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Value Investing in Small Companies For Over 20 Years
THE
ROYCE
FUNDS
Royce Premier Fund
Royce Micro-Cap Fund
1996 Annual Report
www.roycefunds.com
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The Royce Funds
When we took over the management of Pennsylvania Mutual Fund in mid-1973,
small-cap stocks were those under $300 million in market capitalization, not
under $1 billion as they are now defined. This considerable capitalization drift
has permanently changed the small-cap landscape. Small-cap stocks are no longer
"small" by previous standards; no longer "unknown" given that the sector is now
regarded as a professional asset class; and no longer "under-owned" as the
number of small-cap mutual fund offerings has grown to well over 400.
Two Distinct Markets
Given the changes in the small-cap universe (most of which have occurred since
1991), we believe that the small-cap market should now be viewed as two markets
in one: small-cap at the upper end and micro-cap at the lower end of the
capitalization range.
<TABLE>
<S> <C> <C>
Different
performance
SMALL-CAP MICRO-CAP
$300 million - $1 billion $5 million - $300 million Different
1,400 companies 6,500 companies liquidity
$810 billion total capitalization $470 billion total capitalization
Different
institutional
acceptance
</TABLE>
Two Core Funds: Distinct Strategies For Distinct Markets
The Firm uses a two pronged approach, which incorporates both the small and
micro-cap investment universes. We believe that higher portfolio concentration
is necessary for delivering above average results at the upper end and that
diversification is both necessary and appropriate at the lower end. These two
Funds represent The Royce Funds' core investment strategies.
<TABLE>
<S> <C> <C>
ROYCE PREMIER ROYCE MICRO-CAP The Royce Funds'
- Small-cap orientation - Micro-cap orientation two core
- Concentrated portfolio - Broadly diversified philosophies
</TABLE>
Combined Portfolios
Portfolios incorporate approximately equal weightings of each capitalization
(small and micro-cap) strategy.
<TABLE>
<S> <C> <C>
The Pennsylvania
Pennsylvania Mutual Mutual Fund
PMF II blended style of
Royce Value investing
Royce GiftShares remains our
flagship approach.
</TABLE>
Stock Selection - Company And Sector Specific Themes
Stock selection for The Royce Funds incorporates low valuation securities with
attractive risk/reward characteristics. These valuation principles are combined
with specific company attributes, such as assets, dividends, cash flow, markets
and price. The Royce Funds have introduced some of these opportunistic, company
specific, selection themes in funds. Virtually all securities used by these
funds are also found in the core portfolios.
Royce Low-Priced Royce Total Return Royce Global Services
'ch' Stocks under $15 Royce Equity Income 'ch' Globally oriented service
companies
'ch' Dividend-paying securities
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THE
ROYCE
FUNDS
Dear Fellow Shareholders:
We are pleased to present our 1996 investment results and
our new Annual Report format. Included in this Report are
Royce Premier and Royce Micro-Cap performance,
diagnostics, financial statements and a shareholder
letter. This new, combined Annual Report reflects specific
capitalization strategies and selection theme groupings,
around which the individual fund portfolios are managed
and displayed (as shown on the front inside cover).
The year was a good one in terms of absolute and relative
performance, and consistent with our long held tenet -
when a disciplined value approach is combined with small
company investing, above average returns with lower
volatility are possible. This core belief has formed the [Photo]
basis for our approach which emphasizes risk management
and consistency of application. We believe that a system
for rational decision making, whose basic premise is that Charles M. Royce,
the price one pays for an investment makes a significant President and Chief
difference in the returns one receives, is more important Investment Officer
than ever.
1996 PERFORMANCE RESULTS
We invite your comments. THRU 12/31/96: ROYCE PREMIER ROYCE MICRO-CAP
------------- ---------------
Sincerely,
CHARLES M. ROYCE Last 3 months 7.3% 7.7%
Charles M. Royce Last 6 months 9.9% 4.1%
President 1996 18.1% 15.5%
ANNUAL REPORT REFERENCE GUIDE
Royce Premier substantially outperformed the Russell 2000 on a risk adjusted
basis...SEE PAGE 5.
Price to book and price earnings ratios remained low for Royce Premier...SEE
PAGE 6.
Royce Micro-Cap outperformed the Russell 2000 on both an absolute and risk
adjusted basis...SEE PAGE 7.
Consumer products, industrial products and industrial services are Royce
Micro-Cap's top three industry
sectors...SEE PAGE 8.
For Statements of Assets and Liabilities, Statements of Operations,
Statements of Changes in Net Assets and
Financial Highlights...SEE PAGES 9-12.
See Accompanying Schedules of Investments.
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The Royce Funds
Value Investing in Small Companies for
Over 20 Years
1414 Avenue of the Americas
New York, NY 10019
(212) 355-7311
(800) 221-4268
Dear Shareholder:
SMALL-CAP SECURITIES WERE BULLIED IN 1996 FOR A THIRD STRAIGHT
YEAR BY THEIR LARGE-CAP BRETHREN. After running even in the first [MAN]
six months, small-cap stocks fell behind in the more volatile second
half. For the full year, the Russell 2000 Index of small-cap stocks was up 16.5%
versus a gain of 23.0% for the large-cap oriented S&P 500 Index.
Perhaps the more interesting story in 1996 was the return of market
volatility. The Russell 2000 recorded four down months in 1996, twice as many as
in 1995. According to the independent mutual fund evaluation service
Morningstar, 361 mutual funds, or 16% of the 2,255 diversified funds that invest
primarily in domestic stocks, lost money in the fourth quarter, as did one of
every three small-cap funds. More funds were in the red for the fourth quarter
than in the previous three quarters combined. We believe that a higher level of
volatility often precedes a period of lower returns.
Combined with increased volatility was a change in market leadership among
small-cap stocks during the second half. The value style of investing, which was
the market laggard earlier in the year, became a market leader during the latter
half. From the first of the year through the Russell 2000 peak on May 22, the
Russell 2000 Value Index was up 10.3% while the Russell 2000 Growth Index was up
a robust 20.9%. However, from this peak in May through year-end, the Russell
2000 Value Index recorded a gain of 10.1% versus a decline of 8.0% for the
Russell 2000 Growth Index, quite a reversal of events and perhaps a harbinger
for the market in 1997.
The performance of Royce Premier Fund ('Premier') and Royce Micro-Cap Fund
('Micro-Cap') in 1996 reflected these trends, as described in the following
E-Mail that we received from a Royce Fund shareholder:
Job well done. At the beginning of 1996, all of my small-cap funds were
screaming up in value (+3%) except Royce Micro-Cap & Royce Premier. I told
myself that the Royce funds would soon catch them with an explosive move upward,
but you know what, they never did shake the earth with newsworthy jumps in NAV.
Something (else) happened as the year moved along. THE ROYCE FUNDS slowly and
methodically moved up in value while my other small-cap funds were slipping
fast. As the year ende, my Royce funds came out ahead of all but one of my other
small-cap funds, without any gut-wrenching moves up or down.
We have about 10% of our money with your funds, and we look forward to future
dealings with The Royce Funds.
THE THRILL OF REWARD AND THE DENIAL OF RISK
Investment risk and reward are rarely discussed together, as investors
typically focus on one or the other at a time. When times are good, the return
portion of the equation dominates investors' conversations, and when times are
bad, the risk portion moves to center stage. Although the most recent small-cap
cycle clearly favored the 'return' component, the 'risk' segment is always
worthy of equal consideration because it impacts the path of long-term returns.
Risk involves both uncertainty and possibility of loss. Both aspects are
measurable, and both are paramount to the Funds' management philosophy.
To simplify matters, 'uncertainty' relates to fund volatility and is best
measured using two gauges, standard deviation and beta. As the table following
indicates, for the last three years both Premier and Micro-
Cap were among the 'lowest risk' small-cap funds tracked by Morningstar.
1
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MORNINGSTAR RISK*
Premier Micro-Cap
Rank Rank
---- ----
Standard Deviation 4 24
Beta 3 4
Mstar Risk Ratio 4 38
* As of December 31, 1996, Ranking from lowest to highest
out of 242 funds in Morningstar's small-cap objective
category with at least 3 years of history. Please read the
Prospectus for a more complete discussion of risk.
'Possibility of loss' is perhaps more important than statistical measures of
volatility because it takes into account a fund's actual down market results.
Morningstar Risk Ratio actually measures the concept of possibility of loss more
effectively because it considers a fund's underperformance (on a monthly basis)
relative to a safe and attainable return (3-month Treasury bills). As shown
above, both Funds can be considered 'low risk' using this methodology.
While we use various techniques to reduce risk, we cannot prevent the Funds'
net asset values from going down during market downdrafts. However, both Funds
typically have not gone down as much during difficult periods when compared to
their benchmark index, the Russell 2000. Since the Funds' inception on December
31, 1991, there have only been four down quarters for the Russell 2000. IN ALL
CASES, PREMIER AND MICRO-CAP OUTPERFORMED THE INDEX.
RUSSELL 2000 DOWN QUARTER PERFORMANCE
COMPARISON SINCE INCEPTION
QTR RUSSELL
ENDED: 2000 PREMIER MICRO-CAP
------ ---- ------- ---------
12/31/94 -1.9% -0.2% -1.2%
6/30/94 -3.9 -1.1 -1.7
3/31/94 -2.7 +0.8 +0.8
6/30/92 -6.8 -0.2 -3.6
BOTH PREMIER AND MICRO-CAP OUTPERFORMED
RUSSELL 2000 IN ALL FOUR DOWN QUARTERS.
Our focus on risk management remains an important part of our investment
process. While individual market phases reward different risk profiles at
different times, central to the management of the Funds is a belief that PAYING
ATTENTION TO RISK DOES NOT DIMINISH LONG-TERM RETURNS. Although this flies in
the face of modern portfolio theory, it remains one of our principal tenets.
WITHIN THE SMALL-CAP UNION:
ONE COUNTRY, TWO COASTS AND MANY STATES
Many changes have taken place in the small-cap
investment universe over the last ten years and [MAP OF UNITED STATES]
we now believe that small-cap stocks are no longer 'small' by previous
standards; no longer 'unknown' as this sector is now regarded as a professional
asset class; and no longer 'under-owned' as the number of small-cap mutual fund
portfolios has grown to well over 400. What were once deemed small-cap stocks
(under $300 million in market cap) ten years ago and beyond, are now better
defined as 'micro-cap' securities by today's standards. The small-cap universe,
which is presently defined as under $1 billion in market cap, is both broad
(over 7,900 issues) and substantial ($1.3 trillion in total capitalization) and
as different and diverse as California and Rhode Island.
THIS LEADS TO AN IMPORTANT, BUT UNRECOGNIZED, ASPECT OF THE SMALL-CAP MARKET
- -- IT IS REALLY TWO MARKETS IN ONE: SMALL-CAP AT THE UPPER END AND MICRO- CAP AT
THE LOWER END OF THE CAPITALIZATION RANGE. On the surface, the distinction may
seem subtle but upon further investigation the differences are real and
quantifiable.
Given the substantial differences in performance, liquidity and institutional
acceptance within the two markets of the small-cap universe, we have developed
distinct approaches, and funds, for each. (See diagram at the top of the next
page.)
At the upper end of the small-cap range, from $300 million to $1 billion, we
employ a focused portfolio strategy in Royce Premier Fund which emphasizes
companies with superior financial characteristics and/or unusually attractive
business prospects. We believe that a strategy which holds a limited number of
securities is an appropriate strategy to offset the increasing efficiencies
found in this segment of the small-cap market.
2
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<PAGE>
TWO DISTINCT MARKETS
<TABLE>
<S> <C> <C>
SMALL-CAP MICRO-CAP Different
$300 million - $1 billion $5 million - $300 million performance
1,400 companies 6,500 companies
$810 billion total capitalization $470 billion total capitalization Different
liquidity
Different
institutional
acceptance
</TABLE>
At the other end of the capitalization range, below $300 million, are
micro-cap securities, the antithesis of what most professional investors look
for. These securities, unlike those in the upper tier, are generally not well-
known, not well-researched and not easy to buy and sell. However, these are
precisely the conditions that we believe breed good investment opportunities. In
this sector, we use a broadly diversified portfolio strategy in Royce Micro-Cap
Fund to capture these inefficiencies. In our view, the micro-cap sector is what
small-cap was 20 years ago in terms of return potential.
As we indicated earlier, in 1996 bigger was better in the equity market. This
was also the case with the small-cap market, as the following table indicates:
WHY SIZE MATTERED IN
THE SMALL-CAP WORLD
'FROM CALIFORNIA TO RHODE ISLAND'
S&P 600 PERFORMANCE RETURNS BY QUINTILE
SIZE (BY QUINTILES) 1996 PERFORMANCE
Largest 20% 46.0%
Next 20% 29.7%
Middle 20% 23.3%
Next 20% 7.5%
Smallest 20% -4.8%
A similar example of this phenomenon was supplied by Prudential Securities'
quantitative analyst Claudia Mott. Upon examining year-to-date performance of
the broadly based Nasdaq Composite through November 30, she found that the top
10 contributors (most of which are large-cap oriented) produced more than half
of the index's total return. When factoring out the top 100 contributors, she
found that the remaining 4,000+ securities generated a net negative contribution
for the year.
STILLNESS IN THE WATER
Raymond Devoe, author of 'The Devoe Report,' recently
recounted a scuba-diving experience of some 30 years ago which [SHARK]
evoked eerie analogies to the current investment climate. After receiving
certification at his Caribbean beach hotel, Mr. Devoe swam off into the clear,
blue waters of St. Thomas for his first reef dive. Making his way along the
reef, he stopped near a large rock to enjoy an array of colorful plants and the
tropical fish swimming casually among them. After ten minutes, Mr. Devoe
realized something was terribly wrong -- the fish had disappeared as if they
were hiding from something. He was left alone with the sound of his beating
heart and escaping air bubbles. Not knowing the cause of the sudden 'stillness
in the water ', he experienced a sense of panic and returned to the beach
without incident, yet badly shaken.
Mr. Devoe discussed his sensation with many other divers and most responded
with curious looks. Years later he read Peter Mathiessen's 1971 book, Blue
Meridian_--_The Search for the Great White Shark and discovered that 'stillness
in the water ' takes place prior to great white shark attacks. The panic, or
sense that something is wrong, occurs when the brain receives too many
conflicting messages, leading to an eerie sensation that 'something's coming.'
Divers who have survived shark attacks know the sensation and respond to it
appropriately. They have developed instincts or intuition, and have the
experience to rely on them.
Currently, Mr. Devoe and other experienced investors (ourselves included)
cite similar sensations of apprehension about the equity market. Although one
would hardly describe the current equity market as 'standing still' or
'stillness in the water' it does evoke a feeling of unease. In what has been the
longest and strongest bull market in history, with the Dow Jones Industrial
Average up over 4,000 points since October 1990, there is seemingly a universal
accept-
3
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<PAGE>
ance that continued prosperity is nearly guaranteed. Although there haven't been
any shark sightings in quite some time, our intuition tells us that we should
not be quick to rule out the possibility. Our own sense of order is that markets
are cyclical, volatility is to be expected, and performance expectations should
be lower.
We are not forecasting bad things for the market. However, our investment
experience may be helpful in recognizing when things seem out of place. AN
ESTABLISHED DECISION-MAKING FRAMEWORK (INVESTMENT PROCESS) HELPS US, LIKE ANY
GOOD DIVER, AVOID THE MISTAKES OR MISSTEPS CAUSED BY PANIC OR FEAR.
THE ROAD AHEAD
Charles Dow once observed, 'There is always
a disposition in peoples' minds to think [TWO LANE ROAD WITH CLOUDS]
that existing conditions will be permanent.'
In the last several shareholder reports, we have documented why we believe that
the equity market will be different over the next few years. These changes may
already be underway when one considers that the rolling 3-year average annual
total returns for the Russell 2000, which peaked at 28.2% in September 1993,
are now 13.7% as of December 1996. Furthermore, this index is flat since its
peak in late May.
1996 gave us a higher level of market volatility and the shifting success of
investment styles. If these changes continue, 1997 could be a very interesting
year. We are excited about the recent results and remain enthused about the
long-term prospects of our risk-averse style of investing. Your continued
confidence is appreciated.
Sincerely,
Charles M. Royce Jack E. Fockler, Jr. W. Whitney George
Charles M. Royce Jack E. Fockler, Jr. W. Whitney George
President Vice President Vice President
February 3, 1997
PERFORMANCE REVIEWS AND PORTFOLIO ANALYSES FOR ROYCE PREMIER AND ROYCE MICRO-CAP
BEGIN ON PAGES 5 AND 7, RESPECTIVELY, OF THIS REPORT.
All performance information in this Report 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. Royce Micro-Cap Fund invests
primarily in securities of micro-cap companies, which may involve considerably
more risk than investments in securities of larger-cap companies (see
'Investment Risks' in the Prospectus).
Morningstar proprietary ratings reflect historical risk-adjusted performance as
of 12/31/96 and are subject to change monthly. The rating is calculated from a
fund's 3, 5 & 10-year average annual returns, with appropriate fee adjustments
and a risk factor that reflects performance relative to three-month Treasury
bill returns. Ten percent of the funds in an investment category receive five
stars and 22.5% receive four 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 average score for the 242 funds in the small-cap objective category
with a three year history was 1.29 for the three years ended 12/31/96. 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 Russell 2000, Russell 2000 Growth, Russell 2000 Value, S&P 600 and S&P 500
are unmanaged indices of common stocks and include the reinvestment of
dividends.
4
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ROYCE PREMIER FUND
PERFORMANCE REVIEW
WHAT WE DO
Royce Premier Fund ('Premier') uses a risk-averse approach to invest in a
limited portfolio of small-cap securities. Our approach attempts to understand
and value a company's 'private worth' -- what we believe an enterprise would
sell for in a private transaction between rational parties. The price we will
pay for a security must be significantly under our appraisal of its private
worth. Premier's portfolio securities represent our highest confidence
selections within the $300 million to $1 billion capitalization range.
Typically, these are what we define as 'superior companies,' those that have
excellent prospects, high internal rates of return and low leverage.
HOW WE DID
1996 was a seminal year for Royce Premier Fund. The Fund now has five years of
performance history, $317 million in net assets and a 4 star () rating from
Morningstar out of 1,826 equity funds as of December 31, 1996. Premier's value
oriented focus on 'superior companies' within the upper tier of the small-cap
sector served it well in 1996, especially in the second half.
DOWN MARKET* PERFORMANCE COMPARISON
[BAR GRAPH]
ROYCE PREMIER VERSUS RUSSELL 2000
VALUE OF $10,000 INVESTED ON 12/31/91
[LINE GRAPH]
TOTAL RETURNS THROUGH 12/31/96
4th Quarter 1996: +7.3%
1-Year: +18.1%
3-Year Avg. Annual: +12.9%
5-Year Avg. Annual (Incept. 12/31/91): +14.7%
Premier finished ahead of its benchmark index, the Russell 2000, for the fourth
quarter (7.3% versus 5.2%), the second half (9.9% versus 5.6%) and for the full
year (18.1% versus 16.5%). Average annual total return for the last five years
(the Fund's since-inception performance period) was 14.7%.
BECAUSE OF ITS RISK AVERSE NATURE, PREMIER HAS HAD A STRONG SHOWING RELATIVE TO
THE RUSSELL 2000 DURING THE THREE MARKET DOWNTURNS SINCE ITS INCEPTION.
RISK/RETURN COMPARISON
FROM INCEPTION* TO 12/31/96
AVG.ANNUAL STANDARD
TOTAL RETURN DEVIATION RUR
------------ --------- ---
ROYCE PREMIER 14.7% 6.1 2.40
Russell 2000 15.7% 12.1 1.29
SINCE ITS INCEPTION, ROYCE PREMIER HAS SUB-
STANTIALLY OUTPERFORMED THE RUSSELL 2000 ON
A RISK-ADJUSTED BASIS.
RUR - Return Per Unit of Risk: Average annual total
return divided by the annualized standard deviation over
a designated time period. Please read the Prospectus for
a more complete discussion of risk.
*The Fund's inception date was 12/31/91.
As the above graph indicates, Premier's performance since inception was slightly
under the Russell 2000 in a market cycle which generally rewarded high-risk
investments. However, Premier's low-risk profile enabled the Fund to outperform
the index on a risk-adjusted basis.
The Russell 2000 is an unmanaged index of domestic small-cap stocks.
5
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ROYCE PREMIER FUND
PORTFOLIO REVIEW
PORTFOLIO DIAGNOSTICS
---------------------
Median Market Cap: $520 million
Wtd. Avg. P/E Ratio: 15.7x
Wtd. Avg. P/B Ratio: 1.9x
Wtd. Avg. Yield: 2.0%
Fund Assets: $317 million
Turnover Rate: 34%
Symbol: RYPRX
% OF
TOP TEN POSITIONS NET ASSETS
----------------- ----------
1. The Standard Register Company 3.0%
2. Marshall Industries 2.6%
3. Woodward Governor Company 2.6%
4. Florida Rock Industries 2.5%
5. Trenwick Group 2.5%
6. Family Dollar Stores 2.4%
7. Wesco Financial 2.3%
8. New England Business Services 2.2%
9. The Dress Barn 2.2%
10. Lilly Industries 2.2%
Portfolio Concentration: Top 35 Holdings
represent 75% of equity portfolio as of 12/31/96.
MARKET CAP EXPOSURE
[BAR GRAPH]
PORTFOLIO INDUSTRY BREAKDOWN*
[PIE CHART]
IDEAS THAT WORKED
During calendar 1996, each of the following companies made meaningful
positive contributions to our overall performance. There were no examples of hot
new issues, high-priced take-overs or momentum miracles among these winners.
Rather, our top five performers emerged from a series of long-term investment
decisions, carefully considered and executed in prior years. We built our
positions when business conditions were difficult and other investors had voted
negatively on future prospects.
REALIZED AND
SECURITY UNREALIZED GAIN
- ---------------------------- ---------------
Claire's Stores $ 3,786,656
Woodward Governor 3,646,656
The Standard Register Co. 3,610,057
Family Dollar Stores 3,392,535
The Dress Barn 2,742,211
GOOD IDEAS AT THE TIME
Even the best small-cap companies are not immune to the business flu.
Usually, 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 rebounds can take longer than we anticipate.
Unfortunately, a few of our investments never recover. Our five worst performers
in 1996 were:
REALIZED AND
SECURITY UNREALIZED LOSS
- --------------------------- ---------------
Scitex Corporation $ 1,360,002
The Singer Company 1,111,104
Trenwick Group 861,382
Mikasa 806,333
Pennsylvania Manufacturers 654,150
6
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ROYCE MICRO-CAP FUND
PERFORMANCE REVIEW
WHAT WE DO
Royce Micro-Cap Fund ('Micro-Cap') invests in companies with market
capitalizations of $300 million or less. Due to this sector's size and limited
research coverage, there is more opportunity to find pricing inefficiencies.
Therefore, we believe that the potential for higher returns is greater than for
any other sector of the domestic equity market. Our approach attempts to
understand and value a company's 'private worth' -- what we believe an
enterprise would sell for in a private transaction between rational parties. The
price we will pay for a security must be significantly under our appraisal of
its private worth.
HOW WE DID
Like sibling Royce Premier Fund, Royce Micro-Cap Fund finished 1996 with five
years of performance history and a 4 star () rating from Morningstar out of
1,826 equity funds as of December 31, 1996. The Fund has $141 million in net
assets and remains one of the few micro-cap funds with a five year performance
record.
DOWN MARKET* PERFORMANCE COMPARISON
[BAR GRAPH]
ROYCE MICRO-CAP VERSUS RUSSELL 2000
VALUE OF $10,000 INVESTED ON 12/31/91
[LINE GRAPH]
TOTAL RETURNS THROUGH 12/31/96
4th Quarter 1996: +7.7%
1-Year: +15.5%
3-Year Avg. Annual: +12.5%
5-Year Avg. Annual (Incept. 12/31/91): +17.9%
The Fund's micro-cap orientation worked against it for most of 1996, but in its
favor over the longer term. Despite a strong fourth quarter finish for the Fund
versus its relevant benchmark, the Russell 2000 (7.7% versus 5.2%), Micro-Cap
was slightly under the index (15.5% versus 16.5%) for the full year. However,
Micro-Cap's average annual total return since inception of 17.9% was nicely
ahead of the Russell 2000's 15.7% return. We believe that the micro-cap universe
is similar to the small-cap sector of 20 years ago, rich in opportunity and
return potential.
RISK/RETURN COMPARISON
FROM INCEPTION* TO 12/31/96
AVG. ANNUAL STANDARD
TOTAL RETURN DEVIATION RUR
------------ --------- ---
ROYCE MICRO-CAP 17.9% 8.9 2.02
Russell 2000 15.7% 12.1 1.29
SINCE ITS INCEPTION, ROYCE MICRO-CAP HAS
OUTPERFORMED THE RUSSELL 2000 WITH LESS RISK.
RUR - Return Per Unit of Risk: Average annual total return
divided by the annualized standard deviation over a designated
time period. Please read the Prospectus for a more complete
discussion of risk.
* The Fund's inception date was 12/31/91.
Since its inception, the Fund's micro-cap orientation has resulted in higher
absolute and risk-adjusted returns versus the Russell 2000.
The Russell 2000 is an unmanaged index of domestic small-cap stocks.
7
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ROYCE MICRO-CAP FUND
PORTFOLIO REVIEW
PORTFOLIO DIAGNOSTICS
----------------------
Median Market Cap: $159 million
Wtd. Avg. P/E Ratio: 13.8x
Wtd. Avg. P/B Ratio: 1.5x
Wtd. Avg. Yield: 1.3%
Fund Assets: $141 million
Turnover Rate: 70%
Symbol: RYOTX
PORTFOLIO INDUSTRY BREAKDOWN*
[PIE CHART]
COMPANIES BY MARKET CAPITALIZATION
[TRIANGLE PIE CHART]
% OF
TOP TEN POSITIONS NET ASSETS
----------------- ----------
1. Sevenson Environmental Services 1.9%
2. BGS Systems 1.6%
3. Florida Rock Industries 1.5%
4. PXRE 1.5%
5. American Filtrona 1.4%
6. Velcro Industries 1.3%
7. Woodward Governor Company 1.3%
8. Lifetime Hoan 1.2%
9. Duff & Phelps Credit Rating 1.2%
10. Rykoff-Sexton 1.2%
IDEAS THAT WORKED
During calendar 1996, each of the following companies made meaningful
positive contributions to our overall performance. There were no examples of hot
new issues, high-priced take-overs or momentum miracles among these winners.
Rather, our top five performers emerged from a series of long-term investment
decisions, carefully considered and executed in prior years. We built our
positions when business conditions were difficult and other investors had voted
negatively on future prospects.
REALIZED AND
SECURITY UNREALIZED GAIN
- --------------------------- ---------------
Charming Shoppes $ 993,048
Dreco Energy Services 899,440
Standard Commercial 685,059
The Dress Barn 679,720
BGS Systems 652,578
GOOD IDEAS AT THE TIME
Even the best small-cap companies are not immune to the business flu.
Usually, 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 rebounds can take longer than we anticipate.
Unfortunately, a few of our investments never recover. Our five worst performers
in 1996 were:
REALIZED AND
SECURITY UNREALIZED LOSS
- --------------------- ---------------
Chico's FAS $ 473,427
Catherines Stores 396,556
Cato 363,173
Oshkosh Truck 322,050
MK Gold 317,072
8
<PAGE>
<PAGE>
FINANCIAL STATEMENTS
The Schedules of Investments as of December 31, 1996, integral parts of the
Financial Statements for Royce Premier Fund and Royce Micro-Cap Fund, are
accompanying this Report.
- --------------------------------------------------------------------------------
STATEMENTS OF ASSETS AND LIABILITIES AT DECEMBER 31, 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Royce Royce
Premier Fund Micro-Cap Fund
------------ --------------
<S> <C> <C>
ASSETS:
Investments at value (identified cost $237,067,876 and $120,622,141, respectively)................ $284,885,127 $134,644,059
Repurchase agreements (at cost and value)......................................................... 35,700,000 7,000,000
Cash.............................................................................................. 20,742 42,574
Receivable for investments sold................................................................... -- 307,369
Receivable for capital shares sold................................................................ 997,800 272,535
Receivable for dividends and interest............................................................. 777,301 200,994
------------ --------------
TOTAL ASSETS.................................................................................... 322,380,970 142,467,531
------------ --------------
LIABILITIES:
Payable for investments purchased................................................................. 4,728,100 641,861
Payable for capital shares redeemed............................................................... 293,074 270,567
Payable for investment advisory fees.............................................................. 198,349 151,232
Accrued expenses.................................................................................. 137,791 74,831
------------ --------------
TOTAL LIABILITIES............................................................................... 5,357,314 1,138,491
------------ --------------
NET ASSETS...................................................................................... $317,023,656 $141,329,040
------------ --------------
------------ --------------
ANALYSIS OF NET ASSETS:
Undistributed net investment income............................................................... $ 337,754 $ --
Accumulated net realized gain on investments...................................................... 2,827,216 2,052,640
Net unrealized appreciation on investments........................................................ 47,817,251 14,021,918
Capital shares.................................................................................... 40,594 17,369
Additional paid-in capital........................................................................ 266,000,841 125,237,113
------------ --------------
NET ASSETS...................................................................................... $317,023,656 $141,329,040
------------ --------------
------------ --------------
SHARES OUTSTANDING:
(unlimited number of $.001 par value shares authorized for each Fund)............................. 40,593,727 17,369,246
------------ --------------
------------ --------------
NET ASSET VALUE:
(offering and redemption price per share)......................................................... $7.81 $8.14
----- -----
----- -----
</TABLE>
- --------------------------------------------------------------------------------
STATEMENTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1996
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Royce
Premier Royce
Fund Micro-Cap Fund
----------- --------------
<S> <C> <C>
INVESTMENT INCOME:
Income:
Dividends..................................................................................... $ 5,228,170 $ 1,529,935
Interest...................................................................................... 2,102,012 472,846
----------- --------------
Total Income............................................................................. 7,330,182 2,002,781
----------- --------------
Expenses:
Investment advisory fees...................................................................... 2,903,340 1,888,300
Custodian and shareholder servicing fees...................................................... 251,088 157,617
Administrative and office facilities expenses................................................. 175,279 74,389
Professional fees............................................................................. 84,798 40,515
Trustees' fees................................................................................ 33,545 14,892
Other expenses................................................................................ 279,588 172,155
----------- --------------
Total Expenses........................................................................... 3,727,638 2,347,868
Fees Waived by Investment Adviser........................................................ (65,000) (96,036)
----------- --------------
Net Expenses............................................................................. 3,662,638 2,251,832
----------- --------------
Net Investment Income (Loss)............................................................. 3,667,544 (249,051)
----------- --------------
REALIZED AND UNREALIZED GAIN ON INVESTMENTS:
Net realized gain on investments................................................................... 19,648,625 11,111,467
Net change in unrealized appreciation on investments............................................... 25,537,270 7,205,618
----------- --------------
Net realized and unrealized gain on investments.................................................... 45,185,895 18,317,085
----------- --------------
NET INCREASE IN NET ASSETS FROM INVESTMENT OPERATIONS.............................................. $48,853,439 $ 18,068,034
----------- --------------
----------- --------------
</TABLE>
The accompanying notes are an integral part of the financial statements.
9
<PAGE>
<PAGE>
- --------------------------------------------------------------------------------
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Royce Premier Fund Royce Micro-Cap Fund
----------------------------- -----------------------------
Years ended December 31, Years ended December 31,
----------------------------- -----------------------------
1996 1995 1996 1995
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
INVESTMENT OPERATIONS:
Net investment income (loss)................................. $ 3,667,544 $ 3,878,109 $ (249,051) $ 55,739
Net realized gain on investments............................. 19,648,625 16,399,430 11,111,467 2,372,160
Net change in unrealized appreciation on investments......... 25,537,270 20,989,542 7,205,618 6,249,422
------------ ------------ ------------ ------------
Net increase in net assets from investment operations........ 48,853,439 41,267,081 18,068,034 8,677,321
------------ ------------ ------------ ------------
DIVIDENDS AND DISTRIBUTIONS:
Net investment income........................................ (3,591,631) (3,659,780) (65,526) --
Net realized gain on investments............................. (17,598,880) (16,629,199) (8,942,087) (2,163,270)
------------ ------------ ------------ ------------
Total dividends and distributions............................ (21,190,511) (20,288,979) (9,007,613) (2,163,270)
------------ ------------ ------------ ------------
CAPITAL SHARE TRANSACTIONS:
Net proceeds from shares sold................................ 90,607,839 138,651,613 61,828,569 78,958,661
Dividends reinvested......................................... 19,896,838 18,955,637 8,414,310 1,847,447
Cost of shares redeemed...................................... (123,383,399) (78,736,015) (35,703,495) (16,364,647)
------------ ------------ ------------ ------------
Net increase (decrease) in net assets from capital share
transactions.............................................. (12,878,722) 78,871,235 34,539,384 64,441,461
------------ ------------ ------------ ------------
NET INCREASE IN NET ASSETS..................................... 14,784,206 99,849,337 43,599,805 70,955,512
NET ASSETS:
Beginning of year............................................ 302,239,450 202,390,113 97,729,235 26,773,723
------------ ------------ ------------ ------------
End of year.................................................. $317,023,656(a) $302,239,450(a) $141,329,040(b) $ 97,729,235(b)
------------ ------------ ------------ ------------
------------ ------------ ------------ ------------
CAPITAL SHARE TRANSACTIONS:
Shares sold.................................................. 12,081,905 19,665,370 7,781,266 10,880,987
Shares issued for reinvestment of dividends and
distributions............................................. 2,594,157 2,684,934 1,050,757 246,326
Shares redeemed(c)........................................... (16,508,230) (11,134,302) (4,433,643) (2,291,276)
------------ ------------ ------------ ------------
Net increase (decrease) in shares outstanding................ (1,832,168) 11,216,002 4,398,380 8,836,037
------------ ------------ ------------ ------------
</TABLE>
- ------------
(a) Includes undistributed net investment income of $337,754 in 1996 and
$303,771 in 1995.
(b) Includes undistributed net investment income of $0 in 1996 and $55,739 in
1995.
(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.
10
<PAGE>
<PAGE>
- --------------------------------------------------------------------------------
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
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.
<TABLE>
<CAPTION>
Net
Realized Distributions
Net Asset Net and Dividends from Net Net Asset
Value, Investment Unrealized from Net Realized Gain Value,
Beginning Income Gain on Investment on End of Total
of Year (Loss) Investments Income Investments Year Return
--------- ---------- ----------- ------------- ------------- --------- ------
<S> <C> <C> <C> <C> <C> <C> <C>
ROYCE PREMIER FUND (a)
1996....... $7.12 $ 0.10 $1.18 $ (0.10) $ (0.49) $7.81 18.1%
1995....... 6.48 0.10 1.05 (0.09) (0.42) 7.12 17.8%
1994....... 6.41 0.06 0.15 (0.05) (0.09) 6.48 3.3%
1993....... 5.52 0.02 1.03 (0.02) (0.14) 6.41 19.0%
1992....... 5.00 0.02 0.77 (0.02) (0.25) 5.52 15.8%
ROYCE MICRO-CAP FUND (b)
1996....... $7.53 $(0.01) $1.17 -- $ (0.55) $8.14 15.5%
1995....... 6.48 -- 1.24 -- (0.19) 7.53 19.1%
1994....... 6.47 -- 0.23 -- (0.22) 6.48 3.6%
1993....... 5.83 -- 1.38 -- (0.74) 6.47 23.7%
1992....... 5.00 (0.01) 1.48 -- (0.64) 5.83 29.4%
<CAPTION>
Ratio of
Net
Ratio of Investment
Expenses Income Average
Net Assets, to (Loss) to Portfolio Commission
End of Year Average Average Turnover Rate
(in thousands) Net Assets Net Assets Rate Paid+
-------------- ---------- ---------- -------- ----------
<S> <C> <C> <C> <C> <C>
ROYCE PREMIER FUND (a)
1996....... $317,024 1.25% 1.25% 34% $ 0.0621
1995....... 302,239 1.25% 1.48% 39% --
1994....... 202,390 1.38% 1.19% 38% --
1993....... 47,143 1.50% 0.68% 85% --
1992....... 2,329 1.77% 0.53% 116% --
ROYCE MICRO-CAP FUND (b)
1996....... $141,329 1.79% (0.20)% 70% $ 0.0476
1995....... 97,729 1.94% 0.10% 25% --
1994....... 26,774 1.99% 0.02% 54% --
1993....... 10,261 1.99% (0.09)% 116% --
1992....... 3,373 1.69% (0.21)% 171% --
</TABLE>
- ------------
(a) Expense ratios are shown after fee waivers by the investment adviser and
distributor. For the years ended December 31, 1996, 1993 and 1992, the
expense ratios before the waivers would have been 1.28%, 1.68%, and 4.17%,
respectively.
(b) Expense ratios are shown after fee waivers by the investment adviser and
distributor. For the years ended December 31, 1996, 1995, 1994, 1993 and
1992, the expense ratios before the waivers would have been 1.87%, 1.97%,
2.34%, 2.49%, and 3.77%, respectively.
+ For fiscal years beginning on or after October 1, 1995, the Funds are
required to disclose average commission rate paid per share for purchases
and sales of investments.
- --------------------------------------------------------------------------------
REPORT OF INDEPENDENT ACCOUNTANTS
- --------------------------------------------------------------------------------
To the Board of Trustees of The Royce Fund and the Shareholders of Royce Premier
Fund and Royce Micro-Cap Fund:
We have audited the accompanying statements of assets and liabilities of
Royce Premier Fund and Royce Micro-Cap Fund, including the schedules of
investments accompanying the Annual Report, as of December 31, 1996, the related
statements of operations for the year then ended, the statements of changes in
net assets for each of the two years in the period then ended, and the financial
highlights for each of the five years in the period then ended. These financial
statements and financial highlights are the responsibility of the Funds'
management. Our responsibility is to express an opinion on these financial
statements and financial highlights based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of
December 31, 1996 by correspondence with the custodian and brokers. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements and financial highlights referred
to above present fairly, in all material respects, the financial position of
Royce Premier Fund and Royce Micro-Cap Fund as of December 31, 1996, the results
of their operations for the year then ended, the changes in their net assets for
each of the two years in the period then ended, and the financial highlights for
each of the five years in the period then ended, in conformity with generally
accepted accounting principles.
COOPERS & LYBRAND L.L.P.
Boston, Massachusetts
February 7, 1997
11
<PAGE>
<PAGE>
- --------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. 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.
a. 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.
b. 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.
c. 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.
d. 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 accompanying Schedules of Investments contain information
regarding income taxes under the caption 'Income Tax Information'.
e. 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.
f. 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.
2. INVESTMENT ADVISER:
Under the Trust's investment advisory agreement with Quest Advisory Corp.
('Quest'), Quest is paid a monthly fee at an annual rate of 1.0% and 1.5% of the
average net assets of Royce Premier Fund and Royce Micro-Cap Fund, respectively.
For the year ended December 31, 1996, Royce Premier Fund and Royce Micro-Cap
Fund recorded advisory fees of $2,838,340 (net of voluntary waivers of $65,000)
and $1,792,264 (net of voluntary waivers of $96,036), respectively.
3. PURCHASES AND SALES OF INVESTMENT SECURITIES:
For the year ended December 31, 1996, the cost of purchases and the
proceeds from sales of investment securities, other than short-term securities,
were as follows:
Royce Royce Micro-
Premier Fund Cap Fund
------------ --------------
Purchases................ $89,718,803 $112,413,031
Sales.................... $114,490,388 $ 84,707,948
12
<PAGE>
<PAGE>
THE
ROYCE
FUNDS
1414 Avenue of the Americas
New York, NY 10019
FOR GENERAL INFORMATION, TELEPHONE SERVICES,
ADDITIONAL REPORT COPIES & PROSPECTUS INQUIRIES
1-800-221-4268
TO SPEAK TO SHAREHOLDER SERVICES
FOR DIRECT PURCHASES, ACH TRANSACTIONS,
STATEMENT REQUESTS OR ACCOUNT INQUIRIES
1-800-841-1180
TO USE OUR AUTOMATED TELEPHONE SERVICES
1-800-78-ROYCE (787-6923)
ADVISOR SERVICES
FOR FUND MATERIALS, PERFORMANCE UPDATES,
TRANSACTIONS OR ACCOUNT INQUIRIES
1-800-33-ROYCE (337-6923)
LOOK FOR OUR REVISED WEB SITE IN THE SPRING OF '97!
COMPARE UPDATED FUND PERFORMANCE, DOWNLOAD A PROSPECTUS,
CHAT WITH OTHER INVESTORS, MEET THE PORTFOLIO MANAGERS,
FIND OUT WHAT'S NEW - WE LOOK FORWARD TO YOUR VISIT!
HTTP://WWW.ROYCEFUNDS.COM
YOU CAN ALSO REACH THE ROYCE FUNDS BY E-MAIL
[email protected]
STATEMENT OF DIFFERENCES
The checkmark symbol shall be expressed as...... 'ch'
