Value Investing in
Small Companies for 25 Years
THE
ROYCE
FUNDS
ROYCE TOTAL RETURN FUND
ROYCE LOW-PRICED STOCK FUND
ROYCE FINANCIAL SERVICES FUND
1998 Semi-Annual Report
www.roycefunds.com
<PAGE>
THE ROYCE FUNDS ROAD MAP
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TWO PORTFOLIO STRATEGIES
[Blue bar] SMALL-CAP
[Yellow bar] MICRO-CAP
For 25 years, Royce & Associates has utilized a disciplined value approach to
select small and micro-cap companies. Our strategies focus on capitalization
(small or micro-cap) and portfolio construction (concentrated or diversified)
considerations.
- --------------------------------------------------------------------------------
CORE FUNDS
<TABLE>
<S> <C>
The small-cap universe (companies with market caps between [Blue bar]
$300 million and $1 billion) is no longer small, unknown or ROYCE PREMIER
under-owned; therefore, we believe that this greater level Small-Cap Orientation
of efficiency requires greater portfolio concentration. Concentrated Portfolio
The micro-cap universe (companies with market caps between [Yellow bar]
$5 million and $300 million) provides more choices ROYCE MICRO-CAP
(approximately 6,400 companies), yet greater trading Micro-Cap Orientation
difficulties; therefore, we believe that broad diversification Diversified Portfolio
is required given the liquidity constraints of this sector.
- --------------------------------------------------------------------------------
COMBINED FUNDS
These portfolios combine our two core strategies and [Blue bar]
represent our flagship approach. Two of our combined [Yellow bar]
portfolios, Pennsylvania Mutual and PMF II, are designed for PENNSYLVANIA MUTUAL
both individuals and institutions, while Royce GiftShares Diversified Small and Micro-Cap Portfolio
offers one of the few gifting and estate-planning portfolios.
[Blue bar]
[Yellow bar]
PMF II
Diversified Small and Micro-Cap Portfolio
[Blue bar]
[Yellow bar]
ROYCE GIFTSHARES
Concentrated Small and
Micro-Cap Portfolio
- --------------------------------------------------------------------------------
THEME FUNDS [Blue bar]
[Yellow bar]
Theme funds contain stocks primarily found in the core ROYCE TOTAL RETURN
portfolios that have special attributes. One has Dividend-Paying Securities
low-volatility characteristics (dividends), one has the
potential for higher returns and volatility (low-priced ROYCE LOW-PRICED
stocks) and one takes specific sector (financial services) Stocks Priced Below $15
risk. Performance and volatility may be substantially
different for each of these portfolios. ROYCE FINANCIAL SERVICES
Financial Services Companies
</TABLE>
<PAGE>
THE ROYCE FUNDS
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SEMI-ANNUAL REPORT REFERENCE GUIDE
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<TABLE>
<S> <C>
"Curiouser and Curiouser": The Equity Markets. 2
- --------------------------------------------------------------------------
Investing "Through the Looking Glass": Finding Value in 5
an Overvalued Market.
- --------------------------------------------------------------------------
Royce Total Return Fund's emphasis on dividend-paying small 12
companies helped it to provide a 22.8% average annual
total return over the last three years and an overall
five-star (*****) rating from Morningstar out of 2,545
domestic equity funds as of June 30, 1998.
- --------------------------------------------------------------------------
Royce Low-Priced Stock Fund finished the first six months up 14
15.3%--the highest return for the period among all of
The Royce Funds--and outperformed its benchmark index, the
small-cap oriented Russell 2000, for the first half, the
one-year, three-year and since inception (12/15/93) periods
ended June 30, 1998.
- --------------------------------------------------------------------------
Royce Financial Services Fund outperformed the Russell 2000 16
in the first half and provided a since inception (12/15/94)
average annual total return of 18.9% for the period ended
June 30, 1998.
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Updates and Notes: Our New and Improved Website (www.roycefunds.com). 18
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Schedules of Investments and Other Financial Statements. 19
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Postscript: Hang Time. Inside back cover
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</TABLE>
[pull quote]
For 25 years, our value approach has focused on evaluating a company's private
worth -- what we believe an enterprise would sell for in a private transaction
between rational and well-informed parties. This requires a thorough analysis 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.
[end pull quote]
[graphic: looking through magnifying glass at The Royce Funds listing in
newspaper]
AVERAGE ANNUAL TOTAL RETURNS Through June 30, 1998
<TABLE>
<CAPTION>
YEAR-TO-DATE SINCE
FUND (INCEPTION) 1998* 1-YEAR 3-YEAR INCEPTION
- ----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Royce Total Return (12/15/93) 7.3% 17.8% 22.8% 19.2%
- ----------------------------------------------------------------------------------
Royce Low-Priced Stock (12/15/93) 15.3 28.3 20.8 18.2
- ----------------------------------------------------------------------------------
Royce Financial Services (12/15/94) 9.8 13.0 16.4 18.9
- ----------------------------------------------------------------------------------
</TABLE>
* Not annualized.
<PAGE>
[sidebar]
[photo: Charles M. Royce]
Charles M. Royce, President
Many people argue that as long as the U.S. economy remains as robust as it has
been, the stock market should continue to rise. We believe, however, that the
factors that drive the stock market are very complex, and the notion that a
strong economy guarantees a strong market greatly oversimplifies the issue.
Markets will fluctuate.
[end sidebar]
LETTER TO OUR SHAREHOLDERS
- --------------------------------------------------------------------------------
[cartoon graphic: Alice in Wonderland with Queen of Hearts, Mad Hatter and
Rabbit looking at chart of S&P 500 returns (Drawn in the style of Tenniel)]
Drawing by Hank Blaustein; -C- 1998
"CURIOUSER AND CURIOUSER"
Alice's wide-eyed response to Wonderland reflects our own take on the current
equity markets. Returns continued their ascent as all major stock market indices
reached record highs during 1998's first six months. Like the bully at the
playground, the "biggest" companies enjoyed the biggest rewards. The large-cap
indices -- S&P 500 and Dow Jones Industrial Average ("DJIA") -- along with the
technology driven Nasdaq Composite, each posted six-month results well in excess
of their average historic 12-month returns. We expect that most investors never
imagined investing would be so easy. As Berkshire Hathaway Vice Chairman Charlie
Munger once quipped, "If successful investing required merely extrapolating
history (and especially recent market returns), the Forbes 400 would consist
entirely of librarians."
Even more curious are the level and convergence of long and short-term
returns. We looked at quarter-end return periods for the S&P 500 over the last
52 years. We found that the time-weighted composite of one, three, five, 10, 15
and 20-year results ended June 30, 1998 was surpassed only by 1998's first
quarter-ending results. While the short-term returns were exceptional, the
long-term results were even more surprising. We could not help looking at the
median and worst performance periods, as well. Two of the bottom three
performance periods ended shortly after we began to manage Pennsylvania Mutual
Fund 25 years ago. We are all Alices living in Wonderland now.
2 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
For the first six months of 1998, the S&P 500 and DJIA were up 17.7% and
14.2%, respectively, while the Nasdaq Composite was up an even more amazing
20.7%. While it would be easy to declare, as Alice's Dodo did, "Everybody has
won, and all must have prizes," further investigation of first-half results
reveals a telling insight. According to statistics published by FactSet Data,
the S&P 500's 50 largest companies rose nearly 26% in the first half, while the
other 450 gained just 9.5%. Investors' preferences for the biggest and most
well-known companies stem from concerns about a potential economic slowdown,
global economic unrest and liquidity (the ability to easily buy and sell
securities). We find this ironic in that we believe that many of the companies
most likely to be affected by global problems are precisely the ones whose share
prices are rising the fastest.
Small-cap relative returns were affected by both the sector's significantly
higher level of volatility and by the substantial strength of the large-cap
market. For 1998's first half, the Russell 2000 was up an uninspiring 4.9%. As
good as the first quarter was for the index (+10.0%), it was not able to sustain
the pace, dropping 4.7% in the second quarter. As small-cap managers, we are
frequently asked, "if relative valuations and earnings growth for your sector
are better than for large-caps, when will small-cap stock prices reflect this?"
We do not know.
ROLLING RETURN OF THE S&P 500 OVER 1,3,5,10, 15 AND 20-YEAR PERIODS
Ranked by Time-Weighted Score for 210 Periods Ended 3/31/46 Through 6/30/98
<TABLE>
<CAPTION>
Composite
Quarter 1-Year 3-Year 5-Year 10-Year 15-Year 20-Year Return Rank
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Mar-98 48.0% 32.8% 22.4% 19.9% 17.8% 17.7% 20.1% 1
- ---------------------------------------------------------------------------------------
Jun-98 30.0 30.2 23.1 18.6 17.2 17.4 19.1 2
- ---------------------------------------------------------------------------------------
Dec-97 33.3 31.1 20.2 18.0 17.5 16.6 18.6 3
- ---------------------------------------------------------------------------------------
Mar-67 4.7 7.9 10.2 11.1 13.3 14.3 12.5 104
- ---------------------------------------------------------------------------------------
Dec-86 18.6 18.4 19.8 13.8 10.8 10.2 12.5 105
- ---------------------------------------------------------------------------------------
Dec-90 -3.1 14.1 13.1 13.9 13.9 11.1 12.5 106
- ---------------------------------------------------------------------------------------
Jun-49 -9.5 -3.0 7.1 8.6 8.1 2.3 5.0 208
- ---------------------------------------------------------------------------------------
Dec-74 -26.3 -9.2 -2.4 1.2 4.3 6.9 2.7 209
- ---------------------------------------------------------------------------------------
Sep-74 -38.8 -10.6 -4.2 0.5 4.1 7.0 2.1 210
- ---------------------------------------------------------------------------------------
</TABLE>
Note: Composite return percentages were derived by time-weighting the returns of
each of the performance periods allotted by proportion of overall time period
vs. each period (e.g., the total of 1, 3, 5, 10, 15 and 20 is 54. The return for
the 20-year period is weighted 37% {20 [divided by] 54}).
"WHICH WAY? WHICH WAY?"
Alice's question about which direction to follow upon arriving in Wonderland
aptly reflects investor sentiment regarding recent small-cap underperformance.
First the good news. Since the trough in October 1990, small-cap stocks, as
measured by the Russell 2000, have provided a 21.4% average annual total return.
And now the bad news. Since the May 1996 peak, the Russell 2000 has generated a
12.7% average annual total return. What's so bad about a 12.7% average annual
total return? Nothing, until you compare it to the large-cap S&P 500, which over
the same period compounded at a 29.9% average annual rate. Contributing to this
substantial performance disparity were more frequent and severe declines within
the small-cap sector. In fact, since the May 1996 small-cap peak, the Russell
2000 has undergone three separate 10%+ declines, while the S&P 500 has endured
only one. As we have suggested in past letters, higher volatility generally
precedes lower returns and, in our opinion,
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 3
<PAGE>
[sidebar]
We think that the market has recently benefited from the economic misfortune of
other countries, such as Japan, and a superbly profitable moment in the U.S.
economy accompanied by a significant decline in interest rates. None of these
features are permanent and none are likely to continue to have the same
enormously positive impact.
[end sidebar]
provides an edge for value. Performance results for the "growth" and "value"
segments of the Russell 2000 bore this out. From the May 22, 1996 peak through
June 30, 1998, the Russell 2000 Value Index was up 51.5% versus a gain of only
9.6% for the Russell 2000 Growth Index.
SMALL CAP: REVERSAL OF FORTUNE
<TABLE>
<CAPTION>
Total Returns of Russell 2000 vs. S&P 500
From Small-Cap Trough in 1990 and Peak in 1996
- --------------------------------------------------------------------------------
10/31/90- 5/31/96-
5/31/96 6/30/98
- --------------------------------------------------------------------------------
<S> <C> <C>
Russell 2000 233.9% 29.9%
S&P 500 158.7% 75.8%
</TABLE>
CAUSE: MORE FREQUENT AND
SEVERE DECLINES
[bar chart]
<TABLE>
<S> <C> <C>
S&P 500 10/7/97 - -10.8%
10/27/97
Russell 2000 5/22/96 - -15.5%
7/24/96
10/13/97 - -11.5%
1/12/98
4/21/98 - -11.6%
6/15/98
</TABLE>
Since the small-cap peak in May '96, small-caps have undergone three separate
10%+ declines, while the S&P 500 has had only one.
[end bar chart]
We believe that small-cap's higher level of volatility may have
implications for large-cap stocks as well--though many investors tend to look
at this the other way around and insist that large-caps lead small-caps. To us,
however, the small-cap world is more indicative of the "average" stock, so that
at some point, large-cap stocks will take their cues from small-cap's higher
volatility and overall performance. A period of high returns (similar to recent
market experience) -- when accompanied by continued performance divergence --
often precedes a substantial market correction. We believe that this may occur
in the months ahead.
[cartoon graphic: school of small fish chasing large fish with caption "The
next cycle?"]
REASONABLE INVESTORS IN UNREASONABLE TIMES
As we sit back and assess our own six-month results, we are reminded of a
simple, yet important, premise--while we can control our investment process, we
cannot control our relative investment results, especially over the short term.
We believe that a well-planned and consistently applied approach will result in
attractive long-term returns, even when compared to appropriate indices and
peers. In the short term, however, anything can happen, and usually does. Thus,
when we report our semi-
[pull quote]
By not focusing on what we can't
control, our relative results, we are
able to focus on what is important--
understanding risk and reward while
maintaining a long-term perspective.
[end pull quote]
4 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
annual performance results, we try to temper our enthusiasm when things have
gone well and to keep our chins up when they have not. By not focusing on what
we can't control, our relative results, we are able to focus on what is
important -- understanding risk and reward while maintaining a long-term
perspective.
Our investment approach provided a short-term advantage in this period of
higher volatility for small-cap stocks. For 1998's first six months, our
results, while reflecting the small-cap and micro-cap universe in which we
invest, were better than that of our small-cap benchmark index, the Russell
2000. The same performance relationship also has held true since the May 1996
small-cap peak. For a complete review and discussion of our results and our risk
profiles, please see pages 12-17.
RECENT PERFORMANCE RESULTS
<TABLE>
<CAPTION>
Year-to-date 5/22/96 -
1998 6/30/98
- -----------------------------------------------------------------------
<S> <C> <C>
Royce Total Return Fund 7.3% 48.5%
Royce Low-Priced Stock Fund 15.3 33.7
Royce Financial Services Fund 9.8 34.2
Russell 2000 4.9 28.7
</TABLE>
THROUGH THE LOOKING GLASS:
FINDING VALUE IN AN OVERVALUED MARKET
Traditional measures of market value in large-cap stocks, such as
price/earnings, price/book and price/dividends ratios, are at their highest
levels in history. This suggests that we may be approaching fully valued
territory for equity markets overall. We are inclined to agree, and on one level
view the seemingly endless ascent of the market with great concern. On the other
hand, our business buyer's perspective points us in a different direction,
namely that we work in a market of stocks, not a stock market. Successful
investors have always emphasized the importance of a long-term view, one that
centers on understanding the nature of a company's business. It is an idea that
we have utilized throughout our 25 years of investing, one that we think enables
us to find value in an overvalued market, in spite of this apparent paradox.
Overvaluation relates directly to expectations. Many investors are chasing
performance, particularly in large-cap stocks. The current investment standard
is to continue investing in what has worked, not what will work. This is akin to
driving while using only the rear-view mirror. Our practice has always been to
mine low-expectation areas. Currently, we are finding opportunities, especially
in the micro-cap sector. Micro-caps represent the largest domestic equity market
in terms of names and often show little correlation with the large-cap market.
We believe that this sector of the market, which may be higher in risk than the
large-cap market, represents undervalued opportunity, especially in light of the
high expectations and short attention spans of investors in other areas.
"What do you mean by that," said Alice's Caterpillar sternly. "Explain
yourself!" By way of explanation, consider the vast size in our stock-selection
universe -- close to 8,000 public companies currently have market
capitalizations of less than $1 billion.
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 5
<PAGE>
[sidebar]
A question we often hear is "why aren't small-caps doing better if the
valuations are so attractive?" It is worth remembering that valuations may have
nothing to do with performance in the short run. Very often performance comes
well after attractive valuations are present. Patience is critical.
[end sidebar]
The size and diversity of the small-cap and micro-cap sectors allow for any
number of companies to escape the attention of both individual and institutional
investors. Even in a world where information travels across the globe in
seconds, interpretations remain imperfect, due in part to the sheer volume of
data and in part to more human factors. We are still finding well-managed,
financially sound companies that are either unnoticed by, or out of favor with,
the larger investment community. So while equal access to information exists,
you must know where to look and what to do with what you find.
[pull quote]
What value investing pioneer Professor
David Dodd said many years ago has
seldom been more true than it is today:
"There are no new eras, only new
errors."
[end pull quote]
Working in this fashion means that we still believe in market cycles and in
the importance of attempting to reduce risk. Of course, there are those
dissenting voices who insist that we have entered a "new era" of investing where
concepts such as "market cycle," "risk" and "negative return" are the quaint
relics of a distant past. These people insist that markets now move
sequentially, not cyclically, and offer a wildly optimistic view of the market's
future. We must take issue with this argument. What value investing pioneer
Professor David Dodd said many years ago has seldom been more true than it is
today: "There are no new eras, only new errors."
"THE TIME HAS COME, THE WALRUS SAID, TO TALK OF MANY THINGS"
Having enjoyed his first visit so much that he could not manage to stay away for
long, our investment advisor friend recently returned to midtown Manhattan for a
long weekend getaway that included fireworks, a poetry slam, an outdoor swing
concert at Lincoln Center and a stop at our office. The intrepid advisor arrived
with an array of questions. As Alice reminds us, "What is the use of a book
without pictures or conversations?"
When you are looking at a given company, how do the portfolio managers and
analysts interact?
We have substantial interaction between our six analysts and our four portfolio
managers. Our analysts are involved in every step of the stock selection
process. When we are interested in a company, we run a very systematic "fire
drill" on the company's basics. We examine the balance sheet and income
statement history, cash flows, and comments from management to quickly assemble
a snapshot of the company. We insist on having multiple sets of eyes viewing
every company.
6 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
After the "fire drill," what is the next step?
Quantitative information, now available to everybody instantly, is a commodity
today. This access is no longer an edge in and of itself. The next step is
dealing with non-quantitative research activity. When we first look at a given
company, one or two analysts work with a portfolio manager. Once we have decided
to follow through on an idea and begin the strategic analysis process, we test
our idea using the Socratic method. We ask ourselves questions that force us to
delve deeply. This format is critical because it brings together all of the
information we have gathered and opens our eyes to the kinds of risks we are
considering.
[pull quote]
This format is critical because it
brings together all of the information
we have gathered and opens our eyes to
the kinds of risks we are considering.
[end pull quote]
Do portfolio managers do any of their own research or is that left to the
analysts?
Everybody takes an active part in the research process, including both grunt
work and strategic analysis. We all wade through financial statements. We meet
with management. We speak to the company's customers, suppliers and competitors.
The kind of research we do is labor-intensive and time-consuming.
How do you track a company once you own it?
We stay in touch with management, we continue to carefully examine the financial
statements when they are published on a quarterly basis and we look for
developments both within the company and in the economy as a whole that may
affect the company's or its sector's business. Contrary to what people think,
companies do not change very much on a quarter-to-quarter basis. Prices, on the
other hand, change constantly, and we watch them every day.
Are there any advantages you have as an institutional trader that an individual
investor does not enjoy?
We deal with over 100 broker-dealers, which certainly gives us an
advantage. Today's electronic trading systems are a great help. We also attempt
to trade within the spreads, between the bid and ask, in a way that would be
difficult for an individual.
[pull quote]
Contrary to what people think, companies
do not change very much on a
quarter-to-quarter basis. Prices, on the
other hand, change constantly, and we
watch them every day.
[end pull quote]
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 7
<PAGE>
[sidebar]
We think of value investing as planting before the harvest. As confident as we
may feel, we cannot predict when, or even if, harvest time will come.
[end sidebar]
What is the time frame between discovering a company and buying its stock?
It can take hours, days or even months, depending on the situation. The initial
purchase in which we take a small position in a stock is often done quickly and
follows the "fire drill" process. These small positions then "incubate" while we
move through a longer, more complicated strategic analysis that may entail
weeks, or months, of research. It takes a long time for us to gain a high enough
level of confidence to want to build our position in a stock. We generally set a
price that we are willing to pay, and it often requires a lot of patience and
discipline to wait for a stock to arrive at that price. We are looking for
companies trading at discounts of about 50% to our estimate of their value as a
business. It can be frustrating when, during the course of our research, these
attractive discounts disappear, but in order to keep an eye on risk, we cannot
afford a rush to judgment.
SAVING HUMPTY DUMPTY: THE RIGHT BALANCE
Unlike Alice, who followed the Rabbit down the hole "never once considering how
in the world she was to get out again," we view risk management as critical.
Historically, we have focused on five categories of risk as we analyze a
company: financial, business strategy, valuation, market and portfolio. Of
these, financial risk is probably the most important. Small companies, by virtue
of their size, are generally more fragile than large companies, which makes
strong financial condition a paramount concern for us.
How do we specifically attempt to reduce the financial risk inherent in
investing in equities? One of the most important steps involves the careful
scrutiny of the balance sheet. It gives us an x-ray of a company's financial
infrastructure and allows us to check its overall health and well being. The
process entails a number of subjective measures in addition to more objective,
quantifiable ones. It is not simply the numbers that tell the story, but one's
interpretation of their significance. This evaluation is an art. Renaissance
portrait painters sought to convey the essence and personality of their
subjects so that the viewer would see the whole person, not just the face and
figure. A careful reading of a balance sheet should yield similar results.
[graphic: pages from a financial report]
Presented only for illustration.
8 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
Rather than concentrate on traditional ratios such as debt and working
capital, we look at leverage globally: how much equity supports total assets? We
measure leverage by looking at the ratio of assets to stockholders' equity. (Our
bias is toward lower-leveraged companies; typically, in our portfolios, the
average ratio is less than two to one.) Using this method allows us to monitor
changes in all liabilities, not only changes in debt. Items that can have an
adverse affect on a company, such as short-term debt and payables, will give us
clues as to the direction of overall leverage. This paints a more complete
picture than simple debt analysis.
[pull quote]
There is a big difference between a good
balance sheet that is the result of
stock offerings and one that is the
result of doing business the
old-fashioned way -- through earnings.
[end pull quote]
A conservatively capitalized company can better weather storms because it
has the necessary financial reserves. A company with too much debt, on the other
hand, runs a greater risk that stormy weather will turn into a hurricane. In
essence, we seek companies that we believe possess a substantial "margin of
safety" that these reserves can provide. In the spirit of "the best offense is a
good defense," we also view financially strong companies as well positioned to
grow. All reserves are not created equal. We target companies that have grown
their book value through retained earnings, rather than paid in capital; they
have demonstrated their ability to grow from their own success as a business.
At this point, one may well ask, "But don't all portfolio managers read
balance sheets?" Many do, but depending on their investment style or their
experience, they may be more focused on the income statement. Our obsession
takes us into the arcane world of bad debt reserves, inventory policy, warranty
liabilities, pending litigation, pension obligations, pollution and product
liabilities, etc. All of these factors may have a bearing on a company's -- and
by extension a Fund's -- exposure to risk. We look for changes from period to
period that can tell us about a company's direction. If we like the balance
sheet, we want to know how it got there. There is a big difference between a
good balance sheet that is the result of stock offerings and one that is the
result of doing business the old-fashioned way -- through earnings.
The process of balance sheet analysis can be long, is seldom exciting and
certainly never glamorous. It is critical, however, in our search to find the
kind of healthy small-cap companies that have been our mainstay for 25 years.
[pull quote]
In essence, we seek companies that we
believe possess a substantial "margin of
safety" that these reserves can provide.
[end pull quote]
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 9
<PAGE>
[sidebar]
In our investment approach, we strongly believe in the importance of using
volatility to our advantage. Volatility can drive prices to considerable lows
just as easily as it can push them to unreasonable highs. This creates potential
opportunities for us.
[end sidebar]
AND NOW THE TALE IS DONE, AND HOME WE STEER, A
MERRY CREW, BENEATH THE SETTING SUN
As we look to 1998's second half, we are encouraged about the relative prospects
for both our investment universe and investment style.
Relative valuations, as reflected by average P/E ratios and earnings
growth prospects, should favor the small-cap sector. In addition, significant
divergence between large-cap and small-cap performance has historically not been
sustained over long periods (the Russell 2000 just concluded its second worst
two-year relative performance period vis-a-vis the S&P 500 based on quarterly
trailing returns). The worst two-year period, which ended in the fourth quarter
of 1990 (and preceded small-cap's reemergence in 1991-1993), was accompanied by
a general market correction, similar to what we believe is happening now. It is
our belief that this performance divergence has negative implications for the
market as a whole.
A higher level of volatility, present since the small-cap peak in May
1996, in our opinion favors a value style of investing. The current level of
interest rates should also benefit value, at least in a relative sense. Growth
managers, who seek the expansion of price multiples, rely heavily on falling
interest rates to drive their investment process. (P/E multiples and interest
rates act inversely to each other, i.e., as interest rates decline, P/E
multiples tend to expand.) Therefore, a more neutral interest rate environment
should put value on an equal footing. The momentum investing crowd also remains
very involved in small-cap (Internet stocks and cutting edge technology, in
particular), which only increases the sector's vulnerability and volatility.
[cartoon graphic: portfolio managers in a "police line-up"
with caption "Guilty as Charged: Attempting to manage risk."]
10 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
[photo: Jack Fockler, Whitney George, Chuck Royce, Charlie Dreifus, Buzz Zaino]
(l-r) Jack Fockler, Whitney George, Chuck Royce, Charlie Dreifus, Buzz Zaino
We remain committed to the same principles that have served us well over
the last 25 years. We believe that our focus on managing risk within the more
volatile small-cap and micro-cap sectors is especially appropriate at this
juncture in the market. We appreciate your continued support of our work and
welcome your questions and comments. Happy summer days.
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 20, 1998
PS We wanted to take this opportunity to introduce you to the two newest members
of our Senior Staff, Charlie Dreifus and Buzz Zaino.
Charlie, who joined the firm on February 1, 1998, was formerly with Lazard
Freres, where he was the Portfolio Manager for the Lazard Special Equity Fund.
He brings 29 years of experience to Royce & Associates, 18 of them as a
small-cap and micro-cap value portfolio manager. Charlie, who will be involved
in our research efforts, began managing a new portfolio, Royce Special Equity
Fund, on May 1, 1998.
Buzz comes to us from Trust Company of the West where he was Group Managing
Director in charge of the company's small-cap value offerings. He has 30 years
of investment management experience, including 21 years as a small-cap value
portfolio manager. Buzz became the portfolio manager of PMF II on April 1, 1998.
We are very excited to have such seasoned professionals working with us.
PPS This report's excursion into Wonderland was inspired by the extraordinary
market activity of the past few years, which to our eyes resembles the surreal
surroundings brought to life in Lewis Carroll's two classics, Alice's Adventures
in Wonderland and Through the Looking Glass. For those of you made "curiouser
and curiouser" by our "Saving Humpty Dumpty: The Right Balance" heading, the
title refers to the need to keep Humpty Dumpty "balanced" on the wall to prevent
his great fall.
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 11
<PAGE>
[sidebar]
WHAT WE DO
Royce Total Return Fund ("RTR") uses a value approach to invest primarily in
dividend-paying small-cap companies. We believe that this combination of capital
appreciation potential and current income offers a highly effective method for
capturing the returns of the small-cap market.
HOW WE DID
Royce Total Return Fund's emphasis on dividend-paying stocks helped it to
weather small-cap's stormy second quarter and emerge for the first six months
with a return of 7.3%, ahead of its benchmark, the small-cap oriented Russell
2000 index, which returned 4.9%. Making the most significant contributions to
the portfolio's return were stocks in the financial and consumer sectors, while
our risk management approach allowed the Fund to escape the higher levels of
volatility affecting many small-cap stocks. The Fund has outperformed the
Russell 2000 for the one-year, three-year and since inception periods (12/15/93)
with average annual total returns for these periods of 17.8%, 22.8% and 19.2%,
respectively.
Royce Total Return Fund has an overall five-star (*****) rating from Morningstar
out of 2,545 domestic equity funds as of 6/30/98. The Fund also enjoys the
distinction of being Morningstar's lowest-risk small-cap fund as measured by the
Morningstar risk ratio for the three-year period ended 6/30/98. In addition, the
Fund has one of the highest Sharpe ratios (a measure of risk and reward) of any
domestic equity fund in the Morningstar universe for the same three-year period.
Total net assets as of June 30, 1998 were $166 million. At the end of this year,
the Fund will have five years of performance history.
[end sidebar]
ROYCE TOTAL RETURN FUND
- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS (Through 6/30/98)
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
Year-to-date* 7.3%
................................................................................
1-Year 17.8
................................................................................
3-Year 22.8
................................................................................
Since Inception (12/15/93) 19.2
</TABLE>
*Not annualized.
RISK/RETURN COMPARISON Inception (12/15/93) Through 6/30/98
<TABLE>
<CAPTION>
Average Annual Standard
Total Return Deviation RUR
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Royce Total Return 19.2% 6.3 3.05
................................................................................
Russell 2000 15.9% 13.2 1.20
................................................................................
</TABLE>
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.
Since its inception, Royce Total Return has substantially outperformed the
Russell 2000 on BOTH an absolute and a risk-adjusted basis.
- --------------------------------------------------------------------------------
RECENT MARKET PERFORMANCE
- --------------------------------------------------------------------------------
PEAK 5/22/96 PEAK 10/13/97
- -------------------- -------------------
5/22/96 - 6/30/98 10/13/97 - 6/30/98
- -------------------- -------------------
RTR 48.5% RTR 6.4%
- -------------------- -------------------
Russell 2000 28.7% Russell 2000 -1.3%
- -------------------- -------------------
[line chart]
[data points for Russell 2000]
Dec 95 0.00%
Jan 96 -0.11
Feb 96 3.01
Mar 96 5.11
Apr 96 10.73
May 96 15.09
Jun 96 10.36
Jul 96 0.73
Aug 96 6.58
Sep 96 10.75
Oct 96 9.04
Nov 96 13.54
Dec 96 16.51
Jan 97 18.84
Feb 97 15.95
Mar 97 10.48
Apr 97 10.79
May 97 23.12
Jun 97 28.40
Jul 97 34.37
Aug 97 37.45
Sep 97 47.51
Oct 97 41.04
Nov 97 40.12
Dec 97 42.57
Jan 98 40.32
Feb 98 50.69
Mar 98 56.90
Apr 98 57.76
May 98 49.26
Jun 98 49.57
[end line chart]
Royce Total Return has provided strong absolute and relative performance from
the small-cap peak in May 1996
- --------------------------------------------------------------------------------
ROYCE TOTAL RETURN vs. RUSSELL 2000 Value of $10,000 Invested on 12/15/93
- --------------------------------------------------------------------------------
[line chart]
<TABLE>
<CAPTION>
Date Royce Total Return $22,210 Russell 2000 $19,520
<S> <C> <C>
Dec 93 10,000 10,000
Dec 93 10,000 10,350
Mar 94 9,940 10,075
Jun 94 9,960 9,683
Sep 94 10,360 10,355
Dec 94 10,513 10,162
Mar 95 11,149 10,631
Jun 95 12,010 11,627
Sep 95 12,996 12,775
Dec 95 13,336 13,053
Mar 96 13,961 13,720
Jun 96 15,234 14,406
Sep 96 15,512 14,455
Dec 96 16,734 15,206
Mar 97 17,159 14,419
Jun 97 18,861 16,757
Sep 97 20,483 19,251
Dec 97 20,698 18,606
Mar 98 22,128 20,476
Jun 98 22,210 19,520
</TABLE>
[end line chart]
[blue line] Royce Total Return [yellow line] Russell 2000
Includes reinvestment of distributions.
12 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
PERFORMANCE AND PORTFOLIO REVIEW
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
DOWN MARKET PERFORMANCE COMPARISON
All Down Periods of 7.5% or Greater, in Percentages (%)
- --------------------------------------------------------------------------------
[bar chart]
<TABLE>
<CAPTION>
3/18/94 - 5/22/96 - 1/22/97 - 10/13/97 - 4/21/98 -
12/9/94 7/24/96 4/25/97 1/12/98 6/15/98
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Royce Total Return 1.8 -0.5 0.2 -2.7 -3.8
Russell 2000 -12.4 -15.5 -9.2 -11.5 -11.6
</TABLE>
[end bar chart]
[dark blue box] Royce Total Return [light blue box] Russell 2000
Royce Total Return has outperformed the Russell 2000 during all five major
downturns since the Fund's inception.
- -----------------------------------------------------------
PORTFOLIO DIAGNOSTICS
- -----------------------------------------------------------
<TABLE>
<S> <C>
Median Market Cap. $489 million
...........................................................
Weighted Average P/E Ratio 16.0x
...........................................................
Weighted Average P/B Ratio 1.9x
...........................................................
Weighted Average Yield 3.6%
...........................................................
Net Assets $166 million
...........................................................
Turnover Rate 18%
...........................................................
Symbol RYTRX
</TABLE>
- ------------------------------------------
TOP 10 POSITIONS % of Net Assets
- ------------------------------------------
<TABLE>
<S> <C>
Charming Shoppes Conv. Note 2.7
..........................................
Central Steel & Wire Company 2.4
..........................................
Lincoln Electric Holding Co. 2.3
..........................................
Enesco Group 2.2
..........................................
Pennsylvania Manufacturers
Corporation Cl. A 2.2
..........................................
Zenith National Insurance 2.1
..........................................
Arthur J. Gallagher & Co. 2.1
..........................................
Ennis Business Forms 2.0
..........................................
Willis Corroon Group ADR 1.9
..........................................
Garan Incorporated 1.8
</TABLE>
<TABLE>
- ---------------------------------------------------------------------------------------------------------------------
PORTFOLIO SECTOR BREAKDOWN With Examples % of Net Assets*
- ---------------------------------------------------------------------------------------------------------------------
<S> <C>
Industrial Products Building Systems and Components, Construction Materials, Specialty Chemicals and Materials 30
Industrial Services Transportation and Logistics, Printing, Engineering and Construction 18
Financial Intermediaries Insurance, Banking, Brokerage 14
Financial Services Insurance Brokers, Investment Management, Information and Processing 13
Consumer Products Home Furnishings/Appliances, Apparel and Shoes, Publishing 8
Consumer Services Retail, Restaurants/Lodging, Leisure/Entertainment 7
Technology Hardware, Software/Services, Distribution, Telecommunications 6
Natural Resources Oil and Gas, Energy Services, Real Estate 4
</TABLE>
*Excludes cash and short-term investments.
- --------------------------------------------------------------------------------
GOOD IDEAS THAT WORKED
Realized and Unrealized Gain
Year-To-Date Through 6/30/98
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
Talbots $1,180,391
......................................................
Pennsylvania Manufacturers
Corporation Cl. A 1,068,872
......................................................
Central Steel & Wire Company 1,012,580
......................................................
Enesco Group 827,481
......................................................
Arthur J. Gallagher & Co. 823,957
- ------------------------------------------------------
Combined Gain $4,913,281
- ------------------------------------------------------
</TABLE>
- --------------------------------------------------------------------------------
GOOD IDEAS AT THE TIME
Realized and Unrealized Loss
Year-To-Date Through 6/30/98
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
DIMON Incorporated $1,660,488
......................................................
CalMat 560,025
......................................................
Helix Technology Corporation 362,020
......................................................
Arnold Industries 330,250
......................................................
Golden Books Financial Trust 262,500
- ------------------------------------------------------
Combined Loss $3,175,283
- ------------------------------------------------------
</TABLE>
During 1998's first half, the companies listed above made the largest
positive and negative contributions in dollar terms to our performance. Our top
five Good Ideas That Worked contributed 64% to the Fund's total net realized and
unrealized gain for the period. While we are pleased with our successes, we have
learned over the years that there is often more wisdom to be drawn from
failures. An examination of past winners and losers has taught us that this
year's beast can easily be transformed into next year's beauty.
Talbots -- We purchased this woman's apparel retailer when the industry
group was out of favor. The company was also suffering from merchandising
problems and reeling from a disastrous holiday season. All of these factors
depressed the stock price, as the company missed fashion trends on both Wall
Street and Main Street. However, its strong balance sheet and solid franchise
helped it to recover very well, and much sooner than we expected.
DIMON Incorporated -- This tobacco-leaf processor suffered a downturn in
its business cycle in what was already an admittedly unpopular business. While
not currently involved in any tobacco litigation, the jury is still out on this
investment idea.
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 13
<PAGE>
[sidebar]
WHAT WE DO
Royce Low-Priced Stock Fund ("RLP") uses a value approach to invest primarily in
small and micro-cap companies whose market prices are below $15 at the time of
purchase.
HOW WE DID
Royce Low-Priced Stock Fund was up 15.3% for the first half, well ahead of its
benchmark index, the small-cap oriented Russell 2000, which was up 4.9%.
Portfolio holdings in the financial and industrial services sectors made the
greatest impact on the Fund's performance. Its first-half return becomes
especially noteworthy in light of the increased volatility small-caps exhibited
during the second quarter. The Fund also outperformed the Russell 2000 for the
one-year, three-year and since inception (12/15/93) periods ended June 30, 1998,
with average annual returns of 28.3%, 20.8% and 18.2%, respectively.
RLP remains one of only two low-priced stocks funds available and makes its
selections primarily within the small-cap and micro-cap universe. This
intriguing subsector of small and micro-cap receives scant institutional
attention, as many deem stocks trading at these prices to be too risky. Our
experience has taught us differently. We find that such investor indifference
creates potential opportunity for us, as diminished interest can translate into
greater pricing inefficiencies. Low-priced stocks may involve more risk than
many larger, more established companies due to the fact that they are somewhat
difficult to buy and sell, are less well known and receive limited research
coverage. The Fund's total net assets as of June 30, 1998 were $22 million. In
December, the Fund will mark its fifth year of operation.
[end sidebar]
ROYCE LOW-PRICED STOCK FUND
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS (Through 6/30/98)
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
Year-to-date* 15.3%
...............................................................................
1-Year 28.3
...............................................................................
3-Year 20.8
...............................................................................
Since Inception (12/15/93) 18.2
</TABLE>
*Not annualized.
- --------------------------------------------------------------------------------
RISK/RETURN COMPARISON Inception (12/15/93) Through 6/30/98
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Average Annual Standard
Total Return Deviation RUR
...............................................................................
<S> <C> <C> <C>
Royce Low-Priced Stock 18.2% 12.3 1.48
...............................................................................
Russell 2000 15.9% 13.2 1.20
...............................................................................
</TABLE>
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.
Since its inception, Royce Low-Priced Stock has outperformed the Russell 2000 on
BOTH an absolute and a risk-adjusted basis.
- --------------------------------------------------------------------------------
RECENT MARKET PERFORMANCE
- --------------------------------------------------------------------------------
PEAK 5/22/96 PEAK 10/13/97
- ------------------- --------------------
5/22/96 - 6/30/98 10/13/97 - 6/30/98
- ------------------- --------------------
RLP 33.7% RLP 9.1%
- ------------------- --------------------
Russell 2000 28.7% Russell 2000 -1.3%
- ------------------- --------------------
[line chart]
[data points for Russell 2000]
Dec 95 0.00%
Jan 96 -0.11
Feb 96 3.01
Mar 96 5.11
Apr 96 10.73
May 96 15.09
Jun 96 10.36
Jul 96 0.73
Aug 96 6.58
Sep 96 10.75
Oct 96 9.04
Nov 96 13.54
Dec 96 16.51
Jan 97 18.84
Feb 97 15.95
Mar 97 10.48
Apr 97 10.79
May 97 23.12
Jun 97 28.40
Jul 97 34.37
Aug 97 37.45
Sep 97 47.51
Oct 97 41.04
Nov 97 40.12
Dec 97 42.57
Jan 98 40.32
Feb 98 50.69
Mar 98 56.90
Apr 98 57.76
May 98 49.26
Jun 98 49.57
[end line chart]
Royce Low-Priced Stock has provided a performance edge in the current cycle.
- --------------------------------------------------------------------------------
ROYCE LOW-PRICED STOCK vs. RUSSELL 2000 Value of $10,000 Invested on 12/15/93
- --------------------------------------------------------------------------------
[line chart]
<TABLE>
<CAPTION>
Date Royce Low-Priced Stock $21,379 Russell 2000 $19,520
<S> <C> <C>
Dec 93 10,000 10,000
Dec 93 10,000 10,350
Mar 94 9,780 10,075
Jun 94 9,659 9,683
Sep 94 10,259 10,355
Dec 94 10,319 10,162
Mar 95 11,011 10,631
Jun 95 12,131 11,627
Sep 95 13,005 12,775
Dec 95 12,644 13,053
Mar 96 14,443 13,720
Jun 96 15,388 14,406
Sep 96 14,780 14,455
Dec 96 15,526 15,206
Mar 97 15,404 14,419
Jun 97 16,660 16,757
Sep 97 19,125 19,251
Dec 97 18,551 18,606
Mar 98 21,107 20,476
Jun 98 21,379 19,520
</TABLE>
[end line chart]
[blue line] Royce Low-Priced Stock [yellow line] Russell 2000
Includes reinvestment of distributions.
14 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
PERFORMANCE AND PORTFOLIO REVIEW
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
DOWN MARKET PERFORMANCE COMPARISON
All Down Periods of 7.5% or Greater, in Percentages (%)
- --------------------------------------------------------------------------------
[bar chart]
<TABLE>
<CAPTION>
3/18/94- 5/22/96- 1/22/97- 10/13/97- 4/21/98-
12/9/94 7/24/96 4/25/97 1/12/98 6/15/98
<S> <C> <C> <C> <C> <C>
Royce Low-Priced Stock -2.7 -10.5 -4.8 -9.9 -5.5
Russell 2000 -12.4 -15.5 -9.2 -11.5 -11.6
</TABLE>
[end bar chart]
[dark blue box] Royce Low-Priced Stock [light blue box] Russell 2000
Royce Low-Priced Stock has outperformed the Russell 2000 during all five major
downturns since the Fund's inception.
- ---------------------------------------------------
PORTFOLIO DIAGNOSTICS
- ---------------------------------------------------
<TABLE>
<S> <C>
Median Market Cap $171 million
..............................................
Weighted Average P/E Ratio 15.4x
..............................................
Weighted Average P/B Ratio 1.8x
..............................................
Weighted Average Yield 0.8%
..............................................
Net Assets $22 million
..............................................
Turnover Rate 51%
..............................................
Symbol RYLPX
</TABLE>
- -------------------------------------------------
TOP 10 POSITIONS % of Net Assets
- -------------------------------------------------
<TABLE>
<S> <C>
Morrison Knudsen Corporation 3.9
..............................................
Charming Shoppes 3.9
..............................................
Richardson Electronics 2.9
..............................................
Willis Corroon Group ADR 2.8
..............................................
Oakley 2.8
..............................................
Frozen Food Express Industries 2.6
..............................................
Pennsylvania Manufacturers
Corporation Cl. A 2.6
..............................................
Catherines Stores Corporation 2.6
..............................................
Titan Exploration 2.3
..............................................
MacNeal-Schwendler
Corporation 2.2
</TABLE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------
PORTFOLIO SECTOR BREAKDOWN With Examples % of Net Assets*
- ----------------------------------------------------------------------------------------------------
<S> <C>
Industrial Services Transportation and Logistics, Printing, Engineering and Construction 23
Consumer Services Retail, Restaurants/Lodging, Leisure/Entertainment 17
Consumer Products Home Furnishings/Appliances, Apparel and Shoes, Publishing 15
Industrial Products Building Systems and Components, Construction Materials,
Specialty Chemicals and Materials 12
Technology Hardware, Software/Services, Distribution, Telecommunications 11
Natural Resources Oil and Gas, Energy Services, Real Estate 7
Health Surgical Products and Devices, Drugs and Biotech, Health Services 6
Financial Intermediaries Insurance, Banking, Brokerage 5
Financial Services Insurance Brokers, Investment Management,
Information and Processing 4
</TABLE>
*Excludes cash and short-term investments.
- -----------------------------------------------
GOOD IDEAS THAT WORKED
Realized and Unrealized Gain
Year-To-Date Through 6/30/98
- -----------------------------------------------
<TABLE>
<S> <C>
International Isotopes $347,099
...........................................
Buffets 267,496
...........................................
Insituform Technologies Cl. A 245,300
...........................................
Oakley 243,290
...........................................
MovieFone Cl. A 238,816
...........................................
Combined Gain $1,342,001
...........................................
</TABLE>
- -----------------------------------------------
GOOD IDEAS AT THE TIME
Realized and Unrealized Loss
Year-To-Date Through 6/30/98
- -----------------------------------------------
<TABLE>
<S> <C>
Sevenson Environmental Services $149,120
...........................................
Guy F. Atkinson Company 135,450
...........................................
Standard Commercial Corporation 114,431
...........................................
MK Gold Company 101,545
...........................................
RockShox 93,462
...........................................
Combined Loss $594,008
...........................................
</TABLE>
During 1998's first half, the companies listed above made the largest
positive and negative contributions in dollar terms to our performance. Our top
five Good Ideas That Worked contributed 48% to the Fund's total net realized and
unrealized gain for the period. While we are pleased with our successes, we have
learned over the years that there is often more wisdom to be drawn from
failures. An examination of past winners and losers has taught us that this
year's beast can easily be transformed into next year's beauty.
International Isotopes -- We bought this undiscovered micro-cap company on
an IPO because they had bought $70 million in supercollider technology equipment
from the U.S. government for about $5 million, intending to create radioactive
isotopes for prostate cancer treatment.
Sevenson Environmental Services -- Stiff competition in the environmental
clean-up business has prevented the company's financial fortunes from rising the
way that we had initially thought they would. While they have plenty of cash and
securities -- generally a positive sign -- their upside appears limited unless
business conditions turn around rapidly.
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 15
<PAGE>
[sidebar]
WHAT WE DO
Royce Financial Services Fund ("RFS") uses a value approach to invest primarily
in financial services companies.
HOW WE DID
Royce Financial Services Fund finished the first six months ahead of its
benchmark index, the small-cap oriented Russell 2000, up 9.8% versus 4.9% for
the index. The portfolio's concentration in financial companies served it well,
as these stocks comprised one of the first half's strongest sectors, while the
Fund's focus on risk management helped it to escape the higher levels of
volatility exhibited by small-cap stocks. The Fund's three-year and since
inception (12/15/94) returns were 16.4% and 18.9%, respectively.
The Fund is not currently restricted in terms of capitalization, although the
portfolio consists primarily of small-cap companies, an area of the market to
which we bring 25 years of investment experience. Regardless of cap size, our
approach emphasizes strong balance sheets, excellent prospects and high internal
rates of return. Total net assets as of June 30, 1998 were $2.6 million. This
coming December, the Fund will have four years of performance history.
[end sidbar]
ROYCE FINANCIAL SERVICES FUND
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS (Through 6/30/98)
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
Year-to-date* 9.8%
................................................................................
1-Year 13.0
................................................................................
3-Year 16.4
................................................................................
Since Inception (12/15/94) 18.9
</TABLE>
*Not annualized.
- --------------------------------------------------------------------------------
RISK/RETURN COMPARISON Inception (12/15/94) Through 6/30/98
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Average Annual Standard
Total Return Deviation RUR
...............................................................................
<S> <C> <C> <C>
Royce Financial Services 18.9% 9.0 2.10
...............................................................................
Russell 2000 22.0% 13.7 1.61
...............................................................................
</TABLE>
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.
Since its inception, Royce Financial Services has outperformed the Russell 2000
on a risk-adjusted basis.
- --------------------------------------------------------------------------------
RECENT MARKET PERFORMANCE
- --------------------------------------------------------------------------------
PEAK 5/22/96 PEAK 10/13/97
- ----------------------- -----------------------
5/22/96 - 6/30/98 10/13/97 - 6/30/98
....................... .......................
RFS 34.2% RFS 4.5%
....................... .......................
Russell 2000 28.7% Russell 2000 -1.3%
....................... .......................
[line chart]
[data points for Russell 2000]
Dec 95 0.00%
Jan 96 -0.11
Feb 96 3.01
Mar 96 5.11
Apr 96 10.73
May 96 15.09
Jun 96 10.36
Jul 96 0.73
Aug 96 6.58
Sep 96 10.75
Oct 96 9.04
Nov 96 13.54
Dec 96 16.51
Jan 97 18.84
Feb 97 15.95
Mar 97 10.48
Apr 97 10.79
May 97 23.12
Jun 97 28.40
Jul 97 34.37
Aug 97 37.45
Sep 97 47.51
Oct 97 41.04
Nov 97 40.12
Dec 97 42.57
Jan 98 40.32
Feb 98 50.69
Mar 98 56.90
Apr 98 57.76
May 98 49.26
Jun 98 49.57
[end line chart]
Royce Financial Services has provided a performance edge in the current cycle.
- --------------------------------------------------------------------------------
ROYCE FINANCIAL SERVICES vs. RUSSELL 2000 Value of $10,000 Invested on 12/15/94
- --------------------------------------------------------------------------------
[line chart]
<TABLE>
<CAPTION>
Date Royce Financial Services $18,440 Russell 2000 $20,216
<S> <C> <C>
12/15/94 10,000 10,000
12/31/94 10,120 10,525
3/31/95 10,860 11,010
6/30/95 11,699 12,042
9/30/95 12,260 13,232
12/31/95 12,268 13,519
3/31/96 12,765 14,210
6/30/96 13,218 14,920
9/30/96 13,304 14,971
12/31/96 14,062 15,749
3/31/97 14,483 14,933
6/30/97 16,325 17,356
9/30/97 17,421 19,938
12/31/97 16,790 19,270
3/31/98 18,304 21,207
6/30/98 18,440 20,216
</TABLE>
[end line chart]
[blue line] Royce Financial Services [yellow line] Russell 2000
Includes reinvestment of distributions.
16 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
PERFORMANCE AND PORTFOLIO REVIEW
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
DOWN MARKET PERFORMANCE COMPARISON
All Down Periods of 7.5% or Greater, in Percentages (%)
- --------------------------------------------------------------------------------
[bar chart]
<TABLE>
<CAPTION>
5/22/96- 1/22/97- 10/13/97- 4/21/98-
7/24/96 4/25/97 1/12/98 6/15/98
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Royce Financial Services -7.7 -0.8 -8.0 -3.9
Russell 2000 -15.5 -9.2 -11.5 -11.6
</TABLE>
[end bar chart]
[dark blue box] Royce Financial Services [light blue box] Russell 2000
Royce Financial Services has outperformed the Russell 2000 during all four major
downturns since the Fund's inception.
- ---------------------------------------------------
PORTFOLIO DIAGNOSTICS
- ---------------------------------------------------
<TABLE>
<S> <C>
Median Market Cap. $535 million
.............................................
Weighted Average P/E Ratio 13.9x
.............................................
Weighted Average P/B Ratio 1.8x
.............................................
Weighted Average Yield 2.4%
.............................................
Net Assets $2.6 million
.............................................
Turnover Rate 25%
.............................................
Symbol RYGSX
</TABLE>
- -------------------------------------------------
TOP 10 POSITIONS % of Net Assets
- -------------------------------------------------
<TABLE>
<S> <C>
Zenith National Insurance 4.8
.............................................
Pennsylvania Manufacturers
Corporation Cl. A 4.3
.............................................
Willis Corroon Group ADR 4.3
.............................................
Trenwick Group 3.7
.............................................
Arthur J. Gallagher & Co. 3.4
.............................................
The Pioneer Group 3.0
.............................................
The Commerce Group 2.9
.............................................
The Navigators Group 2.9
.............................................
Fund American Enterprises
Holdings 2.8
.............................................
Alleghany Corporation 2.6
</TABLE>
<TABLE>
- --------------------------------------------------------------------------------------------------------------
PORTFOLIO SECTOR BREAKDOWN With Examples % of Net Assets*
- --------------------------------------------------------------------------------------------------------------
<S> <C>
Financial Intermediaries Insurance, Banking, Brokerage 54
Financial Services Insurance Brokers, Investment Management, Information and Processing 41
Industrial Services Transportation and Logistics, Printing, Engineering and Construction 3
Consumer Products Home Furnishings/Appliances, Apparel and Shoes, Publishing 1
Natural Resources Oil and Gas, Energy Services, Real Estate 1
</TABLE>
*Excludes cash and short-term investments.
- --------------------------------------------------------------
GOOD IDEAS THAT WORKED
Realized and Unrealized Gain
Year-To-Date Through 6/30/98
- --------------------------------------------------------------
<TABLE>
<S> <C>
LandAmerica Financial Group $43,695
.............................................
Pennsylvania Manufacturers
Corporation Cl. A 35,000
.............................................
BHI Corporation 32,435
.............................................
Arthur J. Gallagher & Co. 28,544
.............................................
Affiliated Managers Group 22,437
.............................................
Combined Gain $162,111
.............................................
</TABLE>
- -------------------------------------------------------------
GOOD IDEAS AT THE TIME
Realized and Unrealized Loss
Year-To-Date Through 6/30/98
- -------------------------------------------------------------
<TABLE>
<S> <C>
Sevenson Environmental Services $25,546
.............................................
International Semi-Tech 10,500
.............................................
Highlands Insurance Group 9,875
.............................................
Intercargo Corporation 7,500
.............................................
Lazare Kaplan International 7,344
.............................................
Combined Loss $60,765
.............................................
</TABLE>
During 1998's first half, the companies listed above made the largest
positive and negative contributions in dollar terms to our performance. Our top
five Good Ideas That Worked contributed 69% to the Fund's total net realized and
unrealized gain for the period. While we are pleased with our successes, we have
learned over the years that there is often more wisdom to be drawn from
failures. An examination of past winners and losers has taught us that this
year's beast can easily be transformed into next year's beauty.
LandAmerica Financial Group -- This title insurance company came about
from the merger of Lawyers' Title and Commonwealth Title and is part of an
industry many investors seem to be discovering for the first time. Its recent
good fortune is directly tied to the current real estate boom.
Sevenson Environmental Services -- Stiff competition in the environmental
clean-up business has prevented the company's financial fortunes from rising the
way that we had initially thought they would. While they have plenty of cash and
securities -- generally a positive sign -- their upside appears limited unless
business conditions turn around rapidly.
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 17
<PAGE>
UPDATES AND NOTES TO PERFORMANCE AND RISK INFORMATION
- --------------------------------------------------------------------------------
NEW AND IMPROVED...www.roycefunds.com
Visit our newly redesigned website. The site includes both organizational
and navigational changes in an effort to create a more user-friendly interface.
New featured sections include Res Praecipua ("special features") and a weekly
What's New area.
[graphic: desktop computer, "THE ROYCE FUNDS" displayed on the screen]
While we changed the look of our site, and included additional information
for you, we retained the online services that have been popular with our
computer savvy shareholders. Online account access allows our shareholders to
check account values and share balances at their convenience, whenever they
choose. With authorization, shareholders can also purchase additional shares,
make exchanges between Royce Funds or request redemptions. Call Shareholder
Services today to set up your account for online access -- (800) 841-1180.
GIVING A GIFT OR LEAVING A LEGACY -- IT'S YOUR CHOICE!
The dilemma when making a gift is often whether the desire to be generous
outweighs the concern over how the gift will be spent. Will the gift that you
thought would fund a college education rust away in the driveway after a few
years?
Royce GiftShares Fund may be the solution to your gifting concerns. When
you set up a GiftShares account, you establish a trust for your beneficiary. As
the donor, you choose when the beneficiary will have access to the assets by
selecting the termination date of the trust. If you would like the beneficiary
to be able to use the assets before the termination date to pay college
expenses, you may structure the trust so that the Trustee will pay the college
expenses directly to the educational institution. No Porsche payment here! And
while you are enjoying this new form of gifting, you may be able to take
advantage of some tax and estate-planning benefits as well. To receive a
prospectus, which includes fees and expenses, call (800) 221-4268. Please read
the prospectus and Trust Adoption Agreement carefully before investing or
sending money.
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. Investment return and principal value will fluctuate, so that
shares may be worth more or less than their original cost when redeemed. The
Royce Funds invest primarily in securities of small-cap and/or micro-cap
companies that may involve considerably more risk than investments in securities
of larger-cap companies (see "Investment Risks" in the prospectus). 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 6/30/98 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 Total Return Fund received five
stars for the three-year period ended 6/30/98 in the domestic equity investment
category out of 2,545 funds. Ten percent of the funds in an investment category
receive five stars. 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 349 funds in the small-cap objective category
with a three-year history was 1.50 for the three years ended 6/30/98. The lower
the risk ratio, the lower a fund's downside volatility has been. The risk scores
for Royce Premier Fund, Royce Total Return Fund and Pennsylvania Mutual Fund for
this period were 0.74, 0.27 and 0.75, respectively. 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 Value, Russell 2000 Growth, S&P 500 and Dow Jones Industrial
Average are unmanaged indices of domestic common stocks. The Royce Funds and
Royce GiftShares Fund are service marks of The Royce Funds.
18 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
ROYCE TOTAL RETURN FUND JUNE 30, 1998 (unaudited)
- --------------------------------------------------------------------------------
COMMON STOCKS -- 77.1%
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Consumer Products -- 7.7%
Apparel and Shoes - 1.8%
Garan Incorporated 111,800 $ 3,032,575
------------
Collectibles - 2.2%
Enesco Group 116,900 3,594,675
------------
Home Furnishings/Appliances - 2.3%
Bassett Furniture Industries 77,200 2,176,075
La-Z-Boy 6,900 389,850
Velcro Industries 9,000 1,253,250
------------
3,819,175
------------
Sports and Recreation - 1.4%
Sturm, Ruger & Company 134,100 2,246,175
------------
12,692,600
============
Consumer Services -- 1.0%
Restaurants/Lodging - 0.7%
Sbarro 45,600 1,236,900
------------
Retail - 0.3%
Talbots 19,600 513,275
------------
1,750,175
============
Financial Intermediaries -- 10.0%
Insurance - 10.0%
Capitol Transamerica Corporation 102,000 2,097,375
The Commerce Group 76,800 2,976,000
PXRE Corporation 51,700 1,551,000
Pennsylvania Manufacturers
Corporation Cl. A 155,380 3,573,740
Trenwick Group 74,750 2,903,570
Zenith National Insurance 123,500 3,481,156
------------
16,582,841
============
Financial Services -- 12.0%
Insurance Brokers - 5.4%
E.W. Blanch Holdings 13,600 499,800
Crawford & Company Cl. A 102,700 1,925,625
Arthur J. Gallagher & Co. 77,400 3,463,650
Willis Corroon Group ADR+ 244,400 3,070,275
------------
8,959,350
------------
Investment Management - 6.6%
Alliance Capital Management L.P. 70,000 1,771,875
The John Nuveen Company Cl. A 68,500 2,718,594
NVEST L.P. 50,000 1,590,625
PIMCO Advisors Holdings, L.P. 48,050 1,639,706
Phoenix Investment Partners 171,600 1,490,775
The Pioneer Group 65,400 1,720,837
------------
10,932,412
------------
19,891,762
============
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Industrial Products -- 22.9%
Aerospace/Defense - 2.8%
Curtiss-Wright Corporation 55,900 $ 2,190,581
Woodward Governor Company 77,800 2,402,075
------------
4,592,656
------------
Building Systems and Components - 5.8%
International Aluminum
Corporation 42,100 1,305,100
Juno Lighting 87,400 2,064,825
**Paul Mueller Company 60,800 2,356,000
Skyline Corporation 71,700 2,339,212
Woodhead Industries 96,600 1,485,225
------------
9,550,362
------------
Construction Materials - 2.6%
CalMat 99,200 2,182,400
Florida Rock Industries 70,800 2,066,475
------------
4,248,875
------------
Machinery - 4.9%
Lincoln Electric Holding Co. 173,300 3,834,263
Minuteman International 138,500 1,584,094
Nordson Corporation 35,600 1,673,200
Oshkosh Truck Corporation Cl. B 39,300 982,500
------------
8,074,057
------------
Paper and Packaging - 1.4%
P. H. Glatfelter Company 149,800 2,368,713
------------
Pumps, Valves and Bearings - 2.0%
Kaydon Corporation 40,000 1,412,500
NN Ball and Roller 65,000 775,938
Roper Industries 20,000 522,500
Tech/Ops Sevcon 43,700 663,694
------------
3,374,632
------------
Specialty Chemicals and Materials - 1.5%
Lilly Industries Cl. A 74,800 1,617,550
Synalloy Corporation 70,500 951,750
------------
2,569,300
------------
Textiles - 1.7%
Fab Industries 100,200 2,793,075
------------
Other Industrial Products - 0.2%
Landauer 13,400 400,325
------------
37,971,995
============
Industrial Services -- 12.0%
Advertising - 0.7%
True North Communications 41,000 1,199,250
------------
</TABLE>
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 19
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
ROYCE TOTAL RETURN FUND JUNE 30, 1998 (unaudited)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Industrial Services (continued)
Engineering and Construction - 1.4%
Sevenson Environmental Services 86,400 $ 723,600
Stone & Webster 39,100 1,549,337
------------
2,272,937
------------
Food/Tobacco Processors - 1.5%
DIMON Incorporated 145,800 1,640,250
Universal Corporation 25,000 934,375
------------
2,574,625
------------
Industrial Distribution - 2.4%
Central Steel & Wire Company 3,898 3,975,960
------------
Printing - 4.8%
Ennis Business Forms 285,400 3,317,775
New England Business Service 73,400 2,367,150
The Standard Register Company 64,000 2,264,000
------------
7,948,925
------------
Transportation and Logistics - 1.2%
Arnold Industries 132,100 1,948,475
------------
19,920,172
============
Natural Resources -- 4.1%
Energy Services - 0.7%
Carbo Ceramics 35,000 1,194,375
------------
Metals and Mining - 1.5%
Anglogold Limited ADR+ 123,600 2,441,100
------------
Oil and Gas - 1.9%
Devon Energy Corporation 52,300 1,827,231
Kinder Morgan Energy Partners, L.P. 35,000 1,264,375
------------
3,091,606
------------
6,727,081
============
Technology -- 2.5%
Hardware - 2.5%
Dallas Semiconductor
Corporation 50,000 1,550,000
Helix Technology Corporation 109,700 1,645,500
Penn Engineering and
Manufacturing Cl. A 45,500 932,750
------------
4,128,250
============
Miscellaneous -- 4.9% 8,161,957
============
TOTAL COMMON STOCKS
(Cost $112,946,429) 127,826,833
============
PREFERRED STOCK -- 0.1%
Golden Books Financial Trust (Conv.)
(Cost $512,500) 10,000 250,000
============
</TABLE>
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT VALUE
--------- -----
<S> <C> <C>
CORPORATE BONDS -- 6.9%
Charming Shoppes 7.50%
Conv. Sub. Note due 7/15/06 $4,500,000 $ 4,415,625
Credence Systems Corporation 5.25%
Conv. Sub. Note due 9/15/02 1,000,000 812,500
Cymer 3.50%
Conv. Sub. Note due 8/06/04 1,000,000 800,000
HMT Technology Corporation 5.75%
Conv. Sub. Note due 1/15/04 1,000,000 725,000
MacNeal-Schwendler Corporation 7.875%
Conv. Sub. Deb. due 8/18/04 1,965,000 1,972,369
Richardson Electronics 8.25%
Conv. Sub. Deb. due 6/15/06 1,210,000 1,220,587
Standard Commercial 7.25%
Conv. Sub. Deb. due 3/31/07 500,000 419,375
Sunglass Hut International 5.25%
Conv. Sub. Note due 6/15/03 750,000 615,000
System Software Associates 7.00%
Conv. Sub. Note due 9/15/02 500,000 410,000
------------
TOTAL CORPORATE BONDS
(Cost $11,285,909) 11,390,456
============
U.S. TREASURY OBLIGATIONS -- 13.5%
U.S. Treasury Notes
6.25%, due 8/31/00 9,000,000 9,132,210
6.25%, due 8/31/02 8,000,000 8,208,720
5.625%, due 12/31/02 5,000,000 5,021,850
------------
TOTAL U.S. TREASURY OBLIGATIONS
(Cost $22,097,349) 22,362,780
============
</TABLE>
<TABLE>
<S> <C>
REPURCHASE AGREEMENT -- 1.3%
State Street Bank and Trust Company, 5.15%
dated 6/30/98, due 7/01/98, maturity value
$2,100,300 (collateralized by U.S. Treasury
Bonds, 8.375% due 8/15/08 and U.S.
Treasury Notes, 6.125% due 12/31/01, valued
at $2,146,527)
(Cost $2,100,000) 2,100,000
============
TOTAL INVESTMENTS -- 98.9%
(Cost $148,942,187) 163,930,069
CASH AND OTHER ASSETS
LESS LIABILITIES -- 1.1% 1,855,704
------------
NET ASSETS -- 100.0% $165,785,773
============
</TABLE>
- --------------------------------------------------------------------------------
+ American Depository Receipt.
** At June 30, 1998, the Fund owned 5% or more of the Company's outstanding
voting securities thereby making the Company an Affiliated Company as that
term is defined in the Investment Company Act of 1940.
INCOME TAX INFORMATION: The cost of total investments for federal income tax
purposes was $148,942,187. At June 30, 1998, net unrealized appreciation for
all securities amounted to $14,987,882, consisting of aggregate gross
unrealized appreciation of $18,429,927 and aggregate gross unrealized
depreciation of $3,442,045.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
20 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
ROYCE LOW-PRICED STOCK FUND JUNE 30, 1998 (unaudited)
- --------------------------------------------------------------------------------
COMMON STOCKS -- 84.5%
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Consumer Products -- 11.2%
Apparel and Shoes - 2.8%
Oakley* 46,200 $ 617,925
-----------
Home Furnishings/Appliances - 1.2%
Lifetime Hoan Corporation 26,070 260,700
-----------
Publishing - 1.7%
The Topps Company* 121,900 377,128
-----------
Sports and Recreation - 3.2%
Johnson Worldwide
Associates Cl. A* 14,100 178,013
Lund International Holdings* 28,700 326,462
RockShox* 50,000 200,000
-----------
704,475
-----------
Other Consumer Products - 2.3%
Lazare Kaplan International* 25,100 265,119
Toy Biz* 26,000 240,500
-----------
505,619
-----------
2,465,847
===========
Consumer Services -- 12.8%
Leisure/Entertainment - 2.1%
Seattle Filmworks* 60,000 463,125
-----------
Restaurants/Lodging - 3.6%
Buffets* 31,500 494,156
Pizza Inn 55,700 309,831
-----------
803,987
-----------
Retail - 7.1%
Catherines Stores Corporation* 57,400 563,237
Charming Shoppes* 179,600 853,100
Suzy Shier 22,000 145,765
-----------
1,562,102
-----------
2,829,214
===========
Financial Intermediaries -- 4.4%
Insurance - 4.4%
Intercargo Corporation 33,500 393,625
Pennsylvania Manufacturers
Corporation Cl. A 24,800 570,400
-----------
964,025
===========
Financial Services -- 3.7%
Insurance Brokers - 2.8%
Willis Corroon Group ADR+ 49,900 626,869
-----------
Investment Management - 0.9%
Phoenix Investment Partners 22,900 198,944
-----------
825,813
===========
Health -- 4.7%
Drugs and Biotech - 1.0%
BioReliance Corporation* 15,000 225,937
-----------
Personal Care - 1.5%
Jean-Philippe Fragrances* 39,200 316,050
-----------
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Surgical Products and Devices - 2.2%
Haemonetics Corporation* 15,000 $ 240,000
Nitinol Medical Technologies* 32,800 246,000
-----------
486,000
-----------
1,027,987
===========
Industrial Products -- 10.0%
Building Systems and Components - 2.2%
Falcon Products 39,000 492,375
-----------
Paper and Packaging - 1.7%
PalEx* 40,000 380,000
-----------
Pumps, Valves and Bearings - 0.7%
Sun Hydraulics Corporation 10,000 160,000
-----------
Specialty Chemicals and Materials - 5.0%
Aldila* 43,000 284,875
CFC International* 40,100 443,606
Hauser* 30,000 174,375
Synalloy Corporation 14,600 197,100
-----------
1,099,956
-----------
Other Industrial Products - 0.4%
BHA Group Holdings 4,852 80,058
-----------
2,212,389
===========
Industrial Services -- 18.2%
Engineering and Construction - 9.0%
Insituform Technologies Cl. A* 20,700 286,566
Morrison Knudsen Corporation* 61,500 864,844
Sevenson Environmental Services 44,160 369,840
Willbros Group* 30,000 468,750
-----------
1,990,000
-----------
Food/Tobacco Processors - 2.3%
Midwest Grain Products* 20,000 290,000
Standard Commercial
Corporation* 19,441 213,851
-----------
503,851
-----------
Printing - 2.1%
Ennis Business Forms 40,000 465,000
-----------
Transportation and Logistics - 4.8%
Arnold Industries 33,500 494,125
Frozen Food Express Industries 58,000 572,750
-----------
1,066,875
-----------
4,025,726
===========
Natural Resources -- 4.8%
Metals and Mining - 1.0%
MK Gold Company* 222,100 208,219
-----------
Oil and Gas--3.8%
Tom Brown* 17,700 332,981
Titan Exploration* 57,700 512,088
-----------
845,069
-----------
1,053,288
===========
</TABLE>
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 21
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
ROYCE LOW-PRICED STOCK FUND JUNE 30, 1998 (unaudited)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Technology -- 9.8%
Distribution - 4.8%
Perceptron* 35,000 $ 420,000
Richardson Electronics 47,900 646,650
-----------
1,066,650
-----------
Hardware - 1.9%
Electroglas* 15,000 195,937
Newport Corporation 5,000 98,750
Scitex Corporation Limited* 10,000 130,625
-----------
425,312
-----------
Software/Services - 3.1%
MacNeal-Schwendler
Corporation* 50,500 495,531
Tyler Corporation* 17,300 178,406
-----------
673,937
-----------
2,165,899
===========
Miscellaneous -- 4.9% 1,091,944
===========
TOTAL COMMON STOCKS
(Cost $16,916,178) 18,662,132
===========
</TABLE>
<TABLE>
<CAPTION>
VALUE
-----
<S> <C>
REPURCHASE AGREEMENT--15.4%
State Street Bank and Trust Company,
5.15% dated 6/30/98, due 7/01/98,
maturity value $3,400,486
(collateralized by U.S. Treasury
Bonds, 10.625% due 8/15/15 and
7.25% due 5/15/16, valued at
$3,472,266) (Cost $3,400,000) $ 3,400,000
===========
TOTAL INVESTMENTS -- 99.9%
(Cost $20,316,178) 22,062,132
CASH AND OTHER ASSETS
LESS LIABILITIES -- 0.1% 18,016
-----------
NET ASSETS -- 100.0% $22,080,148
===========
</TABLE>
- --------------------------------------------------------------------------------
* Non-income producing.
+ American Depository Receipt.
INCOME TAX INFORMATION: The cost of total investments for federal income tax
purposes was $20,316,178. At June 30, 1998, net unrealized appreciation for all
securities was $1,745,954, consisting of aggregate gross unrealized
appreciation of $2,732,781 and aggregate gross unrealized depreciation of
$986,827.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
22 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
ROYCE FINANCIAL SERVICES FUND JUNE 30, 1998 (unaudited)
- --------------------------------------------------------------------------------
COMMON STOCKS -- 75.6%
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Consumer Products -- 1.0%
Other Consumer Products - 1.0%
Lazare Kaplan International* 2,500 $ 26,406
==========
Financial Intermediaries -- 38.2%
Banking - 0.6%
Banca Quadrum ADR+* 1,000 3,125
Barclays ADR+ 100 11,500
Grupo Financiero ADR+* 2,000 2,500
----------
17,125
----------
Brokerage - 1.1%
Legg Mason 500 28,781
----------
Insurance - 36.5%
Alleghany Corporation* 300 69,975
CNA Surety Corporation* 2,000 29,500
The Commerce Group 2,000 77,500
Fremont General Corporation 500 27,094
Fund American Enterprises
Holdings 500 74,000
Intercargo Corporation 5,000 58,750
LandAmerica Financial Group 1,000 57,250
Leucadia National Corporation 2,000 66,125
The Navigators Group* 4,000 75,750
PICO Holdings* 10,500 45,281
PXRE Corporation 1,500 45,000
Pennsylvania Manufacturers
Corporation Cl. A 5,000 115,000
Trenwick Group 2,500 97,109
Zenith National Insurance 4,500 126,844
----------
965,178
----------
1,011,084
==========
Financial Services -- 29.2%
Information and Processing - 2.9%
American Express Company 100 11,400
Duff & Phelps Credit Rating Co. 500 27,875
Fair Isaac and Company,
Incorporated 1,000 38,000
----------
77,275
----------
Insurance Brokers - 11.9%
E.W. Blanch Holdings 1,500 55,125
Crawford & Company Cl. A 3,000 56,250
Arthur J. Gallagher & Co. 2,000 89,500
Willis Corroon Group ADR+ 9,000 113,063
----------
313,938
----------
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Investment Management - 14.4%
Affiliated Managers Group* 1,100 $ 40,837
Alliance Capital Management L.P. 2,000 50,625
Amvescap ADR+ 200 9,825
C.I. Fund Management 2,000 20,387
The John Nuveen Company Cl. A 1,000 39,687
NVEST L.P. 2,000 63,625
PIMCO Advisors Holdings, L.P. 1,000 34,125
Phoenix Investment Partners 4,000 34,750
The Pioneer Group 3,000 78,937
U.S. Global Investors Cl. A* 5,000 10,000
----------
382,798
----------
774,011
==========
Industrial Services -- 2.2%
Commercial Services - 2.2%
BHI Corporation* 1,500 59,250
==========
Natural Resources -- 0.4%
Metals and Mining - 0.4%
MK Gold Company* 10,000 9,375
==========
Miscellaneous -- 4.6% 4,140 121,123
==========
TOTAL COMMON STOCKS
(Cost $1,742,600) 2,001,249
==========
CORPORATE BOND -- 1.1%
International Semi-Tech, 11.50% Sr.
Note due 8/15/03, principal
amount $100,000
(Cost $58,875) 29,000
==========
REPURCHASE AGREEMENT -- 22.6%
State Street Bank and Trust Company, 5.15%
dated 6/30/98, due 7/01/98, maturity value
$600,086 (collateralized by U.S. Treasury
Notes, 5.00% due 1/31/99, valued at
$615,738)
(Cost $600,000) 600,000
==========
TOTAL INVESTMENTS -- 99.3%
(Cost $2,401,475) 2,630,249
CASH AND OTHER ASSETS
LESS LIABILITIES -- 0.7% 17,909
----------
NET ASSETS -- 100.0% $2,648,158
==========
</TABLE>
- --------------------------------------------------------------------------------
* Non-income producing.
+ American Depository Receipt.
INCOME TAX INFORMATION: The cost of total investments for federal income tax
purposes was $2,401,475. At June 30, 1998, net unrealized appreciation for all
securities was $228,774, consisting of aggregate gross unrealized appreciation
of $336,975 and aggregate gross unrealized depreciation of $108,201.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 23
<PAGE>
STATEMENTS OF ASSETS AND LIABILITIES JUNE 30, 1998 (unaudited)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Royce Total Royce Low- Royce Financial
Return Fund Priced Stock Fund Services Fund
----------- ----------------- ---------------
<S> <C> <C> <C>
ASSETS:
Investments at value (identified cost $146,842,187, $16,916,178 and
$1,801,475, respectively) $161,830,069 $18,662,132 $2,030,249
Repurchase agreements (at cost and value) 2,100,000 3,400,000 600,000
Cash 36,479 5,149 259,254
Receivable for capital shares sold 2,082,993 42,165 660
Receivable for dividends and interest 905,664 12,430 3,770
Receivable for investments sold 256,383 5,625 --
Prepaid expenses and other assets 6,714 1,884 5,447
- -----------------------------------------------------------------------------------------------------------------------------
Total Assets 167,218,302 22,129,385 2,899,380
- -----------------------------------------------------------------------------------------------------------------------------
LIABILITIES:
Payable for investments purchased 1,128,648 15,084 248,126
Payable for capital shares redeemed 122,573 -- --
Payable for investment advisory fees 98,388 15,169 --
Accrued expenses 82,920 18,984 3,096
- -----------------------------------------------------------------------------------------------------------------------------
Total Liabilities 1,432,529 49,237 251,222
- -----------------------------------------------------------------------------------------------------------------------------
Net Assets $165,785,773 $22,080,148 $2,648,158
=============================================================================================================================
ANALYSIS OF NET ASSETS:
Undistributed net investment income (loss) $ 1,987,020 $ (2,072) $ (1,170)
Accumulated net realized gain on investments 4,068,472 2,602,078 282,496
Net unrealized appreciation on investments 14,987,882 1,745,954 228,774
Capital shares 20,536 2,809 388
Additional paid-in capital 144,721,863 17,731,379 2,137,670
- -----------------------------------------------------------------------------------------------------------------------------
Net Assets $165,785,773 $22,080,148 $2,648,158
=============================================================================================================================
SHARES OUTSTANDING:
(unlimited number of $.001 par value shares authorized for each Fund) 20,536,201 2,808,542 388,246
=============================================================================================================================
NET ASSET VALUES (Net Assets [divided by] Shares Outstanding):
(offering and redemption price* per share) $8.07 $7.86 $6.82
=============================================================================================================================
</TABLE>
* Shares redeemed within one year of purchase are subject to a 1% redemption
fee, payable to the Fund.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
24 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
===================================
Royce Total Return Fund
-----------------------------------
Six months ended Year ended
June 30, 1998 December 31,
(unaudited) 1997
===================================
<S> <C> <C>
INVESTMENT OPERATIONS:
Net investment income (loss) $ 1,951,065 $ 1,696,026
Net realized gain on investments 4,132,189 2,348,301
Net change in unrealized appreciation on investments 3,489,241 5,872,331
- ------------------------------------------------------------------------------------------
Net increase in net assets from investment operations 9,572,495 9,916,658
- ------------------------------------------------------------------------------------------
DIVIDENDS AND DISTRIBUTIONS:
Net investment income -- (1,647,104)
Net realized gain on investments -- (2,179,092)
- ------------------------------------------------------------------------------------------
Total dividends and distributions -- (3,826,196)
- ------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS:
Net proceeds from shares sold 85,050,773 87,984,309
Value of shares issued in connection with the
merger of Royce Equity Income Fund -- 34,543,545
Dividends reinvested -- 3,420,793
Cost of shares redeemed (49,283,957) (17,826,184)
- ------------------------------------------------------------------------------------------
Net increase in net assets from capital share
transactions 35,766,816 108,122,463
- ------------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS 45,339,311 114,212,925
NET ASSETS:
Beginning of period 120,446,462 6,233,537
- ------------------------------------------------------------------------------------------
End of period (a) $ 165,785,773 $ 120,446,462
==========================================================================================
CAPITAL SHARE TRANSACTIONS:
Shares sold 10,776,364 12,060,292
Shares issued in connection with the
merger of Royce Equity Income Fund -- 4,913,733
Shares issued for reinvestment of dividends and
distributions -- 456,108
Shares redeemed (6,264,499) (2,396,674)
- ------------------------------------------------------------------------------------------
Net increase in shares outstanding 4,511,865 15,033,459
- ------------------------------------------------------------------------------------------
</TABLE>
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 25
<PAGE>
<TABLE>
<CAPTION>
===================================================================
Royce Low-Priced Stock Fund Royce Financial Services Fund
----------------------------------- -------------------------------
Six months ended Year ended Six months ended Year ended
June 30, 1998 December 31, June 30, 1998 December 31,
(unaudited) 1997 (unaudited) 1997
===================================================================
<S> <C> <C> <C> <C>
INVESTMENT OPERATIONS:
Net investment income (loss) $ (2,072) $ (80,293) $ (1,170) $ (329)
Net realized gain on investments 2,594,335 1,443,527 138,283 415,392
Net change in unrealized appreciation on investments 208,058 1,637,540 97,819 (44,868)
- --------------------------------------------------------------------------------------------------------------------------
Net increase in net assets from investment operations 2,800,321 3,000,774 234,932 370,195
- --------------------------------------------------------------------------------------------------------------------------
DIVIDENDS AND DISTRIBUTIONS:
Net investment income -- -- -- (5,069)
Net realized gain on investments -- (1,717,330) -- (325,296)
- --------------------------------------------------------------------------------------------------------------------------
Total dividends and distributions -- (1,717,330) -- (330,365)
- --------------------------------------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS:
Net proceeds from shares sold 7,053,834 6,050,197 463,091 431,866
Value of shares issued in connection with the
merger of Royce Equity Income Fund -- -- -- --
Dividends reinvested -- 1,599,306 -- 324,635
Cost of shares redeemed (5,870,425) (6,741,432) (445,562) (348,519)
- --------------------------------------------------------------------------------------------------------------------------
Net increase in net assets from capital share
transactions 1,183,409 908,071 17,529 407,982
- --------------------------------------------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS 3,983,730 2,191,515 252,461 447,812
NET ASSETS:
Beginning of period 18,096,418 15,904,903 2,395,697 1,947,885
- --------------------------------------------------------------------------------------------------------------------------
End of period (a) $ 22,080,148 $ 18,096,418 $2,648,158 $2,395,697
==========================================================================================================================
CAPITAL SHARE TRANSACTIONS:
Shares sold 915,545 873,778 72,231 63,855
Shares issued in connection with the
merger of Royce Equity Income Fund -- -- -- --
Shares issued for reinvestment of dividends and
distributions -- 233,476 -- 52,786
Shares redeemed (761,952) (978,403) (69,986) (53,525)
- --------------------------------------------------------------------------------------------------------------------------
Net increase in shares outstanding 153,593 128,851 2,245 63,116
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Includes undistributed net investment income (loss) of $1,987,020, $(2,072)
and $(1,170) in 1998 and $35,955, $0 and $0 in 1997 for Royce Total Return
Fund, Royce Low-Priced Stock Fund and Royce Financial Services Fund,
respectively.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 25
<PAGE>
STATEMENTS OF OPERATIONS SIX MONTHS ENDED JUNE 30, 1998 (unaudited)
- ------------------------------------------------------------------------
<TABLE>
<CAPTION>
Royce Total Royce Low- Royce Financial
Return Fund Priced Stock Fund Services Fund
------------- ------------------- ----------------
INVESTMENT INCOME:
Income:
<S> <C> <C> <C>
Dividends $1,639,471 $ 82,164 $ 17,636
Interest 1,207,172 68,268 104
- ------------------------------------------------------------------------------------------------------------
Total Income 2,846,643 150,432 17,740
- ------------------------------------------------------------------------------------------------------------
Expenses:
Investment advisory fees 716,462 153,528 19,037
Distribution fees -- 25,588 3,173
Shareholder servicing fees 76,346 10,619 583
Custodian fees 32,076 12,887 4,022
Administrative and office facilities expenses 28,300 4,846 633
Audit fees 18,525 6,125 2,865
Registration fees 17,528 7,500 4,206
Trustees' fees 8,222 1,050 135
Legal fees 3,056 445 48
Other expenses 83,158 17,761 5,988
- ------------------------------------------------------------------------------------------------------------
Total Expenses 983,673 240,349 40,690
Fees Waived by Investment Adviser and Distributor (88,095) (87,845) (21,780)
- ------------------------------------------------------------------------------------------------------------
Net Expenses 895,578 152,504 18,910
- ------------------------------------------------------------------------------------------------------------
Net Investment Income (Loss) 1,951,065 (2,072) (1,170)
- ------------------------------------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN ON INVESTMENTS:
Net realized gain on investments 4,132,189 2,594,335 138,283
Net change in unrealized appreciation on investments 3,489,241 208,058 97,819
- ------------------------------------------------------------------------------------------------------------
Net realized and unrealized gain on investments 7,621,430 2,802,393 236,102
- ------------------------------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS FROM INVESTMENT OPERATIONS $9,572,495 $2,800,321 $ 234,932
============================================================================================================
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
This table is presented to show selected data for a share outstanding
throughout each period, and to assist shareholders in evaluating a Fund's
performance for the periods presented.
<TABLE>
<CAPTION>
NET ASSET VALUE, NET INVESTMENT NET REALIZED AND DIVIDENDS FROM
BEGINNING INCOME UNREALIZED GAIN ON NET INVESTMENT
OF PERIOD (LOSS) INVESTMENTS INCOME
=====================================================================================
<S> <C> <C> <C> <C>
ROYCE TOTAL RETURN FUND (a)
++ 1998 $7.52 $ 0.09 $0.46 $ --
1997 6.29 0.11 1.38 (0.11)
1996 5.76 0.14 1.28 (0.16)
1995 5.12 0.13 1.24 (0.13)
1994 5.00 0.02 0.24 (0.02)
1993 5.00 -- -- --
ROYCE LOW-PRICED STOCK FUND (b)
++ 1998 $6.82 $ -- $1.04 $ --
1997 6.30 (0.03) 1.26 --
1996 5.62 (0.03) 1.31 --
1995 5.07 -- 1.14 --
1994 5.01 (0.03) 0.18 --
1993 5.00 -- 0.01 --
ROYCE FINANCIAL SERVICES FUND (c)
++ 1998 $6.21 $ -- $0.61 $ --
1997 6.03 -- 1.16 (0.02)
1996 5.68 0.01 0.81 --
1995 5.06 -- 1.07 --
1994 5.00 -- 0.06 --
- -------------------------------------------------------------------------------------
<CAPTION>
RATIO OF RATIO OF NET AVERAGE
DISTRIBUTIONS FROM NET ASSET NET ASSETS, EXPENSES INVESTMENT PORTFOLIO COMMISSION
NET REALIZED GAIN VALUE, END TOTAL END OF PERIOD TO AVERAGE INCOME (LOSS) TO TURNOVER RATE
ON INVESTMENTS OF PERIOD RETURN (IN THOUSANDS) NET ASSETS AVERAGE NET ASSETS RATE PAID+
==========================================================================================================================
<S> <C> <C> <C> <C> <C> <C> <C> <C>
++ $ -- $8.07 7.3% $165,786 1.25%* 2.72%* 18% $0.0671
(0.15) 7.52 23.7% 120,446 1.25% 3.15% 26% 0.0625
(0.73) 6.29 25.5% 6,234 1.25% 2.50% 111% 0.0605
(0.60) 5.76 26.9% 2,548 1.67% 2.42% 68% --
(0.12) 5.12 5.2% 1,656 1.96% 0.49% 88% --
-- 5.00 0.0% 451 0.29%* (0.29)%* 0% --
++ $ -- $7.86 15.3% $ 22,080 1.49%* (0.02)%* 51% $0.0620
(0.71) 6.82 19.5% 18,096 1.49% (0.47)% 99% 0.0541
(0.60) 6.30 22.8% 15,905 1.88% (0.67)% 137% 0.0464
(0.59) 5.62 22.5% 4,215 1.97% (1.11)% 114% --
(0.09) 5.07 3.0% 1,880 1.89% (1.11)% 95% --
-- 5.01 0.2% 452 0.29%* (0.29)%* 0% --
++ $ -- $6.82 9.8% $ 2,648 1.49%* (0.09)%* 25% $0.0622
(0.96) 6.21 19.4% 2,396 1.49% (0.01)% 66% 0.0616
(0.47) 6.03 14.6% 1,948 1.56% 0.17% 81% 0.0591
(0.45) 5.68 21.2% 1,627 1.97% (0.58)% - 106% --
-- 5.06 1.2% 514 1.78%* 0.00% 0% --
- -------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Expense ratios are shown after fee waivers by the investment adviser and
distributor. For the periods ended June 30, 1998 and December 31, 1997,
1996, 1995, 1994 and 1993, the expense ratios before the waivers would
have been 1.37%, 1.67%, 2.23%, 2.38%, 3.21%, and 2.04%, respectively. The
Fund commenced operations on December 15, 1993.
(b) Expense ratios are shown after fee waivers by the investment adviser and
distributor. For the periods ended June 30, 1998 and December 31, 1997,
1996, 1995, 1994 and 1993, the expense ratios before the waivers would
have been 2.35%, 2.38%, 2.59%, 3.47%, 3.63%, and 2.04%, respectively. The
Fund commenced operations on December 15, 1993.
(c) Expense ratios are shown after fee waivers by the investment adviser and
distributor. For the periods ended June 30, 1998 and December 31, 1997,
1996, 1995 and 1994, the expense ratios before the waivers would have been
3.21%, 3.04%, 3.31%, 3.72% and 3.69%, respectively. The Fund commenced
operations on December 15, 1994.
* Annualized.
+ Beginning in 1996, funds are required to disclose average commission rates
paid per share for purchases and sales of investments.
++ Six months ended June 30, 1998 (unaudited).
26 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
NOTES TO FINANCIAL STATEMENTS (unaudited)
- --------------------------------------------------------------------------------
Summary of Significant Accounting Policies:
Royce Total Return Fund, Royce Low-Priced Stock Fund and Royce Financial
Services Fund (the "Fund" or "Funds") are three series of The Royce Fund (the
"Trust"), a diversified open-end management investment company organized as a
Delaware business trust. Royce Total Return Fund and Royce Low-Priced Stock
Fund commenced operations on December 15, 1993. Royce Financial Services Fund
commenced operations on December 15, 1994 as Royce Global Services Fund, and
changed its name, investment objective and policies on November 25, 1997 to
concentrate its investments in the financial services industry.
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. Dividend
income is recorded on the ex-dividend date and any non-cash dividend income is
recorded at the fair market value of the securities received. 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:
The Funds incur direct and indirect expenses. Expenses directly
attributable to a Fund are charged to the Fund's operations, while expenses
applicable to one or more Royce Funds are allocated in an equitable manner.
Allocated personnel costs of employees of The Royce Funds are included in
administrative and office facilities expenses.
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
reclassifications within the capital accounts. 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 distributable 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, which are held by SSB&T until maturity of the
repurchase agreements, are marked-to-market daily and maintained at a value at
least equal to the principal amount of the repurchase agreement (including
accrued interest). 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 and Distributor:
Under the Trust's investment advisory agreements with Royce & Associates,
Inc. ("Royce"), Royce is entitled to receive a monthly fee at an annual rate
of 1.0%, 1.5% and 1.5% of the average net assets of Royce Total Return Fund,
Royce Low-Priced Stock Fund and Royce Financial Services Fund, respectively.
For the six months ended June 30, 1998, Royce Total Return Fund, Royce
Low-Priced Stock Fund and Royce Financial Services Fund recorded advisory fees
of $628,367 (net of voluntary waivers of $88,095), $91,271 (net of voluntary
waivers of $62,257) and $430 (net of voluntary waivers of $18,607),
respectively.
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 27
<PAGE>
NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
- --------------------------------------------------------------------------------
Royce Fund Services, Inc. ("RFS"), the distributor of the Trust's shares,
is an affiliate of Royce. RFS voluntarily waived distribution fees for Royce
Low-Priced Stock Fund and Royce Financial Services Fund of $25,588 and $3,173,
respectively, for the six months ended June 30, 1998. The 12b-1 distribution
plan provides for maximum fees of .25% per annum of the average net assets of
each of these Funds. Effective December 31, 1997, the 12b-1 distribution plan
for Royce Total Return Fund was terminated.
Purchases and Sales of Investment Securities:
For the six months ended June 30, 1998, the cost of purchases and the
proceeds from sales of investment securities, other than short-term securities,
were as follows:
<TABLE>
<CAPTION>
========================================================================================
Royce Royce Royce
Total Return Fund Low-Priced Stock Fund Financial Services Fund
------------------- ----------------------- ------------------------
<S> <C> <C> <C>
Purchases $74,950,463 $8,942,795 $484,088
- ----------------------------------------------------------------------------------------
Sales $24,183,079 $9,613,524 $599,177
========================================================================================
</TABLE>
Transactions in Shares of Affiliated Companies:
An "Affiliated Company", as defined in the Investment Company Act of
1940, is a company in which a Fund owns at least 5% of the company's
outstanding voting securities. Royce Total Return Fund effected the following
transactions in shares of such companies for the six months ended June 30, 1998.
<TABLE>
<CAPTION>
========================================================================================
Purchases Sales
----------------- -----------------
Affiliated Realized Dividend
Company Shares Cost Shares Cost Gain/Loss Income
- ---------------------- -------- ------ -------- ------ ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
Paul Mueller Company -- -- -- -- -- $72,960
========================================================================================
</TABLE>
Merger Information:
On June 17, 1997, Royce Total Return Fund acquired all of the assets and
assumed all of the liabilities of Royce Equity Income Fund. Based on the
opinion of Fund counsel, the acquisition, which was approved by the
shareholders of Royce Equity Income Fund on May 28, 1997, qualified as a
tax-free reorganization for federal income tax purposes with no gain or loss
recognized to the Funds or their shareholders. Royce Equity Income Fund's net
assets, including $5,201,557 of unrealized appreciation, were combined with
Royce Total Return Fund for total net assets after the acquisition of
$63,558,350. Costs associated with the acquisition were borne by the
Investment Adviser.
28 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
POSTSCRIPT
- --------------------------------------------------------------------------------
[graphic: montage: Wall Street street sign, stock certificates, Stock Market
building front, people working the stock market floor]
[page background image: man shooting a basketball]
HANG TIME
By now, the sight has grown familiar to all of us. A man with a basketball
launches himself off the hardwood into the air from what looks like an absurdly
early spot at the very top -- the very tip -- of the key. Moving gracefully and
effortlessly skyward, he displays an uncanny ability to evade any defender in
his path. The bodies of opponents gyrate at awkward angles, bobbing up and down
in a futile effort to stop him -- they do not even slow him down. As he cruises
toward the basket, there typically remains one hardy soul who will attempt to
forestall the inevitable. Yet this defender is also left confounded and
frustrated. Taking evasive action, the man shifts the ball from his left hand to
his right, now back again to his left, as the last defender plummets earthward,
landing on the court, able only to gaze upward and watch enviously as the man
dunks the ball with an elegance that a dunk is not supposed to possess. Michael
Jordan has done it again.
Jordan's aerial exploits have become the stuff of legend because of
moments such as this. With what looks like a casual disregard for the laws of
gravity, he has risen to be not only the greatest athlete of his time and the
greatest basketball player in the history of the game, but arguably the most
famous human being on the face of the earth. Basketball writers looking for a
way to do justice to his airness' high-flying feats have contributed a new
phrase to our collective lexicon, used to describe anything that lingers longer
in the air than physics or common sense would seem to allow -- Hang Time.
In our view, the stock market of the past four years is best
characterized as Jordanesque in the ability of a different sort of rampaging
bull to remain at lofty levels longer than any rational explanation would seem
capable of justifying. The prognosticators who have explained exactly why the
Dow had reached a peak at (take your pick) 7000, 8000 or 9000 have subsequently
felt like the multitude of sports writers who have prematurely predicted
Jordan's retirement. This explains why we like to avoid prognostication and
instead save our energy for the real game -- striving to build wealth for our
shareholders. The fundamentals of our small-cap value style -- finding
attractively priced companies with solid financials -- are the equivalent
of good shot selection and tough defense.
The market's remarkable hang time, like Jordan's, while enabling it to
fly to unparalleled heights for unequaled lengths of time, also makes it the
exception that proves the rule. Most would agree that Jordan is one of a kind,
and we feel much the same way about the recent run of the market. We should all
enjoy the good times while we can, without losing sight of the fact that, sooner
or later, all good things come to an end. Someday, and the day is not far off,
Michael will be more concerned about a tee time than a tip-off, having returned
the game to mere mortals. We believe that the market, too, will return to more
historical levels of performance and volatility, and when it does, we will be
where we have always been, playing the game with a solid fundamental approach.
[sidebar]
The market's remarkable hang time, like Jordan's, while enabling it to fly to
unparalleled heights for unequaled lengths of time, also makes it the exception
that proves the rule. Most would agree that Jordan is one of a kind, and we feel
much the same way about the recent run of the market.
[end sidebar]
<PAGE>
THE
ROYCE
FUNDS
ONE OF THE INDUSTRY'S MOST EXPERIENCED AND
HIGHLY-RESPECTED SMALL COMPANY VALUE MANAGERS
Charles M. Royce, who has been our primary portfolio manager since 1973, enjoys
one of the longest tenures of any active mutual fund manager. Today, with $3
billion in total assets under management, Royce & Associates, Inc. remains an
independent firm committed to the same principles that have served us well for
25 years.
MULTIPLE FUNDS, COMMON FOCUS
Over the years, we have chosen to concentrate on small company value investing.
Chuck Royce and his team provide investors with a range of funds that take full
advantage of the large and diverse small-cap sector. Our goal is to offer both
individual and institutional investors the best available small-cap value
portfolios by providing above-average full market cycle total returns with
below-average risk.
REALISTIC EXPECTATIONS AND CONSISTENT DISCIPLINE
Royce Premier Fund, Royce Total Return Fund and Pennsylvania Mutual Fund have
been among the "lowest risk" small-cap equity funds available. We cultivated our
approach by paying close attention to risk and by always maintaining the same
discipline, regardless of market movements and trends.
CO-OWNERSHIP OF FUNDS
As part of this commitment, it is important that our employees and shareholders
share a common financial goal; our principals, employees and their affiliates
currently have more than $40 million invested in The Royce Funds.
VALUE INVESTING IN SMALL COMPANIES FOR 25 YEARS
<TABLE>
<S> <C>
THE ROYCE FUNDS ADVISOR SERVICES
1414 Avenue of the Americas For Fund Materials, Performance Updates,
New York, NY 10019 Transactions or Account Inquiries
(800) 33-ROYCE (337-6923)
GENERAL INFORMATION AUTOMATED TELEPHONE SERVICES
Additional Report Copies (800) 78-ROYCE (787-6923)
and Prospectus Inquiries
(800) 221-4268
E-mail: [email protected]
SHAREHOLDER SERVICES
(800) 841-1180 Web address: www.roycefunds.com
</TABLE>
This report must be accompanied or preceded by a current prospectus for one or
more of the Funds. Please read the prospectus carefully before investing or
sending money.
