Value Investing in Small Companies For Over 20 Years
THE
ROYCE
FUNDS
Royce Premier Fund
Royce Micro-Cap Fund
1997 Semi-Annual Report
<PAGE>
THE ROYCE FUNDS ROAD MAP
For over twenty years, Royce & Associates has focused exclusively on small and
micro-cap investing. While we offer a variety of funds, we remain committed to a
risk-averse investment style. Since 1990, the firm has devoted its energies to
two portfolio strategies.
o TWO CORE PORTFOLIO STRATEGIES
CONCENTRATED SMALL-CAP MICRO-CAP
ROYCE PREMIER ROYCE MICRO-CAP
Small-Cap Orientation Micro-Cap Orientation
Concentrated Portfolio Broadly Diversified Portfolio
Portfolios revolve around two main criteria: CAPITALIZATION
(small or micro-cap) and CONCENTRATION. The small-cap universe
(companies with market caps between $300 million and $1 billion)
is no longer small, unknown or under-owned; therefore, WE BELIEVE
THAT THIS GREATER LEVEL OF EFFICIENCY REQUIRES GREATER PORTFOLIO
CONCENTRATION. The micro-cap universe (companies with market caps
between $5 million and $300 million) provides more choices
(approximately 7,000 companies), yet greater trading
difficulties; therefore, WE BELIEVE THAT BROAD DIVERSIFICATION IS
REQUIRED GIVEN THE LIQUIDITY CONSTRAINTS OF THIS SECTOR.
o OPPORTUNISTIC THEMES
ROYCE TOTAL RETURN ROYCE LOW-PRICED
Dividend-Paying Securities Stocks Below $15
We have identified two other attributes for delivering strong
risk-adjusted returns - one has low-risk characteristics
(dividends) and the other (low-priced stocks) has the potential
for high returns. When these attributes are found in stocks we
selected for our core portfolios, we designate them for our
specific theme funds. Performance and volatility may be
substantially different for each of these portfolios.
o COMBINED PORTFOLIOS - OUR FLAGSHIP APPROACH
PENNSYLVANIA MUTUAL PMF II ROYCE GIFTSHARES
Combine Small and Micro-Cap Companies
The combined portfolios encompass approximately EQUAL WEIGHTINGS
of each core strategy. Two of our portfolios, including our
flagship fund Pennsylvania Mutual, are suitable for both
individuals and institutions, while GiftShares offers a unique
gifting and estate planning portfolio.
<PAGE>
SEMI-ANNUAL REPORT REFERENCE GUIDE
After a solid first quarter, Royce Premier flourished
during the strong second quarter to finish ahead of
the Russell 2000 on a year-to-date basis. 8
Royce Premier's top 35 holdings represented
approximately 82% of the equity portfolio. 9
Royce Micro-Cap outperformed the Russell 2000
over the last five years on both an absolute and
risk adjusted basis. 10
Royce Micro-Cap's risk-averse orientation has
resulted in strong relative down market returns. 10
Schedules of Investments and other Financial Statements. 14 - 20
Postscript: All That Jazz. Inside back cover
For over twenty years, our risk-averse approach has focused on evaluating a
company's "private worth" - what we believe an enterprise would sell for in a
private transaction between rational parties. This requires a thorough
understanding of the financial and operating dynamics of a business, as though
we were purchasing the entire company. The price we will pay for a security must
be significantly lower than our appraisal of its private worth.
<TABLE>
<CAPTION>
PERFORMANCE RESULTS
Year-To-Date Since
Fund (Inception) Return 1-Year Inception
<S> <C> <C> <C>
Royce Premier Fund (12/31/91) 14.6% 26.0% 16.1%
Royce Micro-Cap Fund (12/31/91) 10.1% 14.6% 18.2%
</TABLE>
<PAGE>
[ GRAPHIC OMITTED ]
Photo of Charles M. Royce, President
The small-cap world has evolved dramatically during the last ten to fifteen
years, especially in terms of capitalization. When we began managing money in
the early '70's, small-cap was a much less efficient sector; but today, all that
has changed. The small-cap market now behaves more like the large-cap market.
Small and micro-cap are distinct markets, which require distinct strategies. The
idea of two distinct markets inside small-cap is one that we believe will be the
party line in another half dozen years.
Letter to our Shareholders
[ GRAPHIC OMITTED ]
Cartoon: "How come Jasper's mutual fund is up twelve per
cent and mine's up only eight?"
Bigger Was Better . . .
In light of 1997's results to date, investors in small-cap mutual funds are
probably asking similar questions to that posed in the cartoon. Performance in
the first six months resembled that of the last half of 1996. Investors'
preference for easy-to-trade securities enabled larger, more well-known stocks
to perform better, even within the small-cap universe.
After a sluggish start, small-cap securities came roaring back in the
second quarter, posting their best results since 1991. They, however, still
trailed their large company counterparts, which provided impressive second
quarter results to go along with their solid early 1997 returns. For the first
six months, the Russell 2000 Index of small company stocks was up 10.2% versus a
gain of 20.6% for the large-cap oriented S&P 500 Index. The disparity between
large and small-cap is even more dramatic for the one-year period ended June 30,
1997: 34.7% for the S&P 500 versus 16.3% for the Russell 2000. In fact, this is
the widest margin of outperformance by the S&P 500 since the Russell 2000's
inception in 1979. COINCIDENTALLY, THE PREVIOUS TWO PERIODS OF SUBSTANTIAL
SMALL-CAP, ONE-YEAR UNDERPERFORMANCE (APRIL '87 AND MAY '90) OCCURRED JUST PRIOR
TO THE LAST TWO GENERAL MARKET DECLINES. Although periods of large-cap dominance
are not unusual, the magnitude of the current outperformance is almost
unprecedented. Over the last three and one-half calendar years, the S&P 500 has
provided a 23.1% average annual total return versus 14.8% for the Russell 2000.
While not matching the S&P 500, recent small-cap returns, as measured by
the Russell 2000, are excellent in both the absolute and the historical
contexts. It is hard to imagine how anyone who invested in a sector that
produced average annual total returns for the one, five, ten and fifteen-year
periods of 16.3%, 17.9%, 11.1% and 15.1%, respectively, would be disappointed.
It is only through the lens of relative performance that one can find fault.
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...AND SO WAS VALUE
Over the last twelve months, small-cap investors experienced greater
volatility than in recent years. Increased volatility tends to benefit value
investing, as evidenced by year-to-date and one-year performance results.
Despite strong returns in May for growth stocks within the Russell 2000,
sparked by a decline in interest rates in mid-April, value stocks within
the small-cap index retained the performance edge that began in the second
half of 1996. Through the first six months of 1997, the Russell 2000 Value
Index was up 14.8% versus a gain of 5.2% for the Russell 2000 Growth Index.
This performance disparity is even more evident when reviewing the last
twelve months. We believe that the higher level of volatility will continue
within the small-cap sector. This favors our value approach, which takes
advantage of price fluctuations.
WE ARE PLEASED TO REPORT SOLID ABSOLUTE AND RELATIVE SIX AND TWELVE-MONTH
RESULTS. FOR A COMPLETE DISCUSSION OF HOW WE DID, INCLUDING BOTH PERFORMANCE AND
PORTFOLIO DIAGNOSTICS, PLEASE SEE PAGES 8-11.
SMALL-CAP AIN'T WHAT IT USED TO BE
It has been documented by Ibbotson and Associates that small-cap companies
have outperformed their larger counterparts by approximately 2% annually, on
average, since 1926. This performance premium is known as the "small-cap
effect." While this is not an every year occurrence and 2% per annum may not
seem like much, the results are eye-popping when one compounds this differential
over the last 70 years! Even though this performance rule of thumb is generally
accepted, we believe that it can be misleading. The index utilized to calculate
the small-cap effect includes only the "smallest" of small-cap companies, those
in the 9th and 10th deciles of market capitalization. Today, this roughly
equates to companies under $300 million in market capitalization. In contrast,
the world has generally redefined small-cap to include companies under $1
billion. WHAT HAS BEEN LABELED A SMALL-CAP EFFECT SHOULD IN FACT NOW BE VIEWED
AS A MICRO-CAP PHENOMENON. This has important implications for all investors.
The case for two distinct markets-small and micro-cap-is apparent in other
ways as well. The annual rebalancing of the Russell 2000 in June produced an
estimated 30% increase in the index's weighted average market cap ($609 million
versus $468 million at 6/30/96), and for the second year in a row, no companies
with market caps below $100 million were included in the reconstituted index.
Also, according to Morningstar, there are now over 500 small-cap mutual funds,
totaling approximately $100 billion in assets. AS THE WORLD GETS SMALLER,
SMALL-CAP STOCKS ARE GETTING BIGGER, AND MICRO-CAP STOCKS ARE GETTING MORE
INTERESTING.
NO SMOKE, NO MIRRORS
Just recently, one of our children asked a question that parents often
hear, "WHAT EXACTLY DO YOU DO?" This question is posed to us frequently by
shareholders and investment advisors as well, and it often leads to more
questions. We thought it would be useful to employ a "Q and A" format to
communicate our core beliefs, which have been developed over the last 25 years,
principally by Chuck Royce.
[ GRAPHIC OMITTED ]
Cartoon: Male adult, male child
3
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Within the small-cap market ($300 million to $1 billion), we utilize a
concentrated approach. We focus our efforts on identifying those forty to fifty
companies that we believe will give us the absolute best performance in this
slightly more efficient area. The micro-cap area (below $300 million) is really
what the small-cap area was twenty years ago, in that these stocks represent the
last frontier of domestic equity opportunity. We use a diversified approach
because of liquidity constraints and the higher-than-usual volatility in this
sector.
In the exchange that follows, Whitney George and Jack Fockler discuss some
of these tenets. Whitney joined our firm six years ago as a "maitre d'" serving
on the front line of our investment activity. Whitney's talent and steady
contributions have enabled him to move to chef status as a portfolio manager in
our "restaurant." Jack joined us eight years ago primarily working with clients.
Jack's and Whitney's responsibilities have expanded into a central role; both
are now managing directors. We hope this helps you become more familiar with our
investment philosophy.
. . . an organized and intensive process
that includes interviewing a company's
customers, competitors and suppliers. This
"detective work" universally is not done
on Wall Street.
WHAT DO YOU LOOK FOR IN A COMPANY? Essentially, we are interested in three
things-strong balance sheets, strong evidence of success and strong prospects.
Small and micro-cap entities can be very fragile; and, as a result, we look for
companies that can survive during times that are difficult for their products or
their particular industry as a whole. We maintain primary focus on internal
returns: namely, return on assets and return on invested capital. Both measures
provide a deeper insight into a company's health. In essence, we seek growing
businesses that produce free cash flow.
IS A COMPANY'S ANNUAL REPORT WORTH READING? One of the most important and
under appreciated sources of information is the annual report. We are
enthusiastic and diligent readers of annual reports and not just for the
numbers. We look for the obvious and the not-so-obvious signals that a CEO or
Chairman is sending in the various discussions. We look at what is being said
and not said, and compare what we find to previous years' reports. Dog-eared
annual reports are our standard.
DO YOU CONSIDER THE QUANTITATIVE OR QUALITATIVE ASPECTS OF YOUR RESEARCH TO
BE THE MOST IMPORTANT? While quantitative research remains the cornerstone of
our process, it is the qualitative aspects that take on an increasingly
important role. Information is readily available to everyone, so being the
fastest reader or collector of documents no longer affords the advantage it once
did. The non-quantitative effort is where we add value, and it is also the most
fun.
ONE OF THE MOST IMPORTANT AND UNDER
APPRECIATED SOURCES OF INFORMATION IS THE
ANNUAL REPORT.
WHAT DO YOU WANT TO ACCOMPLISH WHEN YOU MEET WITH COMPANY MANAGEMENT TEAMS?
We listen carefully to their plans, aspirations and dreams for the business. The
research process begins as we assess their credibility and that of their plans.
As careful investors, we must be able to trust management.
HOW DO YOU CONFIRM THEIR ASPIRATIONS AND DREAMS? Management meetings are
just a starting point. It's very important to be able to validate what we have
been told. We
4
<PAGE>
do this through an organized and intensive process that includes interviewing a
company's customers, competitors and suppliers. This "detective work"
universally is not done on Wall Street.
ARE THERE CERTAIN STANDARDS THAT YOU LOOK FOR WHEN YOU TALK TO MANAGEMENT?
Honesty is paramount, both in actions and thought processes. We try to
understand motivations and make certain management's intentions are consistent
with ours. We look for confirmation of integrity in all corporate actions. We
spend considerable time reviewing proxies for conflicts and governance issues
that others often gloss over.
WE SPEND CONSIDERABLE TIME REVIEWING
PROXIES FOR CONFLICTS AND GOVERNANCE ISSUES
THAT OTHERS OFTEN GLOSS OVER.
HOW DO YOU FIND NEW IDEAS FOR THE PORTFOLIOS? We are open-minded and
non-discriminating about how new ideas find their way into the firm. We think of
ourselves as "shop-a-holics" when it comes to finding a new name, and we are
prepared to talk to anyone or look anywhere to learn about an idea. This means
shopping at Wall Street "supermarkets," regional firms and research boutiques.
We even go to "garage sales" where there is no analytical coverage. But, at the
end of the day, we are exceptionally discriminating about our purchases.
DO YOU INVEST IN INITIAL PUBLIC OFFERINGS (IPOS)? We do significant analyses of
IPOs, although this does not necessarily mean that we are significant investors.
While IPOs represent a wonderful source of new ideas, our interest in them tends
to be six to eighteen months following the initial offering, when the prices are
more to our liking.
DO YOU INVEST IN TECHNOLOGY STOCKS? While we believe the technology sector is a
vibrant and important part of our economy, we view the investment opportunity
somewhat differently. Most of the attention in this sector is on cutting-edge
companies. While this is an exciting and potentially rewarding area, it is also
very difficult. These companies tend to be consumers, not producers, of cash,
and it's hard for us to feel comfortable that the financial characteristics we
are looking for will be in place five years from now. Our preferred type of
technology investment, while not on the front line, is able to deliver
comparable growth without the inherent risk. Electronics distributors are a good
example of a low-risk way to participate in what has historically been a
high-risk sector.
WHILE IPOS REPRESENT A WONDERFUL SOURCE OF
NEW IDEAS, OUR INTEREST IN THEM TENDS TO
BE SIX TO EIGHTEEN MONTHS FOLLOWING THE
INITIAL OFFERING, WHEN THE PRICES ARE MORE
TO OUR LIKING.
HOW DIFFICULT IS IT TO KEEP TRACK OF NAMES IN THE PORTFOLIOS? It is not as big a
project as one might think. The business world does not change as rapidly as the
stock market. While a company's stock price may change daily, earnings are only
reported quarterly, and the balance sheet evolves even more slowly. We combine a
running evaluation of these slower developments with a very disciplined and
rigorous tracking process that continually focuses on the relationship of
"private worth" to market price.
5
<PAGE>
Value works because markets are cyclical. We think of ourselves as risk
managers. It is not a fruitful idea to focus only on risk. We're committed
to the idea of finding stocks that we believe can double in value over
approximately a four-year time frame while keeping risk levels relatively
low.
HOW DO ROYCE ANALYSTS INTERACT WITH THE PORTFOLIO MANAGERS? We sit together
in an open environment that encourages constant dialogue; there are no
offices in which to hide. Our analysts generally work together in teams;
multiple eyes reduce nearsightedness. They are not industry specialists,
but generalists. This is in contrast to most firms, which organize their
research effort around specific industries and designate analysts to cover
narrow niches. The problem with industry analysts is that they tend to fall
in love with their sectors.
We want our analysts to be able to recognize good companies, regardless of
sector. We require written records of our thought processes; this minimizes the
human tendency to reinvent a story as circumstances change.
OUR ANALYSTS GENERALLY WORK TOGETHER IN
TEAMS; MULTIPLE EYES REDUCE NEARSIGHTEDNESS.
HOW IMPORTANT IS TRADING EXECUTION? Execution is critical to successful
small-cap investing because costs are higher than in the large-cap market.
Indeed, spreads of 5% or more between a stock's bid and ask price are not
uncommon. Daily trading volume is often low, demanding significant patience on
the part of the trader/buyer. Many a good large-cap manager who ventures into
the small and micro-cap universes becomes immediately frustrated by the trading
nuances of the sector. We work hard at this part of our business and believe
that our 20+ years of experience give us an edge.
HOW DO YOU WEIGH YOUR OWN EVALUATIONS VERSUS THOSE OF OUTSIDE ANALYSTS? It's
only through doing your own work that you're able to develop confidence and
conviction. Much of Wall Street's research is directed toward those companies
that provide opportunities for making money through trading or investment
banking. While we use outside research, it is for general context purposes only.
WHAT HAPPENS WHEN A STOCK THAT YOU LIKE GOES DOWN IN PRICE? This gives us a
reason to go back and review the work to gain an understanding as to why the
stock has declined. If we find we have missed something, then we re-evaluate how
bad the situation is and how much is already reflected in the price. Hopefully,
the outcome is higher conviction coinciding with a more attractive purchase
price. We are not afraid to average down (buy more shares at lower prices) when
our conviction level is in place.
IT'S ONLY THROUGH DOING YOUR OWN WORK THAT
YOU'RE ABLE TO DEVELOP CONFIDENCE AND
CONVICTION.
HOW DOES ONE AVOID UNDERPERFORMANCE? It's not clear that one can avoid
underperformance in the short-run because the greatest opportunities come when
conditions are at their worst. We try to address this by being realistic in
terms of our holding period, which is generally four years on average, and by
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recognizing that this year's poor performer may be the stock that everyone
wants to own several years later. Stock selection and performance are not
related in the short-term.
WHAT SHOULD BE EXPECTED FROM AN INVESTMENT MANAGER? Investors should look for a
return that is reasonable and an approach that stresses absolute, not relative,
performance goals. Although relative performance comparisons are useful, they
should not drive the evaluation process; you cannot eat from the table of
relative performance. We also think managers should communicate openly, sharing
their successes, failures and expectations with their investors.
[ GRAPHIC OMITTED ]
Picture of 2 Lane Road and rising sun with clouds
[ GRAPHIC OMITTED ]
Photo of Jack Fockler, Whitney George and Chuck Royce
THE ROAD AHEAD
While the last two and one-half calendar years have produced only one down
quarter for small-cap stocks, there is plenty of evidence to suggest the road
ahead will be different. Since May '96 volatility has been higher in the small
and micro-cap sectors, usually a prelude to lower returns. We believe that
active management and a value orientation are especially appropriate in this
more volatile environment. Although large-cap stocks have been market leaders
for over three years, we do not believe that this is a permanent condition. The
market's preference for large and liquid securities will run its course as it
has before.
Although absolute returns for the market are likely to diminish following
this extraordinary return period, we remain excited about near and long-term
prospects for our risk-averse style of investing. Your continued confidence is
appreciated.
Sincerely,
/s/ Charles M. Royce /s/ W. Whitney George /s/ Jack E. Fockler, Jr.
Charles M. Royce W. Whitney George Jack E. Fockler, Jr.
President Vice President Vice President
July 25, 1997
We want to pay tribute to our friend and colleague, Tom Ebright, who passed
away on July 14, 1997. For over sixteen years, Tom was a substantial
contributor and valued partner of our firm. He is survived by his wife,
Joyce, his two daughters, Jennifer and Ellen, and many shareholders and
friends who knew and loved Tom.
7
<PAGE>
WHAT WE DO Royce Premier Fund ("Premier") uses a risk-averse value approach to
invest primarily in a concentrated portfolio of small-cap stocks with market
caps between $300 million and $1 billion. The securities in Premier's portfolio
include our highest confidence selections, those we define as "superior
companies" because of their solid balance sheets, excellent prospects and high
internal rates of return.
HOW WE DID After more than holding its own in the difficult first quarter, Royce
Premier Fund flourished during the strong second quarter to finish the first six
months up 14.6%. The Fund's focus on high quality small-cap companies helped it
to outperform its benchmark index, the Russell 2000, which was up 10.2% for the
first half. Premier also enjoyed a performance edge over the Russell 2000 in the
one-year period (26.0% vs. 16.3%). The Fund, with five and one-half years of
performance history and $430 million in net assets, has a 4-star (****) rating
from Morningstar, out of 1,997 equity funds as of June 30, 1997. The average
annual total return for the Fund since inception was 16.1%.
Since the small-cap sector has always been more volatile, we believe that
paying attention to risk is critical to delivering above-average, long-term
returns. Risk is typically evaluated in terms of uncertainty, by measuring fund
volatility through standard deviation and beta, and also in terms of possibility
of loss, by measuring actual down market performance. Premier's risk averse
orientation has resulted in low risk rankings and superior down market
performance versus the Russell 2000 and its small-cap peers.
ROYCE PREMIER FUND
TOTAL RETURNS
Through 6/30/97
- -----------------------------------
1997 (through 6/30) 14.6%
- -----------------------------------
1-Year 26.0%
- -----------------------------------
3-Year Average Annual 18.2%
- -----------------------------------
5-Year Average Annual 17.5%
- -----------------------------------
Since Inception (12/31/91) 16.1%
Average Annual
RISK/RETURN COMPARISON
Five-Year Period Ended 6/30/97
<TABLE>
<CAPTION>
Average Annual Standard
Total Return Deviation RUR
<S> <C> <C> <C>
Royce Premier 17.5% 6.7 2.62
Russell 2000 17.9% 12.3 1.45
</TABLE>
Over the last five years, ROYCE PREMIER HAS SUBSTANTIALLY OUTPERFORMED THE
RUSSELL 2000 on a risk-adjusted basis.
DOWN MARKET
PERFORMANCE
COMPARISON (Bar Graph)
(All Down Periods of 5% or Greater)
In Percentages (%)
Royce Russell
Premier 2000
2/12/92-7/8/92 0.0% -12.6%
3/18/94-12/9/94 -4.2% -13.3%
5/22/96-7/24/96 -6.4% -15.6%
1/22/97-4/25/97 0.3% -9.2%
Royce Premier's risk-averse investment orientation has resulted in strong
relative returns in down markets.
ROYCE PREMIER VERSUS RUSSELL 2000 (Line Graph)
Value of $10,000 Invested on 12/31/91*
Date RPR Rus
12/31/91 10000 10000
3/31/92 10160 10750
6/30/92 10140 10017
9/30/92 10440 10303
12/31/92 11580 11841
3/31/93 12125 12346
6/30/93 12608 12615
9/30/93 12923 13718
12/31/93 13784 14079
3/31/94 13891 13704
6/30/94 13741 13171
9/30/94 14258 14085
12/31/94 14236 13823
3/31/95 14851 14460
6/30/95 16103 15815
9/30/95 16807 17378
12/31/95 16774 17755
3/31/96 17339 18662
6/30/96 18022 19595
9/30/96 18469 19662
12/31/96 19813 20684
3/31/97 20041 19613
6/30/97 22705 22794
*Current year returns through June 30.
Includes reinvestment of distributions.
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<PAGE>
Performance & Portfolio Review
MARKET CAP EXPOSURE (Bar Graph)
Cap Size in millons % of Portfolio
[less than] $300 7%
$300-$500 37%
$500-$1,000 44%
[greater than] $1,000 12%
PORTFOLIO DIAGNOSTICS
Median Market Cap $586 million
Weighted Average P/E Ratio 17.5x
Weighted Average P/B Ratio 1.8x
Weighted Average Yield 1.1%
Net Assets $430 million
Turnover Rate 13%
Symbol RYPRX
The Fund's P/E and P/B ratios remained low.
<TABLE>
<CAPTION>
TOP TEN POSITIONS
% of Net Assets
<S> <C> <C>
1. Stanhome 3.2
2. Marshall Industries 3.1
3. Wesco Financial 2.9
4. Trenwick Group 2.9
5. New England
Business Service 2.7
6. Florida Rock Industries 2.7
7. The Standard Register Co. 2.3
8. The Pioneer Group 2.3
9. Charming Shoppes 2.2
10. CalMat 2.2
</TABLE>
Top 35 holdings represented 82% of equity
portfolio as of 6/30/97.
PORTFOLIO INDUSTRY BREAKDOWN (Pie Chart)
% of Net Assets*
Industrial Products 18
Financial Intermediaries 17
Retail 13
Industrial Services 12
Financial Services 12
Technology 8
Natural Resources 8
Consumer Products 7
Consumer Services 3
Health 2
*excludes cash and cash equivalents.
GOOD IDEAS THAT WORKED
<TABLE>
<CAPTION>
Security Realized and Unrealized Gain
- -------- ----------------------------
<S> <C>
Wesco Financial $5,364,100
Oakley 2,681,478
Stanhome 2,610,394
Family Dollar Stores 2,380,116
Marshall Industries 2,047,275
</TABLE>
During 1997's first half, the above companies made the largest positive
contributions, in dollar terms, to our overall performance. Among these
winners, there were no examples of hot new issues, high-priced takeovers or
momentum miracles. Rather, our top five performers emerged from a series of
long-term investment decisions. We built our positions when business
conditions were difficult and other investors had voted negatively on future
prospects.
GOOD IDEAS AT THE TIME
<TABLE>
<CAPTION>
Security Realized and Unrealized Loss
- -------- ----------------------------
<S> <C>
The Standard Register Company $543,375
Sotheby's Holdings Cl. A 481,300
The Pioneer Group 467,156
Charming Shoppes 455,176
Buffets 202,464
</TABLE>
Even the best small-cap companies can have periods of declining
performance. We believe if their balance sheets are strong and they have a
history of high internal returns, these companies will recover. We are
generally well-rewarded for our persistence, although market price rebounds
can take longer than we anticipated. Occasionally, we elect to redeploy the
assets into other opportunities. The above companies had the largest
negative impact on the Fund's performance.
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ROYCE MICRO-CAP FUND
WHAT WE DO Royce Micro-Cap Fund ("Micro-Cap") invests primarily in companies
with market capitalizations of $300 million or less. We believe the buying
opportunities in this sector have more potential for higher returns than any
other in the domestic equity market due to limited institutional attention and
research coverage.
HOW WE DID Although the Fund's micro-cap orientation was a hindrance in a market
which favored larger, more well-known companies, Royce Micro-Cap Fund managed to
match the small-cap oriented Russell 2000 index in the first six months of 1997
(10.1% vs. 10.2%). While near-term performance roughly paralleled that of the
Russell 2000, long-term performance is a different matter. Micro-Cap holds a
performance advantage over the Russell 2000 in both the five-year (18.6% vs.
17.9%) and since inception (18.2% vs. 16.2%) periods. The Fund, with $155
million in net assets, remains one of the few micro-cap funds with five years of
performance history and an investment manager with almost 25 years of micro-cap
experience. We strongly believe that managing risk is a key component to
delivering above-average returns in this volatile sector of the small-cap
market. Risk is typically evaluated in terms of uncertainty, by measuring fund
volatility through standard deviation and beta, and also in terms of possibility
of loss, by measuring actual down market performance. Micro-Cap's risk-averse
orientation has resulted in low risk rankings and solid down market performance
versus the Russell 2000 and its small-cap peers.
ROYCE MICRO-CAP FUND
TOTAL RETURNS
Through 6/30/97
- -----------------------------------
1997 (through 6/30) 10.1%
- -----------------------------------
1-Year 14.6%
- -----------------------------------
3-Year Average Annual 16.5%
- -----------------------------------
5-Year Average Annual 18.6%
- -----------------------------------
Since Inception (12/31/91) 18.2%
Average Annual
RISK/RETURN COMPARISON
Five-Year Period Ended 6/30/97
<TABLE>
<CAPTION>
Average Annual Standard
Total Return Deviation RUR
<S> <C> <C> <C>
Royce Micro-Cap 18.6% 9.2 2.02
Russell 2000 17.9% 12.3 1.45
</TABLE>
Over the last five years, Royce Micro-Cap has outperformed the Russell 2000 on
both an absolute and a risk-adjusted basis.
DOWN MARKET PERFORMANCE COMPARISON (Bar Graph)
(All Down Periods of 5% or Greater)
In Percentages (%)
Period Royce Micro-Cap Russell 2000
2/12/92-7/8/92 -1.5% -12.6%
3/18/94-12/9/94 -4.4% -13.3%
5/22/96-7/24/96 -8.7% -15.6%
1/22/97-4/25/97 -5.1% -9.2%
Royce Micro-Cap's risk-averse investment orientation has resulted in strong
relative returns in down markets.
ROYCE MICRO-CAP VERSUS RUSSELL 2000 (Line Graph)
Value of $10,000 Invested on 12/31/91*
Date RMC RUS
12/31/91 10000 10000
3/31/92 11100 10750
6/30/92 10700 10017
9/30/92 11421 10303
12/31/92 12941 11841
3/31/93 14184 12346
6/30/93 14207 12615
9/30/93 15316 13718
12/31/93 16004 14079
3/31/94 16127 13704
6/30/94 15855 13171
9/30/94 16770 14085
12/31/94 16572 13823
3/31/95 17185 14460
6/30/95 18464 15815
9/30/95 19717 17378
12/31/95 19731 17755
3/31/96 20544 18662
6/30/96 21906 19595
9/30/96 21172 19662
12/31/96 22798 20684
3/31/97 22602 19613
6/30/97 25095 22794
*Current year returns through June 30.
Includes reinvestment of distributions.
10
<PAGE>
PERFORMANCE & PORTFOLIO REVIEW
MARKET CAP EXPOSURE (Bar Graph)
Cap Size in millions % of Portfolio
- -------------------- --------------
less than $300 82%
$300-$500 16%
$500-$1,000 2%
greater than $1,000 0%
PORTFOLIO DIAGNOSTICS
- ---------------------
Median Market Cap $156 million
Weighted Average P/E Ratio 16.0x
Weighted Average P/B Ratio 1.6x
Weighted Average Yield 0.9%
Net Assets $155 million
Turnover Rate 22%
Symbol RYOTX
The Fund's P/E and P/B ratios remained low.
GOOD IDEAS THAT WORKED
<TABLE>
<CAPTION>
Security Realized and Unrealized Gain
- -------- ----------------------------
<S> <C>
Rykoff-Sexton $796,889
Willbros Group 689,081
Oshkosh B'Gosh Cl. A 646,740
Weyco Group 575,635
Performance Technologies 548,344
</TABLE>
During 1997's first half, the above companies made the largest positive
contributions, in dollar terms, to our overall performance. Among these
winners, there were no examples of hot new issues, high-priced takeovers or
momentum miracles. Rather, our top five performers emerged from a series of
long-term investment decisions. We built our positions when business
conditions were difficult and other investors had voted negatively on future
prospects.
<TABLE>
<CAPTION>
TOP TEN POSITIONS
% of Net Assets
<S> <C> <C>
1. Sevenson Environmental
Services 2.3
2. PXRE Corporation 1.7
3. Bassett Furniture Industries 1.5
4. Florida Rock Industries 1.5
5. BGS Systems, Inc. 1.4
6. Duff & Phelps Credit Rating 1.4
7. Oshkosh B'Gosh Cl. A 1.4
8. Pennsylvania
Manufacturers Cl. A 1.3
9. Johnson Worldwide
Associates Cl. A 1.3
10. PCA International 1.3
</TABLE>
PORTFOLIO INDUSTRY BREAKDOWN (Pie Chart)
% of Net Assets*
Industrial Products 22
Consumer Products 21
Industrial Services 16
Technology 13
Financial Intermediaries 9
Financial Services 6
Retail 5
Consumer Services 4
Natural Resources 2
Health 1
Utilities 1
*excludes cash and cash equivalents.
GOOD IDEAS AT THE TIME
<TABLE>
<CAPTION>
Security Realized and Unrealized Loss
- -------- ----------------------------
<S> <C>
Rush Enterprises $731,975
Open Plan Systems 477,505
Sagebrush 401,496
The Rival Company 345,426
Guy F. Atkinson Company 308,467
</TABLE>
Even the best small-cap companies can have periods of declining
performance. We believe if their balance sheets are strong and they have a
history of high internal returns, these companies will recover. We are
generally well-rewarded for our persistence, although market price rebounds
can take longer than we anticipated. Occasionally, we elect to redeploy the
assets into other opportunities. The above companies had the largest
negative impact on the Fund's performance.
11
<PAGE>
UPDATES & NOTES TO PERFORMANCE AND RISK INFORMATION
THE ROYCE FUNDS UNVEILS AN UPDATED WEB SITE
We want to draw your attention to our newly enhanced internet web site
(www.roycefunds.com) where you can find out more about our small and micro-cap
mutual fund offerings, obtain the most recent quarterly performance, and review
recent articles and Fund write-ups as well as up-to-the minute topics.
ROYCE & ASSOCIATES, INC. NAME CHANGE (FORMERLY QUEST ADVISORY CORP.)
We recently announced a name change of the Funds' Investment Adviser, from
Quest Advisory Corp. to Royce & Associates, Inc. The new name change more
closely identifies the name of the Adviser with that of the Funds that it
manages and recognizes the important contributions of the Adviser's associates.
NOTES TO PERFORMANCE AND RISK INFORMATION
All performance information is presented on a total return basis and
reflects the reinvestment of distributions. Past performance is no guarantee of
future results. Share prices will fluctuate, so that shares may be worth more or
less than their original cost when redeemed. This report is not authorized for
distribution unless preceded or accompanied by a current prospectus. Please read
the prospectus carefully before investing or sending money.
Morningstar proprietary ratings reflect historical risk-adjusted
performance as of 6/30/97 and are subject to change monthly. The rating is
calculated from a fund's three, five and ten-year average annual returns with
appropriate fee adjustments and a risk factor that reflects performance relative
to three-month Treasury bill returns. Royce Premier Fund received three and five
stars for the three- and five-year periods ended June 30, 1997 in the domestic
equity category out of 1,997 and 1,134 funds, respectively. Ten percent of the
funds in an investment category receive five stars, 22.5% receive four stars,
and 35% receive three stars. Morningstar risk ratio, beta and standard deviation
are measures of a fund's relative risk and are calculated for the trailing
36-month period. Morningstar proprietary risk ratio measures a fund's downside
volatility relative to all equity funds which have an average score of 1.00. The
lower the risk ratio, the lower a fund's downside volatility has been. Beta is a
measure of sensitivity to market movements compared to the unmanaged S&P 500
index, with the beta of the S&P 500 equal to 1.00. A low beta means that a
fund's market related volatility has been low. Standard deviation is a
statistical measure within which a fund's total returns have varied over time.
The greater the standard deviation, the greater a fund's volatility. The indices
referred to in this report are unmanaged indices of domestic common stocks.
12
<PAGE>
FINANCIAL STATEMENTS
Schedules of Investments 14-16
Statements of Assets and Liabilities 17
Statements of Changes in Net Assets 18
Statements of Operations and
Financial Highlights 19
Notes to Financial Statements 20
SCHEDULES OF INVESTMENTS
ROYCE PREMIER FUND June 30, 1997 (unaudited)
COMMON STOCKS - 85.8%
Shares Value
------ -----
CONSUMER PRODUCTS - 6.5%
Gibson Greetings* 346,100 $ 7,787,250
Juno Lighting 324,900 5,279,625
Oakley* 570,700 8,025,469
Sturm, Ruger & Company 343,900 6,749,037
---------
27,841,381
----------
CONSUMER SERVICES - 2.2%
Buffets* 611,785 5,161,936
Sbarro 160,800 4,462,200
---------
9,624,136
---------
FINANCIAL INTERMEDIARIES - 14.2%
The Commerce Group 351,600 8,658,150
Leucadia National Corporation 281,700 8,715,094
Orion Capital Corporation 64,900 4,786,375
Pennsylvania Manufacturers Cl. A 279,510 4,332,405
Trenwick Group 334,650 12,549,375
Wesco Financial 38,800 12,619,700
Zenith National Insurance 348,500 9,409,500
----------
61,070,599
----------
FINANCIAL SERVICES - 10.1%
E.W. Blanch Holdings 290,500 7,752,719
Crawford & Company Cl. A 373,350 5,740,256
Arthur J. Gallagher & Co. 244,200 9,218,550
The John Nuveen Company Cl. A 144,100 4,503,125
The Pioneer Group 423,600 9,742,800
Willis Corroon Group ADR+ 565,700 6,328,769
----------
43,286,219
----------
HEALTH - 2.0%
Haemonetics Corporation* 451,200 8,629,200
----------
INDUSTRIAL PRODUCTS - 15.4%
Curtiss-Wright Corporation 122,000 7,106,500
Fab Industries 162,000 5,072,625
P. H. Glatfelter Company 234,900 4,698,000
Kaydon Corporation 160,900 7,984,662
Lilly Industries Cl. A 461,400 9,285,675
The Lincoln Electric Company 187,800 7,183,350
The Standard Register Company 321,800 9,855,125
Unifi 160,400 5,994,950
Woodward Governor Company 251,956 9,070,416
----------
66,251,303
----------
INDUSTRIAL SERVICES - 10.2%
Air Express International 112,400 4,467,900
Arnold Industries 444,000 7,548,000
Bowne & Co. 174,000 6,068,250
DIMON Incorporated 235,200 6,232,800
Morrison Knudsen* 566,600 $ 7,719,925
New England Business Service 446,700 11,753,794
----------
43,790,669
----------
NATURAL RESOURCES - 6.6%
Tom Brown* 348,210 7,399,462
CalMat 440,500 9,470,750
Florida Rock Industries 288,700 11,728,438
----------
28,598,650
----------
RETAIL - 11.5%
Charming Shoppes* 1,840,700 9,606,153
The Dress Barn* 330,500 6,444,750
Family Dollar Stores 255,400 6,959,650
Sotheby's Holdings Cl. A 345,900 5,837,063
Stanhome 415,900 13,672,712
The Talbots 206,000 7,004,000
----------
49,524,328
----------
TECHNOLOGY - 7.1%
Dionex Corporation* 91,200 4,674,000
Electroglas* 197,000 4,961,937
Marshall Industries* 359,300 13,383,925
National Computer Systems 287,100 7,644,038
----------
30,663,900
----------
TOTAL COMMON STOCKS
(Cost $282,818,124) 369,280,385
-----------
U.S. TREASURY OBLIGATION - 3.3%
U.S. Treasury Notes, principal amount
$14,000,000, 7.00% due 4/15/99
(Cost $14,194,687) 14,220,920
----------
REPURCHASE AGREEMENT - 12.6%
State Street Bank and Trust Company,
5.15% dated 6/30/97, due 7/01/97,
maturity value $54,007,725, (collateralized
by U.S. Treasury Notes, 6% due 5/31/98,
valued at $55,080,110)
(Cost $54,000,000) 54,000,000
----------
TOTAL INVESTMENTS - 101.7%
(Cost $351,012,811) 437,501,305
LIABILITIES LESS CASH AND
OTHER ASSETS - (1.7)% (7,188,444)
----------
NET ASSETS - 100.0% $430,312,861
============
* Non-income producing.
+ American Depository Receipt.
INCOME TAX INFORMATION: The cost of total investments for federal income tax
purposes was $351,012,811. At June 30, 1997, net unrealized appreciation for all
securities amounted to $86,488,494, consisting of aggregate gross unrealized
appreciation of $88,860,787 and aggregate gross unrealized depreciation of
$2,372,293.
The accompanying notes are an integral part of the financial statements.
14
<PAGE>
SCHEDULES OF INVESTMENTS
ROYCE MICRO-CAP FUND June 30, 1997 (unaudited)
COMMON STOCKS - 91.9%
Shares Value
------ -----
CONSUMER PRODUCTS - 17.9%
Aldila* 240,000 $1,335,000
Bassett Furniture Industries 85,000 2,406,563
Conso Products Co.* 35,875 439,469
Fedders Corporation Cl. A 125,400 705,375
Garan Incorporated 33,200 668,150
Gibson Greetings* 45,000 1,012,500
J & J Snack Foods Corp.* 79,300 1,219,238
Jean-Philippe Fragrances* 162,500 1,015,625
Johnson Worldwide Associates Cl. A* 157,750 2,031,031
Justin Industries 18,900 240,975
Kit Manufacturing Co.* 32,200 305,900
Lifetime Hoan Corporation* 127,780 1,118,075
Lund International Holdings* 58,200 654,750
Midwest Grain Products* 116,800 1,547,600
Mity-Lite* 30,220 419,303
Oshkosh B'Gosh Cl. A 97,600 2,122,800
Pentech International* 220,600 551,500
The Rival Company 46,800 690,300
The Sirena Apparel Group* 110,000 330,000
The Smithfield Companies 33,800 371,800
Steck-Vaughn Publishing * 57,500 776,250
Thomaston Mills Cl. A 107,000 1,003,125
Thor Industries 60,800 1,512,400
The Topps Company* 442,500 1,852,969
Velcro Industries 22,700 1,861,400
Weyco Group 25,100 1,631,500
----------
27,823,598
----------
CONSUMER SERVICES - 4.2%
800-JR CIGAR 50,000 1,037,500
Cornell Corrections 70,400 1,161,600
Jenny Craig* 86,800 602,175
MovieFone Cl. A* 60,900 422,494
PCA International 99,900 1,998,000
Sagebrush* 157,200 805,650
Shoney's* 99,662 591,743
----------
6,619,162
----------
FINANCIAL INTERMEDIARIES - 8.4%
ALLIED Life Financial 56,650 1,118,838
BHI Corporation 30,500 671,000
Highlands Insurance Group* 57,100 1,149,137
Intercargo Corporation 75,900 891,825
Medical Assurance* 22,079 896,959
Nobel Insurance 53,750 799,531
Oriental Financial Group 35,000 988,750
PXRE Corporation 83,524 2,568,363
Pennsylvania Manufacturers Cl. A 135,072 2,093,616
Piper Jaffray Companies 15,700 321,850
RLI Corp. 23,200 845,350
Trenwick Group 18,900 708,750
----------
13,053,969
----------
FINANCIAL SERVICES - 5.3%
E.W. Blanch Holdings 46,100 1,230,294
Duff & Phelps Credit Rating 72,500 2,202,188
Eaton Vance Corp. 30,000 834,375
Investors Financial Services 16,774 $ 796,765
Old Guard Group 79,900 1,203,494
Phoenix Duff & Phelps 231,000 1,703,625
U.S. Global Investors Cl. A* 137,000 286,844
----------
8,257,585
----------
HEALTH - 1.2%
Hauser* 73,900 397,212
Life Technologies 18,800 521,700
Nitinol Medical Technologies* 63,300 957,413
----------
1,876,325
----------
INDUSTRIAL PRODUCTS - 18.6%
American Buildings Company* 38,000 1,026,000
American Filtrona 46,800 1,918,800
BHA Group 66,539 1,230,972
Blessings Corporation 64,100 665,037
CFC International* 91,800 895,050
Carbo Ceramics 44,000 1,199,000
Chemfab Corporation* 56,400 1,184,400
Curtiss-Wright Corporation 15,900 926,175
DeVlieg-Bullard* 395,400 1,359,187
Fab Industries 59,700 1,869,356
Falcon Products 84,000 1,128,750
Hawkins Chemical 138,226 1,140,365
Holophane Corporation* 13,000 260,000
International Aluminum 42,700 1,131,550
Knape & Vogt Manufacturing 16,900 270,400
Mestek* 15,000 309,375
Myers Industries 58,800 992,250
Oregon Steel Mills 33,300 663,919
Oshkosh Truck Corporation Cl. B 71,600 1,020,300
Penn Engineering and Manufacturing 73,300 1,438,512
Puerto Rican Cement Company 40,900 1,331,806
Quaker Chemical 10,450 181,569
Shorewood Packaging* 64,700 1,471,925
Simpson Manufacturing Co.* 50,800 1,346,200
Special Metals Corporation 55,000 1,072,500
Synalloy Corporation 73,700 1,298,963
Versa Technologies 23,500 370,125
Woodward Governor Company 31,648 1,139,328
----------
28,841,814
----------
INDUSTRIAL SERVICES - 14.7%
Aceto Corporation 29,700 434,362
AirNet Systems* 98,800 1,617,850
Guy F. Atkinson Company* 96,000 670,500
Circle International Group 51,300 1,353,038
Devcon International* 62,400 288,600
Frozen Food Express Industries 170,250 1,468,406
Insituform Technologies Cl. A* 212,500 1,301,562
Jaco Electronics* 74,600 536,188
Kenan Transport 33,430 681,136
Lufkin Industries 30,500 800,625
Merrill Corporation 30,900 1,123,987
New England Business Service 42,300 1,113,019
Open Plan Systems* 100,600 402,400
Perini Corporation* 72,700 536,163
15
<PAGE>
SCHEDULES OF INVESTMENTS
ROYCE MICRO-CAP FUND June 30, 1997 (unaudited)
Shares Value
------ -----
INDUSTRIAL SERVICES - (continued)
Rush Enterprises* 127,300 $ 795,625
Rykoff-Sexton 81,400 1,897,637
Sevenson Environmental Services 184,000 3,588,000
Standard Commercial* 77,633 1,348,873
Vallen Corporation* 64,000 1,168,000
Willbros Group* 111,400 1,768,475
----------
22,894,446
----------
NATURAL RESOURCES - 2.0%
Florida Rock Industries 56,000 2,275,000
MK Gold Company* 517,900 809,219
----------
3,084,219
----------
RETAIL - 3.9%
The Bombay Company* 73,000 365,000
Catherines Stores Corporation* 135,000 506,250
Cato Corporation Cl. A 114,500 622,594
Chico's FAS* 73,100 388,344
Deb Shops 113,700 454,800
Garden Ridge* 5,000 62,500
Lechters* 237,300 1,038,187
Mikasa Cl. B 47,700 679,725
Suzy Shier 140,000 912,415
Urban Outfitters* 72,500 1,015,000
----------
6,044,815
----------
TECHNOLOGY - 10.6%
BGS Systems, Inc. 81,200 2,233,000
CEM Corporation* 85,700 739,162
CSP* 95,805 712,550
DH Technology* 112,200 1,823,250
Giga-tronics* 18,000 126,000
ILC Technology* 148,220 1,593,365
Kentek Information Systems 72,400 561,100
Landauer 36,200 839,387
MacNeal-Schwendler 102,600 $ 1,115,775
Newport Corporation 110,300 1,240,875
PCD* 57,900 1,013,250
Performance Technologies* 108,000 1,647,000
Richardson Electronics 228,000 1,895,250
Technical Communications* 63,600 568,425
Woodhead Industries 17,900 337,863
----------
16,446,252
----------
UTILITIES - 0.4%
Southern Union Company* 25,725 588,459
----------
MISCELLANEOUS - 4.7% 7,314,515
----------
Total Common Stocks
(Cost $120,898,844) 142,845,159
-----------
REPURCHASE AGREEMENT - 7.1%
State Street Bank and Trust Company,
5.15% dated 6/30/97, due 7/01/97,
maturity value $11,001,574,
collateralized by U.S. Treasury Notes,
6% due 5/31/98, valued at $11,222,447)
(Cost $11,000,000) 11,000,000
----------
TOTAL INVESTMENTS - 99.0%
(Cost $131,898,844) 153,845,159
CASH AND OTHER ASSETS LESS
LIABILITIES - 1.0% 1,578,783
----------
NET ASSETS - 100.0% $155,423,942
============
* Non-income producing.
INCOME TAX INFORMATION: The cost of total investments for federal income tax
purposes was $131,898,844. At June 30, 1997, net unrealized appreciation for all
securities amounted to $21,946,315, consisting of aggregate gross unrealized
appreciation of $28,542,182 and aggregate gross unrealized depreciation of
$6,595,867.
The accompanying notes are an integral part of the financial statements.
16
<PAGE>
<TABLE>
STATEMENTS OF ASSETS AND LIABILITIES June 30, 1997 (unaudited)
<CAPTION>
Royce Royce
Premier Micro-Cap
Fund Fund
------- ---------
<S> <C> <C>
ASSETS:
Investments at value (identified cost $297,012,811
and $120,898,844, respectively) $ 383,501,305 $ 142,845,159
Repurchase agreements (at cost and value) 54,000,000 11,000,000
Cash 561,385 917,598
Receivable for investments sold - 1,403,496
Receivable for capital shares sold 3,204,469 335,709
Receivable for dividends and interest 809,389 127,870
Prepaid expenses and other assets 26,408 11,375
- ----------------------------------------------------------------------------------------
Total Assets 442,102,956 156,641,207
- ----------------------------------------------------------------------------------------
LIABILITIES:
Payable for investments purchased 11,127,272 888,438
Payable for capital shares redeemed 196,588 153,456
Payable for investment advisory fees 331,706 103,576
Accrued expenses 134,529 71,795
- ----------------------------------------------------------------------------------------
Total Liabilities 11,790,095 1,217,265
- ----------------------------------------------------------------------------------------
Net Assets $ 430,312,861 $ 155,423,942
- ----------------------------------------------------------------------------------------
ANALYSIS OF NET ASSETS:
Undistributed net investment income $ 2,474,161 $ -
Net investment loss - (39,649)
Accumulated net realized gain on investments 12,940,808 8,251,465
Net unrealized appreciation on investments 86,488,494 21,946,315
Capital shares 48,066 17,340
Additional paid-in capital 328,361,332 125,248,471
- ----------------------------------------------------------------------------------------
Net Assets $ 430,312,861 $ 155,423,942
========================================================================================
SHARES OUTSTANDING:
(unlimited number of $.001 par value
shares authorized for each Fund) 48,065,798 17,340,358
========================================================================================
NET ASSET VALUE:
(offering and redemption price per share) $8.95 $8.96
========================================================================================
The accompanying notes are an integral part of the financial statements.
</TABLE>
17
<PAGE>
<TABLE>
STATEMENTS OF CHANGES IN NET ASSETS
<CAPTION>
Royce Premier Fund Royce Micro-Cap Fund
Six Months ended Year ended Six Months ended Year ended
June 30, 1997 December 31, June 30, 1997 December 31,
INVESTMENT OPERATIONS: (unaudited) 1996 (unaudited) 1996
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net investment income (loss) $ 2,136,407 $ 3,667,544 $ (39,649) $ (249,051)
Net realized gain on investments 10,113,592 19,648,625 6,198,825 11,111,467
Net change in unrealized appreciation on investments 38,671,243 25,537,270 7,924,397 7,205,618
- ------------------------------------------------------------------------------------------------------------------------------------
Net increase in net assets from investment operations 50,921,242 48,853,439 14,083,573 18,068,034
- ------------------------------------------------------------------------------------------------------------------------------------
DIVIDENDS AND DISTRIBUTIONS:
Net investment income - (3,591,631) - (65,526)
Net realized gain on investments - (17,598,880) - (8,942,087)
- ------------------------------------------------------------------------------------------------------------------------------------
Total dividends and distributions - (21,190,511) - (9,007,613)
- ------------------------------------------------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS:
Net proceeds from shares sold 103,264,365 90,607,839 25,017,476 61,828,569
Dividends reinvested - 19,896,838 - 8,414,310
Cost of shares redeemed (40,896,402) (123,383,399) (25,006,147) (35,703,495)
- ------------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in net assets from
capital share transactions 62,367,963 (12,878,722) 11,329 34,539,384
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS 113,289,205 14,784,206 14,094,902 43,599,805
NET ASSETS:
Beginning of period 317,023,656 302,239,450 141,329,040 97,729,235
- ------------------------------------------------------------------------------------------------------------------------------------
End of period $430,312,861 (a) $317,023,656 (a) $155,423,942 (b) $141,329,040(b)
- ------------------------------------------------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS:
Shares sold 12,575,838 12,081,905 3,002,408 7,781,266
Shares issued for reinvestment of dividends
and distributions - 2,594,157 - 1,050,757
Shares redeemed (c) (5,103,767) (16,508,230) (3,031,296) (4,433,643)
- ------------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in shares outstanding 7,472,071 (1,832,168) (28,888) 4,398,380
- ------------------------------------------------------------------------------------------------------------------------------------
(a) Includes undistributed net investment income of $2,474,161 in 1997 and $337,754 in 1996.
(b) Includes net investment loss of $(39,649) in 1997 and $0 in 1996.
(c) Shares redeemed within one year of purchase are subject to a 1% redemption fee,
payable to the Funds, which is used to offset costs associated with the redemption.
The accompanying notes are an integral part of the financial statements.
</TABLE>
18
<PAGE>
<TABLE>
STATEMENTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 1997 (UNAUDITED)
<CAPTION>
Royce Royce
Premier Micro-Cap
INVESTMENT INCOME: Fund Fund
------- --------
<S> <C> <C>
INCOME:
Dividends $ 2,816,389 $ 989,471
Interest 1,480,235 89,807
- --------------------------------------------------------------------------------------------------------------------
Total Income 4,296,624 1,079,278
- --------------------------------------------------------------------------------------------------------------------
EXPENSES:
Investment advisory fees 1,735,012 1,053,255
Custodian and shareholder servicing fees 168,480 90,816
Administrative and office facilities expenses 112,046 47,136
Professional fees 1,045 10,631
Trustees' fees 24,881 11,106
Other expenses 150,061 89,130
- --------------------------------------------------------------------------------------------------------------------
Total Expenses 2,191,525 1,302,074
Fees Waived by Investment Adviser (31,308) (183,147)
- --------------------------------------------------------------------------------------------------------------------
Net Expenses 2,160,217 1,118,927
- --------------------------------------------------------------------------------------------------------------------
Net Investment Income (Loss) 2,136,407 (39,649)
- --------------------------------------------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN ON INVESTMENTS:
Net realized gain on investments 10,113,592 6,198,825
Net change in unrealized appreciation on investments 38,671,243 7,924,397
- --------------------------------------------------------------------------------------------------------------------
Net realized and unrealized gain on investments 48,784,835 14,123,222
- --------------------------------------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS FROM INVESTMENT OPERATIONS $50,921,242 $ 14,083,573
- --------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of the financial statements.
</TABLE>
<TABLE>
FINANCIAL HIGHLIGHTS June 30, 1997 (unaudited)
This table is presented to show selected data for a share outstanding throughout each period, and to assist shareholders in
evaluating the Funds' performance for the periods presented.
<CAPTION>
Net Asset Value, Net Investment Net Realized and Dividends from Distributions from Net Asset Net Assets,
Beginning Income Unrealized Gain on Net Investment Net Realized Gain Value, End Total End of Period
of Period (Loss) Investments Income on Investments of Period Return (in thousands)
ROYCE PREMIER FUND (a)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
+1997 $7.81 $ 0.04 $1.10 $ - $ - $8.95 14.6% $430,313
1996 7.12 0.10 1.18 (0.10) (0.49) 7.81 18.1% 317,024
1995 6.48 0.10 1.05 (0.09) (0.42) 7.12 17.8% 302,239
1994 6.41 0.06 0.15 (0.05) (0.09) 6.48 3.3% 202,390
1993 5.52 0.02 1.03 (0.02) (0.14) 6.41 19.0% 47,143
1992 5.00 0.02 0.77 (0.02) (0.25) 5.52 15.8% 2,329
ROYCE MICRO-CAP FUND (b)
+1997 $8.14 $ $0.82 $ - $ - $8.96 10.1% $155,424
1996 7.53 (0.01) 1.17 - (0.55) 8.14 15.5% 141,329
1995 6.48 - 1.24 - (0.19) 7.53 19.1% 97,729
1994 6.47 - 0.23 - (0.22) 6.48 3.6% 26,774
1993 5.83 - 1.38 - (0.74) 6.47 23.7% 10,261
1992 5.00 (0.01) 1.48 - (0.64) 5.83 29.4% 3,373
(a)Expense ratios are shown after fee waivers by the investment adviser. For the
periods ended June 30, 1997, and December 31, 1996, 1993 and 1992, the expense
ratios before the waivers would have been 1.26%, 1.28%, 1.68%, and 4.17%,
respectively.
(b)Expense ratios are shown after fee waivers by the investment adviser. For the
periods ended June 30, 1997, and December 31, 1996, 1995, 1994, 1993 and 1992,
the expense ratios before the waivers would have been 1.85%, 1.87%, 1.97%,
2.34%, 2.49%, and 3.77%, respectively.
* Annualized.
** For fiscal years beginning on or after October 1, 1995, the Fund is required
to disclose its average commission rate paid per share for purchases and sales
of investments.
+ Six months ended June 30, 1997.
</TABLE>
19
<PAGE>
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Royce Premier Fund and Royce Micro-Cap Fund ("Fund" or "Funds") are two series
of The Royce Fund (the "Trust"), a diversified open-end management investment
company. The Trust, originally established as a business trust under the laws of
Massachusetts, converted to a Delaware business trust at the close of business
on June 28, 1996. The Funds commenced operations on December 31, 1991.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of income and expenses during the reporting period. Actual
results could differ from those estimates.
Valuation of investments:
Securities listed on an exchange or on the Nasdaq National Market System are
valued on the basis of the last reported sale prior to the time the valuation is
made or, if no sale is reported for such day, at their bid price for
exchange-listed securities and at the average of their bid and asked prices for
Nasdaq securities. Quotations are taken from the market where the security is
primarily traded. Other over-the-counter securities for which market quotations
are readily available are valued at their bid price. Securities for which market
quotations are not readily available are valued at their fair value under
procedures established and supervised by the Board of Trustees. Bonds and other
fixed income securities may be valued by reference to other securities with
comparable ratings, interest rates and maturities, using established independent
pricing services.
Investment transactions and related investment income:
Investment transactions are accounted for on the trade date and dividend income
is recorded on the ex-dividend date. Interest income is recorded on the accrual
basis. Realized gains and losses from investment transactions and unrealized
appreciation and depreciation are determined on the basis of identified cost for
book and tax purposes.
Expenses:
Expenses directly attributable to each Fund are charged to that Fund's
operations while expenses which are applicable to all Funds are allocated in an
equitable manner.
Taxes:
As qualified regulated investment companies under Subchapter M of the Internal
Revenue Code, the Funds are not subject to income taxes to the extent that each
Fund distributes substantially all of its taxable income for its fiscal year.
The Schedules of Investments include information regarding income taxes under
the caption "Income Tax Information."
Distributions:
Any dividend and capital gain distributions are recorded on the ex-dividend date
and paid annually in December. These distributions are determined in accordance
with income tax regulations which may differ from generally accepted accounting
principles. Permanent book and tax basis differences relating to shareholder
distributions will result in reclassification to paid-in capital and may affect
net investment income per share. Undistributed net investment income may include
temporary book and tax basis differences which will reverse in a subsequent
period. Any taxable income or gain remaining at fiscal year end is distributed
in the following year.
Repurchase agreements:
The Funds enter into repurchase agreements with respect to portfolio securities
solely with State Street Bank and Trust Company ("SSB&T"), the custodian of the
Funds' assets. Each Fund restricts repurchase agreements to maturities of no
more than seven days. Securities pledged as collateral for repurchase agreements
are held by SSB&T until maturity of the repurchase agreements. Repurchase
agreements could involve certain risks in the event of default or insolvency of
SSB&T, including possible delays or restrictions upon the ability of each Fund
to dispose of its underlying securities.
INVESTMENT ADVISER:
Under the Trust's investment advisory agreement with Royce & Associates, Inc.
("Royce") (formerly Quest Advisory Corp.), Royce is paid a monthly fee at an
annual rate of 1.0% and 1.50% of the average net assets of Royce Premier Fund
and Royce Micro-Cap Fund, respectively. For the six months ended June 30, 1997,
Royce Premier Fund and Royce Micro-Cap Fund recorded advisory fees of $1,703,704
(net of voluntary waivers of $31,308) and $870,108 (net of voluntary waivers of
$183,147), respectively.
PURCHASE AND SALES OF INVESTMENT SECURITIES:
For the six months ended June 30, 1997, the cost of purchases and the proceeds
from sales of investment securities, other than short-term securities, were as
follows:
<TABLE>
<CAPTION>
Royce Premier Fund Royce Micro-Cap Fund
------------------ --------------------
<S> <C> <C>
Purchases $ 90,711,254 $ 30,001,261
Sales $ 40,879,911 $ 35,923,383
</TABLE>
20
<PAGE>
So while the "bulls" of both basketball and the market may reach dazzling new
heights this year, we will continue to hone our approach and emphasize building
returns over the long term.
Postscript
ALL THAT JAZZ
[ GRAPHIC OMITTED ]
Basketball on top of first paragraph of text
This year's National Basketball Association Championship Finals pitted the
high-flying exploits of Michael Jordan and the Chicago Bulls against the Utah
Jazz. The appearance this year of the Jazz represented the culmination of over a
decade's work for two of the game's premier players, John Stockton and league
MVP Karl Malone. To achieve a consistent level of success, these two players
have relied on a style of play that is the complete antithesis of Jordan & Co.'s
acrobatic airborne style. The Jazz are patient; they rely on the fundamentals of
intelligent ballhandling and passing, smart shot selection and tough defense.
Their two stalwarts, Stockton & Malone, specialize in one of basketball's
oldest and most reliable plays, the pick and roll. Stockton dribbles the ball
toward the 6'10" Malone, who sets the "pick," standing in the way of the player
defending the smaller, quicker Stockton, in effect taking that in effect taking
that opponent out of the play. Malone then "rolls" toward the basket to receive
a pass from Stockton and make an easy score. This formula has been confounding
the team's opponents for years, in spite of the fact that every team the Jazz
plays knows what is coming. The key to the duo's success lies in their
execution, in their ability to master a fundamentally sound approach.
You might describe the fundamental approach we bring to small-cap value
investing as our version of the pick and roll. Whether in basketball or stock
selection, each approach hinges on two elements working closely in sync with one
another to achieve success. We employ the "pick" on small-cap stocks with the
"roll" toward a disciplined value approach. Consistent application over the
years may have made what we do predictable, but we have been no less successful
for being so. For over twenty years, we have emphasized the fundamentals of
investing when looking for small company stocks. As value investing continues to
"score points" with solid returns in 1997, we are witnessing what looks like a
return to a period of higher volatility. This environment gives us the
"home-court advantage," as a more volatile market demands active management and
closer attention to risk factors. The importance we place on a company's
financial characteristics at the time of purchase is the essential element to
our risk-averse value approach.
<PAGE>
WHY VALUE INVESTORS RELY ON
THE ROYCE FUNDS
o ONE OF THE MOST WELL-RESPECTED AND OLDEST SMALL-CAP INVESTMENT MANAGERS WITH
A VALUE ORIENTATION - We are an independent small-cap manager with over 20
years of investment management experience. Based in New York, Royce has more
than $2 billion in total assets under management - all dedicated to small
and micro-cap value investing. We offer a full range of small-cap, open-end
mutual funds and closed-end funds, providing investors and advisors with a
wide variety of small-cap alternatives.
o DEDICATED PROFESSIONALS WITH A SINGULAR FOCUS - Over the last 20 years, we
have built substantial trading and research relationships in an attempt to
provide shareholders with the best possible small-cap portfolios available.
Our time-tested investment approach is supported by 12 professionals.
Charles M. Royce, Chief Investment Officer, remains the primary portfolio
manager.
o REALISTIC EXPECTATIONS AND CONSISTENT RESULTS - Royce Premier, Royce Total
Return and Pennsylvania mutual are consistently ranked among the "lowest
risk" small-cap equity funds available. We offer a systematic and
disciplined investment approach that avoids style and capitalization drift.
All the funds seek to provide above average full market cycle total returns
with below average risk.
o CO-OWNERSHIP OF FUNDS - We believe it is important for our employees'
financial interests to be congruent with our shareholders' financial
interests. The Firm's officers and employees currently have more than $30
million invested in the Funds.
VALUE INVESTING IN SMALL COMPANIES FOR OVER 20 YEARS
For General Information, Advisor Services
Additional Report Copies For Fund Materials, Performance Updates,
& Prospectus Inquiries Transactions or Account Inquiries
(800) 221-4268 (800) 59-ROYCE (597-6923)
Shareholder Services Automated Telephone Services
(800) 841-1180 (800) 78-ROYCE (787-6923)
E-mail: [email protected]
The Royce Funds 1414 Avenue of the Americas New York, NY 10019
This report must be accompanied by or preceded by a current prospectus of
each of the Funds. Please read the prospectus carefully before investing or
sending money.
