December 31, 1994.
For the year ended December 31, 1994, the aggregate amount of brokerage
transactions of each Fund having a research component and the amount of
commissions paid by each Fund for such transactions were as follows:
<TABLE>
<CAPTION>
Brokerage Transactions Commissions Paid
Fund Having a Research Component For Such Transactions
- ---- --------------------------- ---------------------
<S> <C> <C>
Royce Value Fund $ 35,290,829 $115,592
Royce Equity Income Fund 42,720,179 171,128
Royce Premier Fund 111,406,730 348,875
Royce Micro-Cap Fund 1,514,807 7,296
Royce Low-Priced Stock Fund 999,173 7,001
Royce Total Return Fund 961,777 3,845
Royce Global Services Fund 39,899 147*
</TABLE>
- -----------------
* For the period from December 15, 1994 (commencement of operations) to December
31, 1994.
Certain of the Funds acquired securities of their respective "regular
brokers" (as such term is defined in Rule 10b-1 under the 1940 Act) or of the
parent of their "regular brokers" during the year ended December 31, 1994, and
their respective aggregate holdings of such securities had market values at
December 31, 1994, as follows: Royce Value Fund -- A.G. Edwards, Inc. $55,800,
Lehman Brothers Holdings Inc. -- $529,525, PaineWebber Group -- $471,000, and
Piper Jaffray Companies Inc. -- $348,600; and Royce Global Services Fund --
Merrill Lynch & Co., Inc. -- $3,575 and Morgan Stanley Group Inc. -- $11,800.
CODE OF ETHICS AND RELATED MATTERS
Quest, QDI and QMC (collectively, "Quest-related persons") and The Royce
Funds have adopted a Code of Ethics under which directors, officers, employees
and partners of Quest-related persons and interested trustees/directors,
officers and employees of The Royce Funds are prohibited from personal trading
in any security which is then being purchased or sold or considered for purchase
or sale by a Royce Fund or any other Quest or QMC account. Such persons are
permitted to engage in other personal securities transactions if (i) the
securities involved are issued by the Government of the United States, certain
short-term debt securities, money market instruments, shares of affiliated or
non-affiliated registered
18
<PAGE>
open-end investment companies or shares acquired from an issuer in a rights
offering or under an automatic dividend reinvestment plan or (ii) they first
obtain permission to trade from Quest's Compliance Officer and an executive
officer of Quest. The Code contains standards for the granting of such
permission, and it is expected that permission to trade will be granted only in
a limited number of instances.
Quest's and QMC's clients include several private investment companies in
which Quest or QMC has (and, therefore, Charles M. Royce, Jack E. Fockler, Jr.
and/or W. Whitney George may be deemed to beneficially own) a share of up to 15%
of the company's realized and unrealized net capital gains from securities
transactions, but less than 5% of the company's equity interests. The Code of
Ethics does not restrict transactions effected by Quest or QMC for such private
investment company accounts. Transactions for such private investment company
accounts are subject to Quest's and QMC's allocation policies and procedures.
See "Portfolio Transactions".
As of March 31, 1995, Quest-related persons and members of their immediate
families beneficially owned shares of The Royce Funds having a total value of
approximately $14.6 million, and Quest's and QMC's equity interests in such
private investment companies totalled approximately $3.6 million.
PRICING OF SHARES BEING OFFERED
The purchase and redemption price of each Fund's shares is based on the
Fund's current net asset value per share. See "Net Asset Value Per Share" in the
Funds' Prospectuses.
As set forth under "Net Asset Value Per Share", the Funds' custodian
determines the net asset value per share of each Fund at the close of regular
trading on the New York Stock Exchange on each day that the Exchange is open.
The Exchange is open on all weekdays which are not holidays. Thus, it is closed
on Saturdays and Sundays and on New Year's Day, Washington's Birthday, Good
Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving and Christmas.
REDEMPTIONS IN KIND
It is possible that conditions may arise in the future which would, in the
judgment of the Board of Trustees or management, make it undesirable for a Fund
to pay for all redemptions in cash. In such cases, payment may be made in
portfolio securities or other property of the Fund. However, the Trust has
obligated itself under the 1940 Act to redeem for cash all shares presented for
redemption by any one shareholder up to $250,000 (or 1% of the Trust's net
assets if that is less) in any 90-day period. Securities delivered in payment of
redemptions would be valued at the same value assigned to them in computing the
net asset value per share for purposes of such redemption. Shareholders
receiving such securities would incur brokerage costs when these securities are
sold.
TAXATION
Each Fund has qualified and intends to remain qualified each year for the
tax treatment applicable to a regulated investment company under Subchapter M of
the Internal Revenue Code of 1986, as amended (the "Code"). To so qualify, a
Fund must comply with certain requirements of the Code relating to, among other
things, the source of its income and the diversification of its assets.
19
<PAGE>
By so qualifying, a Fund will not be subject to Federal income taxes to the
extent that its net investment income and capital gain net income are
distributed, so long as the Fund distributes, as ordinary income dividends, at
least 90% of its investment company taxable income.
A non-deductible 4% excise tax will be imposed on a Fund to the extent that
the Fund does not distribute (including by declaration of certain dividends),
during each calendar year, (i) 98% of its ordinary income for such calendar
year, (ii) 98% of its capital gain net income for the one-year period ending
October 31 of such calendar year and (iii) certain other amounts not distributed
in previous years. To avoid the application of this tax, each Fund intends to
distribute substantially all of its net investment income and capital gain net
income at least annually to its shareholders.
Each Fund will maintain accounts and calculate income by reference to the
U.S. dollar for U.S. Federal income tax purposes. Investments calculated by
reference to foreign currencies will not necessarily correspond to a Fund's
distributable income and capital gains for U.S. Federal income tax purposes as a
result of fluctuations in foreign currency exchange rates. Furthermore, if any
exchange control regulations were to apply to a Fund's investments in foreign
securities, such regulations could restrict that Fund's ability to repatriate
investment income or the proceeds of sales of securities, which may limit the
Fund's ability to make sufficient distributions to satisfy the 90% distribution
requirement and avoid the 4% excise tax.
Income earned or received by a Fund from investments in foreign securities
may be subject to foreign withholding taxes unless a withholding exemption is
provided under an applicable treaty. Any such taxes would reduce that Fund's
cash available for distribution to shareholders. It is currently anticipated
that none of the Funds will be eligible to elect to "pass through" such taxes to
their shareholders for purposes of enabling them to claim foreign tax credits or
other U.S. income tax benefits with respect to such taxes.
If a Fund invests in stock of a so-called passive foreign investment
company ("PFIC"), such Fund may be subject to Federal income tax on a portion of
any "excess distribution" with respect to, or gain from the disposition of, such
stock. The tax would be determined by allocating such distribution or gain
ratably to each day of the Fund's holding period for the stock. The amount so
allocated to any taxable year of the Fund prior to the taxable year in which the
excess distribution or disposition occurs would be taxed to the Fund at the
highest marginal income tax rate in effect for such years, and the tax would be
further increased by an interest charge. The amount allocated to the taxable
year of the distribution or disposition would be included in the Fund's
investment company taxable income and, accordingly, would not be taxable to the
Fund to the extent distributed by the Fund as a dividend to shareholders. In
lieu of being taxable in the manner described above, such Fund may be able to
elect to include annually in income its pro rata share of the ordinary earnings
and net capital gain (whether or not distributed) of the PFIC. In order to make
this election, the Fund would be required to obtain annual information from the
PFICs in which it invests, which in many cases may be difficult to obtain.
Alternatively, if eligible, the Fund may be able to elect to mark to market its
PFIC stock, resulting in the stock being treated as sold at fair market value on
the last business day of each taxable year. Any resulting gain would be reported
as ordinary income, and any resulting loss would not be recognized.
Investments of a Fund in securities issued at a discount or providing for
deferred interest payments or payments of interest in kind (which investment are
subject to special tax rules under the Code) will affect the amount, timing and
character of distributions to shareholders. For example, a Fund which acquires
securities issued at a discount will be required to accrue as ordinary income
each year a portion of the discount (even though the Fund may not have received
cash interest payments equal to the amount included in income) and to distribute
such income each year in order to maintain its qualification as a
20
<PAGE>
regulated investment company and to avoid income and excise taxes. In order to
generate sufficient cash to make distributions necessary to satisfy the 90%
distribution requirement and to avoid income and excise taxes, the Fund may have
to dispose of securities that it would otherwise have continued to hold.
DISTRIBUTIONS
For Federal income tax purposes, distributions by each Fund from net
investment income and from any net realized short-term capital gain are taxable
to shareholders as ordinary income, whether received in cash or reinvested in
additional shares. Ordinary income generally cannot be offset by capital losses.
For corporate shareholders, distributions of net investment income (but not
distributions of short-term capital gains) may qualify in part for the 70%
dividends received deduction for purposes of determining their regular taxable
income. (However, the 70% dividends received deduction is not allowable in
determining a corporate shareholder's alternative minimum taxable income.) The
amount qualifying for the dividends received deduction generally will be limited
to the aggregate dividends received by the Fund from domestic corporations. The
dividends received deduction for corporate shareholders may be further reduced
or eliminated if the shares with respect to which dividends are received by the
Fund are treated as debt-financed or are deemed to have been held for fewer than
46 days, or under other generally applicable statutory limitations.
So long as a Fund qualifies as a regulated investment company and satisfies
the 90% distribution requirement, distributions by such Fund from net capital
gains will be taxable as long-term capital gains, whether received in cash or
reinvested in shares and regardless of how long a shareholder has held his or
its Fund shares. Such distributions are not eligible for the dividends received
deduction. Long-term capital gains of non-corporate shareholders, although fully
includable in income, currently are taxed at a lower maximum marginal Federal
income tax rate than ordinary income.
Distributions by a Fund in excess of its current and accumulated earnings
and profits will reduce a shareholder's basis in Fund shares (but, to that
extent, will not be taxable) and, to the extent such distributions exceed the
shareholder's basis, will be taxable as capital gain assuming the shareholder
holds Fund shares as capital assets.
A distribution will be treated as paid during a calendar year if it is
declared in October, November or December of the year to shareholders of record
in such month and paid by January 31 of the following year. Such distributions
will be taxable to such shareholders as if received by them on December 31, even
if not paid to them until January. In addition, certain other distributions made
after the close of a taxable year of a Fund may be "spilled back" and treated as
paid by the Fund (other than for purposes of avoiding the 4% excise tax) during
such year. Such dividends would be taxable to the shareholders in the taxable
year in which the distribution was actually made by the Fund.
The Trust will send written notices to shareholders regarding the amount
and Federal income tax status as ordinary income or capital gain of all
distributions made during each calendar year.
BACK-UP WITHHOLDING/WITHHOLDING TAX
Under the Code, certain non-corporate shareholders may be subject to 31%
withholding on reportable dividends, capital gains distributions and redemption
payments ("back-up withholding"). Generally, shareholders subject to back-up
withholding will be those for whom a taxpayer identification number and certain
required certifications are not on file with the Trust or who, to the Trust's
knowledge, have furnished an incorrect number. In addition, the Trust is
required to withhold from distributions to any shareholder who does not certify
to the Trust that such shareholder is not subject to back-up
21
<PAGE>
withholding due to notification by the Internal Revenue Service that such
shareholder has under-reported interest or dividend income. When establishing an
account, an investor must certify under penalties of perjury that such
investor's taxpayer identification number is correct and that such investor is
not subject to or is exempt from back-up withholding.
Ordinary income distributions paid to shareholders who are non-resident
aliens or which are foreign entities will be subject to 30% United States
withholding tax unless a reduced rate of withholding or a withholding exemption
is provided under an applicable treaty. Non-U.S. shareholders are urged to
consult their own tax advisers concerning the United States tax consequences to
them of investing in a Fund.
TIMING OF PURCHASES AND DISTRIBUTIONS
At the time of an investor's purchase, a Fund's net asset value may reflect
undistributed income or capital gains or net unrealized appreciation of
securities held by the Fund. A subsequent distribution to the investor of such
amounts, although it may in effect constitute a return of his or its investment
in an economic sense, would be taxable to the shareholder as ordinary income or
capital gain as described above. Investors should carefully consider the tax
consequences of purchasing Fund shares just prior to a distribution as they will
receive a distribution that is taxable to them.
SALES OR REDEMPTIONS OF SHARES
Gain or loss recognized by a shareholder upon the sale, redemption or other
taxable disposition of Fund shares (provided that such shares are held by the
shareholder as a capital asset) will be treated as capital gain or loss,
measured by the difference between the adjusted basis of the shares and the
amount realized on the sale or exchange. Such gain or loss will be long-term
capital gain or loss if the shares disposed of were held for more than one year.
A loss will be disallowed to the extent that the shares disposed of are replaced
(including by receiving shares upon the reinvestment of distributions) within a
period of 61 days, beginning 30 days before and ending 30 days after the sale of
the shares. In such a case, the basis of the shares acquired will be increased
to reflect the disallowed loss. A loss recognized upon the sale, redemption or
other taxable disposition of shares held for 6 months or less will be treated as
a long-term capital loss to the extent of any long-term capital gain
distributions received with respect to such shares.
* * *
The foregoing relates to Federal income taxation. Distributions, as well as
any gains from a sale, redemption or other taxable disposition of Fund shares,
also may be subject to state and local taxes. Under current law, so long as each
Fund qualifies for the Federal income tax treatment described above, it is
believed that neither the Trust nor any Fund will be liable for any income or
franchise tax imposed by Massachusetts.
Investors are urged to consult their own tax advisers regarding the
application to them of Federal, state and local tax laws.
22
<PAGE>
DESCRIPTION OF THE TRUST
TRUST ORGANIZATION
The Trust was established as a Massachusetts business trust by a
Declaration of Trust, effective October 22, 1985. A copy of the Declaration of
Trust, as amended, is on file with the Secretary of the Commonwealth of
Massachusetts. The Trust has an unlimited authorized number of shares of
beneficial interest, which may be divided into an unlimited number of series
and/or classes without shareholder approval. (Each Fund presently has only one
class of shares.) These shares are entitled to one vote per share (with
proportional voting for fractional shares). Shares vote by individual series
except as otherwise required by the 1940 Act or when the Trustees determine that
the matter affects shareholders of more than one series.
Three of the four Trustees currently in office were elected by the Trust's
predecessor's stockholders. There will normally be no meeting of shareholders
for the election of Trustees until less than a majority of such Trustees remain
in office, at which time the Trustees will call a shareholders' meeting for the
election of Trustees. In addition, Trustees may be removed from office by
written consents signed by the holders of a majority of the outstanding shares
of the Trust and filed with the Trust's custodian or by a vote of the holders of
a majority of the outstanding shares of the Trust at a meeting duly called for
this purpose upon the written request of holders of at least 10% of the Trust's
outstanding shares. Upon the written request of 10 or more shareholders of the
Trust, who have been shareholders for at least 6 months and who hold shares
constituting at least 1% of the Trust's outstanding shares, stating that such
shareholders wish to communicate with the Trust's other shareholders for the
purpose of obtaining the necessary signatures to demand a meeting to consider
the removal of a Trustee, the Trust is required (at the expense of the
requesting shareholders) to provide a list of its shareholders or to distribute
appropriate materials. Except as provided above, the Trustees may continue to
hold office and appoint their successors.
Shares are freely transferable, are entitled to distributions as declared
by the Trustees and, in liquidation of the Trust, are entitled to receive net
assets of their series. Shareholders have no preemptive rights. The Trust's
fiscal year ends on December 31.
SHAREHOLDER LIABILITY
Under Massachusetts law, shareholders of a Massachusetts business trust
may, under certain circumstances, be held personally liable for the obligations
of the Trust. However, the Declaration of Trust disclaims shareholder liability
for acts or obligations of the Trust and requires that notice of such disclaimer
be given in each agreement, obligation or instrument entered into or executed by
the Trust or the Trustees. The Declaration of Trust provides for indemnification
out of a series' property for all losses and expenses of any shareholder of that
series held liable on account of being or having been a shareholder. Thus, the
risk of shareholders incurring financial loss on account of shareholder
liability is limited to circumstances in which their particular series was
unable to meet its obligations.
PERFORMANCE DATA
The Funds' performances may be quoted in various ways. All performance
information supplied for the Funds is historical and is not intended to indicate
future returns. Each Fund's share price and total returns fluctuate in response
to market conditions and other factors, and the value of a Fund's shares when
redeemed may be more or less than their original cost.
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<PAGE>
TOTAL RETURN CALCULATIONS
Total returns quoted reflect all aspects of a Fund's return, including the
effect of reinvesting dividends and capital gain distributions, and any change
in the Fund's net asset value per share (NAV) over the period. Average annual
total returns are calculated by determining the growth or decline in value of a
hypothetical historical investment in the Fund over a stated period, and then
calculating the annually compounded percentage rate that would have produced the
same result if the rate of growth or decline in value had been constant over the
period. For example, a cumulative return of 100% over ten years would produce an
average annual total return of 7.18%, which is the steady annual rate of return
that would equal 100% growth on a compounded basis in ten years. While average
annual total returns are a convenient means of comparing investment
alternatives, investors should realize that a Fund's performance is not constant
over time, but changes from year to year, and that average annual total returns
represent averaged figures as opposed to the actual year-to-year performance of
the Fund.
In addition to average annual total returns, a Fund's unaveraged or
cumulative total returns, reflecting the simple change in value of an investment
over a stated period, may be quoted. Average annual and cumulative total returns
may be quoted as a percentage or as a dollar amount, and may be calculated for a
single investment, a series of investments or a series of redemptions, over any
time period. Total returns may be broken down into their components of income
and capital (including capital gains and changes in share prices) in order to
illustrate the relationship of these factors and their contributions to total
return. Total returns and other performance information may be quoted
numerically or in a table, graph or similar illustration.
HISTORICAL FUND RESULTS
The following table shows certain of the Funds' total returns for the
periods indicated. Such total returns reflect all income earned by each Fund,
any appreciation or depreciation of the assets of such Fund and all expenses
incurred by such Fund for the stated periods. The table compares the Funds'
total returns to the record of the Russell 2000 Index (Russell 2000) and
Standard & Poor's 500 Composite Stock Price Index (S&P 500) over the same
periods. The comparison to the Russell 2000 shows how the Funds' total returns
compared to the record of a broad index of small capitalization stocks. The S&P
500 comparison is provided to show how the Funds' total returns compared to the
record of a broad average of common stock prices over the same period. The Funds
have the ability to invest in securities not included in the indices, and their
investment portfolios may or may not be similar in composition to the indices.
Figures for the indices are based on the prices of unmanaged groups of stocks,
and, unlike the Funds, their returns do not include the effect of paying
brokerage commissions and other costs and expenses of investing in a mutual
fund.
<TABLE>
<CAPTION>
Period Ended
Fund December 31, 1994 Russell 2000 S&P 500
- ---- ----------------- ------------ -------
<S> <C> <C> <C>
Royce Value Fund
- ----------------
1 Year Total Return - 1.64% - 1.81% + 1.32%
5 Year Average Annual Total Return + 7.38 +10.20 + 8.69
10 Year Average Annual Total Return +10.82 +11.54 +14.28
Royce Equity Income Fund
1 Year Total Return - 3.26% - 1.81% + 1.32%
Average Annual Total Return since 1-2-90 + 7.57 + 9.99 + 8.31
(commencement of operations)
24
<PAGE>
Period Ended
Fund December 31, 1994 Russell 2000 S&P 500
- ---- ----------------- ------------ -------
Royce Premier Fund
- ------------------
1 Year Total Return + 3.28% - 1.81% + 1.32%
Average Annual Total Return since 1-1-92 +12.50 +11.40 + 6.27
(commencement of operations)
Royce Micro-Cap Fund
1 Year Total Return + 3.55% - 1.81% + 1.32%
Average Annual Total Return since 1-1-92 +18.34 +11.40 + 6.27
(commencement of operations)
Royce Low-Priced Stock Fund
1 Year Total Return + 2.98% - 1.81% + 1.32%
Average Annual Total Return since 12-15-93 + 3.05 + 1.56 + 2.23
(commencement of operations)
Royce Total Return Fund
1 Year Total Return + 5.13% - 1.81% + 1.32%
Average Annual Total Return since 12-15-93 + 4.91 + 1.56 + 2.23
(commencement of operations)
</TABLE>
During the applicable period ended December 31, 1994, a hypothetical
$10,000 investment in certain of the Funds would have grown as indicated below,
assuming all distributions were reinvested:
<TABLE>
<CAPTION>
Fund/Period Commencement Date Hypothetical Investment at December 31, 1994
- ----------------------------- --------------------------------------------
<S> <C>
Royce Value Fund (1-1-85) $ 27,925
Royce Equity Income Fund (1-2-90) 14,402
Royce Premier Fund (1-1-92) 14,236
Royce Micro-Cap Fund (1-1-92) 16,572
Royce Low-Priced Stock Fund (12-15-93) 10,300
Royce Total Return Fund (12-15-93) 10,513
</TABLE>
The Funds' performances may be compared in advertisements to the
performance of other mutual funds in general or to the performance of particular
types of mutual funds, especially those with similar investment objectives. Such
comparisons may be expressed as mutual fund rankings prepared by Lipper
Analytical Services, Inc. ("Lipper"), an independent service that monitors the
performance of registered investment companies. The Funds' rankings by Lipper
for the one-year period ended December 31, 1994 were:
<TABLE>
<CAPTION>
Fund Lipper Ranking
- ---- --------------
<S> <C>
Royce Value Fund 130 out of 283 small company growth funds
Royce Equity Income Fund 60 out of 120 equity income funds
Royce Premier Fund 46 out of 283 small company growth funds
Royce Micro-Cap Fund 42 out of 283 small company growth funds
Royce Low-Priced Stock Fund 51 out of 283 small company growth funds
Royce Total Return Fund 18 out of 412 growth and income funds
</TABLE>
25
<PAGE>
Money market funds and municipal funds are not included in the Lipper survey.
The Lipper performance analysis ranks funds on the basis of total return,
assuming reinvestment of distributions, but does not take sales charges or
redemption fees payable by shareholders into consideration and is prepared
without regard to tax consequences.
The Lipper General Equity Funds Average can be used to show how the Funds'
performances compare to a broad-based set of equity funds. The Lipper General
Equity Funds Average is an average of the total returns of all equity funds
(excluding international funds and funds that specialize in particular
industries or types of investments) tracked by Lipper. As of December 31, 1994,
the average included 155 capital appreciation funds, 564 growth funds, 283 small
company growth funds, 412 growth and income funds and 120 equity income funds.
Capital appreciation, growth and small company growth funds usually invest
principally in common stocks, with long-term growth as a primary goal. Growth
and income and equity income funds tend to be more conservative in nature and
usually invest in a combination of common stocks, bonds, preferred stocks and
other income-producing securities. Growth and income and equity income funds
generally seek to provide their shareholders with current income as well as
growth of capital, unlike growth funds which may not produce income.
The Lipper Growth & Income Fund Index can be used to show how the Total
Return Fund's performance compares to a set of growth and income funds. The
Lipper Growth & Income Fund Index is an equally-weighted performance index,
adjusted for capital gains distributions and income dividends, of the 30 largest
qualifying funds within Lipper's growth & income investment objective category.
The Lipper Global Fund Index can be used to show how the Global Services
Fund's performance compares to a set of global funds. The Lipper Global Fund
Index is an equally-weighted performance index, adjusted for capital gains
distributions and income dividends, of the 30 largest qualifying funds in
Lipper's global investment objective category.
Ibbotson Associates (Ibbotson) provides historical returns of the capital
markets in the United States. The Funds' performance may be compared to the
long-term performance of the U.S. capital markets in order to demonstrate
general long-term risk versus reward investment scenarios. Performance
comparisons could also include the value of a hypothetical investment in common
stocks, long-term bonds or U.S. Treasury securities. Ibbotson calculates total
returns in the same manner as the Funds.
The capital markets tracked by Ibbotson are common stocks, small
capitalization stocks, long-term corporate bonds, intermediate-term government
bonds, long-term government bonds, U.S. Treasury bills and the U.S. rate of
inflation. These capital markets are based on the returns of several different
indices. For common stocks, the S&P 500 is used. For small capitalization
stocks, return is based on the return achieved by Dimensional Fund Advisors
(DFA) Small Company Fund. This fund is a market-value-weighted index of the
ninth and tenth deciles of the New York Stock Exchange (NYSE), plus stocks
listed on the American Stock Exchange (AMEX) and over-the-counter (OTC) with the
same or less capitalization as the upper bound of the NYSE ninth decile. As of
December 31, 1994, DFA contained approximately 2,000 stocks, with a median
market capitalization of about $80 million.
The S&P 500 Composite Stock Price Index is an unmanaged index of common
stocks frequently used as a general measure of stock market performance. The
Index's performance figures reflect changes of market prices and quarterly
reinvestment of all distributions.
The S&P SmallCap 600 Index is an unmanaged market-weighted index consisting
of 600 domestic stocks chosen for market size, liquidity and industry group
representation. As of September 30, 1994, the weighted mean market value of a
company in this Index was approximately $400 million.
26
<PAGE>
The Russell 2000, prepared by the Frank Russell Company, tracks the return
of the common stock of the 2,000 smallest out of the 3,000 largest publicly
traded U.S.-domiciled companies by market capitalization. The Russell 2000
tracks the return on these stocks based on price appreciation or depreciation
and includes dividends.
U.S. Treasury bonds are securities backed by the credit and taxing power of
the U.S. government and, therefore, present virtually no risk of default.
Although such government securities fluctuate in price, they are highly liquid
and may be purchased and sold with relatively small transaction costs (direct
purchase of U.S. Treasury securities can be made with no transaction costs).
Returns on intermediate-term government bonds are based on a one-bond portfolio
constructed each year, containing a bond that is the shortest non-callable bond
available with a maturity of not less than five years. This bond is held for the
calendar year and returns are recorded. Returns on long-term government bonds
are based on a one-bond portfolio constructed each year, containing a bond that
meets several criteria, including having a term of approximately 20 years. The
bond is held for the calendar year and returns are recorded. Returns on U.S.
Treasury bills are based on a one-bill portfolio constructed each month,
containing the shortest term bill having not less than one month to maturity.
The total return on the bill is the month-end price divided by the previous
month-end price, minus one. Data up to 1976 is from the U.S. Government Bond
file at the University of Chicago's Center for Research in Security Prices; the
Wall Street Journal is the source thereafter. Inflation rates are based on the
Consumer Price Index.
Quest may, from time to time, compare the performance of common stocks,
especially small capitalization stocks, to the performance of other forms of
investment over periods of time.
From time to time, in reports and promotional literature, the Funds'
performances also may be compared to other mutual funds tracked by financial or
business publications and periodicals, such as KIPLINGER's, INDIVIDUAL INVESTOR,
MONEY, FORBES, BUSINESS WEEK, BARRON's, FINANCIAL TIMES, FORTUNE, MUTUAL FUNDS
MAGAZINE AND THE WALL STREET JOURNAL. In addition, financial or business
publications and periodicals as they relate to fund management, investment
philosophy and investment techniques may be quoted.
Morningstar, Inc.'s proprietary risk ratings may be quoted in advertising
materials. For the three years ended December 31, 1994, the average risk score
for the 1,311 equity funds rated by Morningstar with a three-year history was
0.97; the average risk score for the 119 small company funds rated by
Morningstar with a three-year history was 1.09; and the average risk score for
the 54 equity income funds rated by Morningstar with a three-year history was
0.63. For the three years ended December 31, 1994, the risk scores for the Funds
with a three-year history, and their ranks within Morningstar's equity funds
category and either its small company or equity income funds categories, as
applicable, were as follows:
<TABLE>
<CAPTION>
Rating within Morningstar Category of
Morningstar ----------------------------------------------------------------
Fund Risk Score Equity Funds Small Company Funds Equity Income Funds
- ---- ---------- ------------ ------------------- -------------------
<S> <C> <C> <C> <C>
Value 0.54 Within lowest 10% Within lowest 10% --
Equity Income 0.38 Within lowest 5% -- Lowest risk score
Premier 0.25 Within lowest 5% Lowest risk score --
Micro-Cap 0.43 Within lowest 5% Within lowest 5% --
</TABLE>
The Funds' performances may also be compared to those of other compilations
or indices.
Advertising for the Funds may contain examples of the effects of periodic
investment plans, including the principle of dollar cost averaging. In such a
program, an investor invests a fixed dollar amount in a fund at periodic
intervals, thereby purchasing fewer shares when prices are high and more shares
when prices are low. While such a strategy does not assure a profit or guard
against loss in a declining market, the investor's average cost per share can be
lower than if fixed numbers of shares are purchased at the same intervals. In
evaluating such a plan, investors should consider their ability to continue
purchasing shares during periods of low price levels.
The Funds may be available for purchase through retirement plans or other
programs offering deferral of or exemption from income taxes, which may produce
superior after-tax returns over time. For
27
<PAGE>
example, a $1,000 investment earning a taxable return of 10% annually would have
an after-tax value of $2,004 after ten years, assuming tax was deducted from the
return each year at a 28% rate. An equivalent tax-deferred investment would have
an after-tax value of $2,147 after ten years, assuming tax was deducted at a 28%
rate from the tax-deferred earnings at the end of the ten-year period.
RISK MEASUREMENTS
Quantitative measures of "total risk," which quantify the total variability
of a portfolio's returns around, or below, its average return, may be used in
advertisements and in communications with current and prospective shareholders.
These measures include standard deviation of total return and the Morningstar
risk statistic. Such communications may also include market risk measures, such
as beta, and risk-adjusted measures of performance such as the Sharpe Ratio,
Treynor Ratio, Jensen's Alpha and Morningstar's star rating system.
Standard Deviation. The risk associated with a fund or portfolio can be
viewed as the volatility of its returns, measured by the standard deviation of
those returns. For example, a fund's historical risk could be measured by
computing the standard deviation of its monthly total returns over some prior
period, such as three years. The larger the standard deviation of monthly
returns, the more volatile, i.e., spread out around the fund's average monthly
total return, the fund's monthly total returns have been over the prior period.
Standard deviation of total return can be calculated for funds of different
objectives, ranging from equity funds to fixed income funds, and can be measured
over different time frames. The standard deviation figures presented are
annualized statistics based on the trailing 36 monthly returns. Approximately
68% of the time, the annual total return of a fund will differ from its mean
annual total return by no more than plus or minus the standard deviation figure.
95% of the time, a fund's annual total return will be within a range of plus or
minus 2x the standard deviation from its mean annual total return.
Beta. Beta measures the sensitivity of a security's, or portfolio's,
returns to the market's returns. It measures the relationship between a fund's
excess return (over 3-month T-bills) and the excess return of the benchmark
index (S&P 500 for domestic equity funds). The market's beta is by definition
equal to 1. Portfolios with betas greater than 1 are more volatile than the
market, and portfolios with betas less than 1 are less volatile than the market.
For example, if a portfolio has a beta of 2, a 10% market excess return would
be expected to result in a 20% portfolio excess return, and a 10% market loss
would be expected to result in a 20% portfolio loss (excluding the effects of
any firm-specific risk that has not been eliminated through diversification).
Morningstar Risk. The Morningstar proprietary risk statistic evaluates a
fund's downside volatility relative to that of other funds in its class based on
the underperformances of the fund relative to the riskless T-bill return. It
then compares this statistic to those of other funds in the same broad
investment class.
Sharpe Ratio. Also known as the Reward-to-Variability Ratio, this is the
ratio of a fund's average return in excess of the risk-free rate of return
("average excess return") to the standard deviation of the fund's excess
returns. It measures the returns earned in excess of those that could have been
earned on a riskless investment per unit of total risk assumed.
Treynor Ratio. Also known as the Reward-to-Volatility Ratio, this is the
ratio of a fund's average excess return to the fund's beta. It measures the
returns earned in excess of those that could have been earned on a riskless
investment per unit of market risk assumed. Unlike the Sharpe Ratio, the Treynor
Ratio uses market risk (beta), rather than total risk (standard deviation), as
the measure of risk.
28
<PAGE>
Jensen's Alpha. This is the difference between a fund's actual returns and
those that could have been earned on a benchmark portfolio with the same amount
of risk, i.e., the same beta, as the portfolio. Jensen's Alpha measures the
ability of active management to increase returns above those that are purely a
reward for bearing market risk.
Morningstar Star Ratings. Morningstar, Inc. is a mutual fund rating service
that rates mutual funds on the basis of risk-adjusted performance. Ratings may
change monthly. Funds with at least three years of performance history are
assigned ratings from one star (lowest) to five stars (highest). Morningstar
ratings are calculated from the funds' three-, five- and ten-year average annual
returns (when available). Funds' returns are adjusted for fees and sales loads.
Ten percent of the funds in an investment category receive five stars, 22.5%
receive four stars, 35% receive three stars, 22.5% receive two stars, and the
bottom 10% receive one star.
None of the quantitative risk measures taken alone can be used for a
complete analysis and, when taken individually, can be misleading at times.
However, when considered in some combination and with the total returns of a
fund, they can provide the investor with additional information regarding the
volatility of a fund's performance. Such risk measures will change over time and
are not necessarily predictive of future performance or risk.
29
