Value Investing in
Small Companies for 25 Years
THE
ROYCE
FUNDS
ROYCE PREMIER FUND
ROYCE MICRO-CAP 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 of Small-Cap Orientation
efficiency requires greater portfolio concentration. Concentrated Portfolio
The micro-cap universe (companies with market caps between $5 [Yellow bar]
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
offers one of the few gifting and estate-planning portfolios. Micro-Cap Portfolio
[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 low-volatility Dividend-Paying Securities
characteristics (dividends), one has the potential for higher
returns and volatility (low-priced stocks) and one takes ROYCE LOW-PRICED
specific sector (financial services) risk. Performance and Stocks Priced Below $15
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
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Investing "Through the Looking Glass": Finding 5
Value in an Overvalued Market.
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Royce Premier Fund, with its concentrated portfolio, effectively 12
navigated through a volatile second quarter for small-cap companies
and enjoyed a performance edge for the first half over its benchmark
index, the small-cap oriented Russell 2000.
- --------------------------------------------------------------------------------
Royce Micro-Cap Fund outperformed the Russell 2000 for the 14
first half, as well as for the one-year, five-year and since
inception (12/31/91) periods ended June 30, 1998.
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Updates and Notes: Our New and Improved Website (www.roycefunds.com). 16
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Schedules of Investments and Other Financial Statements. 18
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Postscript: Hang Time. Inside back cover
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</TABLE>
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.
[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 5-YEAR INCEPTION
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Royce Premier Fund (12/31/91) 8.5% 12.1% 15.1% 15.5%
- --------------------------------------------------------------------------------
Royce Micro-Cap Fund** (12/31/91) 6.4% 20.5% 16.3% 18.6%
</TABLE>
* Not annualized. ** Investment Class.
<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.
"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,
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}).
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&P500 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.
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-
[cartoon graphic: school of small fish chasing large fish with caption "The
next cycle?"]
[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 12-15.
RECENT PERFORMANCE RESULTS
<TABLE>
<CAPTION>
Year-to-date 5/22/96 -
1998 6/30/98
- -----------------------------------------------------------------------
<S> <C> <C>
Royce Premier Fund 8.5% 38.5%
Royce Micro-Cap Fund 6.4 35.1
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 Premier Fund ("RPR") uses a value approach to invest primarily in a
concentrated portfolio of small-cap stocks with market caps between $300 million
and $1 billion. In selecting securities for Premier's portfolio, we search for
companies that possess solid balance sheets, excellent prospects and high
internal rates of return.
HOW WE DID
Royce Premier Fund, with its concentrated portfolio of high-quality small-cap
companies, effectively navigated through small-cap's more difficult second
quarter and outperformed its benchmark index, the small-cap oriented Russell
2000, for the first six months. The Fund was up 8.5% versus 4.9% for the Russell
2000 in the first half. Strong performances by companies in the consumer,
industrial and financial sectors contributed to the Fund's gains, while our
focus on risk management helped to limit the Fund's exposure to the higher
levels of volatility exhibited by small-cap stocks. The Fund's average annual
total returns for the three and five-year periods were 16.5% and 15.1%
respectively, in line with the Fund's 15.5% average annual total return since
its inception on 12/31/91.
Royce Premier Fund remained one of Morningstar's lowest risk small-cap funds as
measured by the Morningstar risk ratio for the three-year period ended June 30,
1998. We are proud to report that the Fund was recently named by Money magazine
as one of its "Money 100." Total net assets as of June 30, 1998 were $594
million. At year-end, the Fund will have seven years of performance history.
[end sidebar]
ROYCE PREMIER FUND
- --------------------------------------------------------------------------------
<TABLE>
AVERAGE ANNUAL TOTAL RETURNS (Through 6/30/98)
- --------------------------------------------------------------------------------
<S> <C>
Year-to-date* 8.5%
................................................................................
1-Year 12.1
................................................................................
3-Year 16.5
................................................................................
5-Year 15.1
................................................................................
Since Inception (12/31/91) 15.5
</TABLE>
*Not annualized.
<TABLE>
<CAPTION>
RISK/RETURN COMPARISON Inception (12/31/91) Through 6/30/98
Average Annual Standard
Total Return Deviation RUR
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Royce Premier 15.5% 7.3 2.12
................................................................................
Russell 2000 16.2% 12.9 1.26
................................................................................
</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 Premier has substantially outperformed the Russell
2000 on a risk-adjusted basis.
[mountain chart]
- --------------------------------------------------------------------------------
RECENT MARKET PERFORMANCE
- --------------------------------------------------------------------------------
[line chart]
PEAK 5/22/96 PEAK 10/13/97
5/22/96 - 6/30/98 10/13/97 - 6/30/98
- -------------------- -------------------
RPR 38.5% RPR 1.3%
- -------------------- -------------------
Russell 2000 28.7% Russell 2000 -1.3%
- -------------------- -------------------
[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
[end line chart]
Royce Premier has provided strong absolute and relative performance from the
small-cap peak in May 1996
- --------------------------------------------------------------------------------
ROYCE PREMIER vs. RUSSELL 2000 Value of $10,000 Invested on 12/31/91
- --------------------------------------------------------------------------------
[line chart]
<TABLE>
<CAPTION>
Date Royce Premier $25,457 Russell 2000 $26,552
<S> <C> <C>
12/31/91 10,000 10,000
3/31/92 10,160 10,750
6/30/92 10,140 10,017
9/30/92 10,440 10,303
12/31/92 11,580 11,841
3/31/93 12,125 12,346
6/30/93 12,608 12,615
9/30/93 12,923 13,718
12/31/93 13,784 14,079
3/31/94 13,891 13,704
6/30/94 13,741 13,171
9/30/94 14,258 14,085
12/31/94 14,236 13,823
3/31/95 14,851 14,460
6/30/95 16,103 15,815
9/30/95 16,807 17,378
12/31/95 16,774 17,755
3/31/96 17,339 18,662
6/30/96 18,022 19,595
9/30/96 18,469 19,662
12/31/96 19,813 20,684
3/31/97 20,041 19,613
6/30/97 22,705 22,794
9/30/97 24,837 26,186
12/31/97 23,461 25,309
3/31/98 25,727 27,852
6/30/98 25,457 26,552
</TABLE>
[end line chart]
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>
2/12/92 - 3/18/94 - 5/22/96 - 1/22/97 - 10/13/97 - 4/21/98 -
7/8/92 12/9/94 7/24/96 4/25/97 1/12/98 6/15/98
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Royce Premier 0.0 -4.2 -6.4 0.3 -11.0 -6.8
Russell 2000 -11.9 -12.4 -15.5 -9.2 -11.5 -11.6
</TABLE>
[end bar chart]
Royce Premier has outperformed the Russell 2000 during all six major downturns
since the Fund's inception.
- -----------------------------------------------------------
PORTFOLIO DIAGNOSTICS
- -----------------------------------------------------------
<TABLE>
<S> <C>
Median Market Cap. $595 million
...........................................................
Weighted Average P/E Ratio 19.5x
...........................................................
Weighted Average P/B Ratio 2.0x
...........................................................
Weighted Average Yield 1.5%
...........................................................
Net Assets $594 million
...........................................................
Turnover Rate 11%
...........................................................
Symbol RYPRX
</TABLE>
- ------------------------------------------
TOP 10 POSITIONS % of Net Assets
- ------------------------------------------
<TABLE>
<S> <C>
Enesco Group 3.5
..........................................
Charming Shoppes 3.1
..........................................
Gibson Greetings 3.0
..........................................
Morrison Knudsen Corporation 3.0
..........................................
National Computer Systems 2.9
..........................................
Florida Rock Industries 2.9
..........................................
Tom Brown 2.8
..........................................
New England
Business Service 2.8
..........................................
The Commerce Group 2.7
..........................................
Trenwick Group 2.7
</TABLE>
The top 35 positions
represented 86% of
the equity portfolio
as of 6/30/98.
<TABLE>
- ---------------------------------------------------------------------------------------------------------------------
PORTFOLIO SECTOR BREAKDOWN With Examples % of Net Assets*
- ---------------------------------------------------------------------------------------------------------------------
<S> <C>
Industrial Products Building Systems and Components, Construction Materials, Specialty Chemicals and Materials 23
Financial Intermediaries Insurance, Banking, Brokerage 17
Industrial Services Transportation and Logistics, Printing, Engineering and Construction 15
Financial Services Insurance Brokers, Investment Management, Information and Processing 13
Consumer Services Retail, Restaurants/Lodging, Leisure/Entertainment 10
Consumer Products Home Furnishings/Appliances, Apparel and Shoes, Publishing 8
Technology Hardware, Software/Services, Distribution, Telecommunications 6
Natural Resources Oil and Gas, Energy Services, Real Estate 6
Health Surgical Products and Devices, Drugs and Biotech, Health Services 2
</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>
Morrison Knudsen Corporation $5,084,575
......................................................
National Computer Systems 4,976,860
......................................................
Buffets 3,887,830
......................................................
Oakley 3,845,151
......................................................
Florida Rock Industries 3,781,388
- ------------------------------------------------------
Combined Gain $21,575,804
- ------------------------------------------------------
</TABLE>
- --------------------------------------------------------------------------------
GOOD IDEAS AT THE TIME
Realized and Unrealized Loss
Year-To-Date Through 6/30/98
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
Unitrode Corporation $3,844,915
......................................................
CalMat 3,639,563
......................................................
Denbury Resources 3,158,494
......................................................
DIMON Incorporated 2,117,901
......................................................
Arnold Industries 1,281,763
- ------------------------------------------------------
Combined Loss $14,042,636
- ------------------------------------------------------
</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 50% 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.
Morrison Knudsen -- This global engineering and construction company was
brought out of bankruptcy by entrepreneur Dennis Washington after he merged
Washington Construction into the bankrupt Morrison Knudsen. We bought the stock
prior to the merger on word of Washington's arrival. Recent acquisitions have
given us confidence that this company will return to its historically strong
position.
Unitrode Corporation -- After this well managed semi-conductor manufacturer's
stock fell from $42 to $18, we thought that we found a bargain. When it dropped
to $13, we admitted our mistake, sold it and moved on.
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 13
<PAGE>
[sidebar]
WHAT WE DO
Royce Micro-Cap Fund ("RMC") uses a value approach to invest primarily in
companies with market capitalizations of $300 million or less. We believe that
the buying opportunities in this more volatile sector have a greater potential
for higher returns than any other in the domestic equity market due to limited
institutional attention and research coverage.
HOW WE DID
Royce Micro-Cap Fund outperformed its benchmark index, the small-cap oriented
Russell 2000, for the first six months, returning 6.4% versus 4.9% for the index
in what was a difficult period for small and micro-cap stocks. Companies in the
financial intermediaries, natural resources and industrial services sectors led
the way in terms of the portfolio's performance. The Fund outperformed the
Russell 2000 for the one-year, five-year and since inception periods (12/31/91)
as well. The Fund's average annual total return since inception was 18.6% and
total net assets were approximately $209 million as of June 30, 1998. The end of
this year will mark its seventh year of operation, making it one of the more
established micro-cap funds available.
Although the micro-cap category is beginning to emerge from obscurity, in
general it is still not well known or well understood by many investors. While
micro-cap companies are higher in risk than larger, more established companies,
we believe that the sector offers the best value in the domestic equity arena.
Thus, our enthusiasm for micro-cap stocks remains very strong.
[end sidebar]
ROYCE MICRO-CAP FUND+
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS (Through 6/30/98)
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
Year-to-date* 6.4%
...............................................................................
1-Year 20.5
...............................................................................
3-Year 17.9
...............................................................................
5-Year 16.3
...............................................................................
Since Inception (12/31/91) 18.6
</TABLE>
*Not annualized.
- --------------------------------------------------------------------------------
RISK/RETURN COMPARISON Inception (12/31/91) Through 6/30/98
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Average Annual Standard
Total Return Deviation RUR
...............................................................................
<S> <C> <C> <C>
Royce Micro-Cap 18.6% 9.8 1.89
...............................................................................
Russell 2000 16.2% 12.9 1.26
...............................................................................
</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 Micro-Cap has outperformed the Russell 2000 on BOTH
an absolute and a risk-adjusted basis.
- --------------------------------------------------------------------------------
RECENT MARKET PERFORMANCE
- --------------------------------------------------------------------------------
[line chart]
PEAK 5/22/96 PEAK 10/13/97
- ------------------- --------------------
5/22/96 - 6/30/98 10/13/97 - 6/30/98
- ------------------- --------------------
RMC 35.1% RMC 1.6%
- ------------------- --------------------
Russell 2000 28.7% Russell 2000 -1.3%
- ------------------- --------------------
[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 Micro-Cap has provided strong absolute and relative performance from the
small-cap peak in May 1996
- --------------------------------------------------------------------------------
ROYCE MICRO-CAP vs. RUSSELL 2000 Value of $10,000 Invested on 12/31/91
- --------------------------------------------------------------------------------
[line chart]
<TABLE>
<CAPTION>
Date Royce Micro-Cap $30,240 Russell 2000 $26,552
<S> <C> <C>
12/31/91 10,000 10,000
3/31/92 11,100 10,750
6/30/92 10,700 10,017
9/30/92 11,421 10,303
12/31/92 12,941 11,841
3/31/93 14,184 12,346
6/30/93 14,207 12,615
9/30/93 15,316 13,718
12/31/93 16,004 14,079
3/31/94 16,127 13,704
6/30/94 15,855 13,171
9/30/94 16,770 14,085
12/31/94 16,572 13,823
3/31/95 17,185 14,460
6/30/95 18,464 15,815
9/30/95 19,717 17,378
12/31/95 19,731 17,755
3/31/96 20,544 18,662
6/30/96 21,906 19,595
9/30/96 21,172 19,662
12/31/96 22,798 20,684
3/31/97 22,602 19,613
6/30/97 26,132 22,794
9/30/97 29,015 26,186
12/31/97 28,426 25,309
3/31/98 31,359 27,852
6/30/98 30,240 26,552
</TABLE>
[end line chart]
Includes reinvestment of distributions.
+ All performance and risk information presented herein is for RMC's Investment
Class. Shares of RMC's Consultant Class, which commenced operations on May 4,
1998, bear an annual distribution expense which is not borne by the Investment
Class.
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>
2/12/92 - 3/18/94 - 5/22/96 - 1/22/97 - 10/13/97 - 4/21/98 -
7/8/92 12/9/94 7/24/96 4/25/97 1/12/98 6/15/98
<S> <C> <C> <C> <C> <C> <C>
Royce Micro-Cap -1.5 -4.4 -8.7 -5.1 -7.8 -8.6
Russell 2000 -11.9 -12.4 -15.5 -9.2 -11.5 -11.6
</TABLE>
[end bar chart]
Royce Micro-Cap has outperformed the Russell 2000 during all six major downturns
since the Fund's inception.
- ---------------------------------------------------
PORTFOLIO DIAGNOSTICS
- ---------------------------------------------------
<TABLE>
<S> <C>
Median Market Cap. $188 million
...................................................
Weighted Average P/E Ratio 15.8x
...................................................
Weighted Average P/B Ratio 1.9x
...................................................
Weighted Average Yield 0.9%
...................................................
Net Assets $209 million
...................................................
Turnover Rate 21%
...................................................
Symbol RYOTX
</TABLE>
- ---------------------------------------------------
TOP 10 POSITIONS % of Net Assets
- ---------------------------------------------------
<TABLE>
<S> <C>
Richardson Electronics 2.0
...................................................
Oshkosh B'Gosh Cl. A 1.6
...................................................
Pennsylvania
Manufacturers Corp. Cl. A 1.5
...................................................
Velcro Industries 1.4
...................................................
Duff & Phelps Credit Rating Co. 1.3
...................................................
Insituform Technologies Cl. A 1.3
...................................................
Newport Corporation 1.3
...................................................
VideoServer 1.3
...................................................
PXRE Corporation 1.2
...................................................
BHI Corporation 1.2
</TABLE>
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------
PORTFOLIO SECTOR BREAKDOWN With Examples % of Net Assets*
- ---------------------------------------------------------------------------------------------------------------------
<S> <C>
Industrial Products Building Systems and Components, Construction Materials, Specialty Chemicals and Materials 24
Technology Hardware, Software/Services, Distribution, Telecommunications 20
Consumer Products Home Furnishings/Appliances, Apparel and Shoes, Publishing 14
Industrial Services Transportation and Logistics, Printing, Engineering and Construction 12
Financial Intermediaries Insurance, Banking, Brokerage 11
Consumer Services Retail, Restaurants/Lodging, Leisure/Entertainment 6
Natural Resources Oil and Gas, Energy Services, Real Estate 5
Health Surgical Products and Devices, Drugs and Biotech, Health Services 4
Financial Services Insurance Brokers, Investment Management,
Information and Processing 3
Utilities Utilities 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>
International Isotopes $1,285,208
.................................................
Instituform Technologies Cl. A 1,265,894
.................................................
Duff & Phelps Credit Rating Co. 1,134,106
.................................................
Velcro Industries 974,451
.................................................
LandAmerica Financial Group 972,051
- -------------------------------------------------
Combined Gain $5,631,710
- -------------------------------------------------
</TABLE>
- -------------------------------------------------
GOOD IDEAS AT THE TIME
Realized and Unrealized Loss
Year-To-Date Through 6/30/98
- -------------------------------------------------
<TABLE>
<S> <C>
Perceptron $1,024,269
.................................................
RockShox 984,933
.................................................
Johnson Worldwide Associates Cl. A 788,750
.................................................
Axiohm Transaction Solutions 697,943
.................................................
Highlands Insurance Group 662,613
- -------------------------------------------------
Combined Loss $4,158,508
- -------------------------------------------------
</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 44% 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 -- Atypically, 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.
Perceptron -- A company that manufactures three-dimensional image units for
automobile-inspection robots saw its stock price drop precipitously, a decline
that unfortunately continued after we bought the stock. A product transition
cycle contributed to the dismal performance of the stock.
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 15
<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. 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 indicate your wishes when you establish the trust. 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).
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 and Russell 2000 Growth are unmanaged indices of
small-cap domestic common stocks and the S&P 500 and Dow Jones Industrial
Average are unmanaged indices of large-cap domestic common stocks. The Royce
Funds and Royce GiftShares Fund are service marks of The Royce Funds.
16 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
THE ROYCE FUNDS
- --------------------------------------------------------------------------------
FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
Schedules of Investments 18-22
- ----------------------------------------------------------
Statements of Assets and Liabilities 23
- ----------------------------------------------------------
Statements of Changes in Net Assets 24
- ----------------------------------------------------------
Statements of Operations and
Financial Highlights 25
- ----------------------------------------------------------
Notes to Financial Statements 26-27
- ----------------------------------------------------------
</TABLE>
[graphic: looking through magnifying glass at The Royce Funds listing in
newspaper]
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
ROYCE PREMIER FUND JUNE 30, 1998 (unaudited)
- --------------------------------------------------------------------------------
COMMON STOCKS -- 88.1%
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Consumer Products -- 9.7%
Apparel and Shoes - 2.1%
Oakley* 923,800 $ 12,355,825
------------
Collectibles - 3.5%
Enesco Group 680,200 20,916,150
------------
Publishing - 3.0%
Gibson Greetings* 718,800 17,970,000
------------
Sports and Recreation - 1.1%
Sturm, Ruger & Company 390,900 6,547,575
------------
57,789,550
============
Consumer Services -- 7.6%
Restaurants/Lodging - 3.6%
Applebee's International 530,100 11,860,987
Buffets* 616,785 9,675,815
------------
21,536,802
------------
Retail - 4.0%
Charming Shoppes* 3,904,600 18,546,850
Talbots 196,300 5,140,606
------------
23,687,456
------------
45,224,258
============
Financial Intermediaries -- 15.7%
Insurance - 15.7%
The Commerce Group 418,000 16,197,500
LandAmerica Financial Group 177,100 10,138,975
Leucadia National Corporation 412,300 13,631,669
Pennsylvania Manufacturers
Corporation Cl. A 387,010 8,901,230
Trenwick Group 412,100 16,007,509
Wesco Financial Corporation 36,230 14,165,930
Zenith National Insurance 498,100 14,040,194
------------
93,083,007
============
Financial Services -- 10.4%
Insurance Brokers - 6.9%
E.W. Blanch Holdings 290,500 10,675,875
Crawford & Company Cl. A 373,350 7,000,313
Arthur J. Gallagher & Co. 291,100 13,026,725
Willis Corroon Group ADR + 832,500 10,458,281
------------
41,161,194
------------
Investment Management - 3.5%
The John Nuveen Company Cl. A 216,800 8,604,250
The Pioneer Group 467,800 12,308,988
------------
20,913,238
------------
62,074,432
============
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Health -- 1.8%
Surgical Products and Devices - 1.8%
Haemonetics Corporation* 659,300 $ 10,548,800
============
Industrial Products -- 20.8%
Aerospace/Defense - 3.3%
Curtiss-Wright Corporation 269,900 10,576,706
Woodward Governor Company 287,556 8,878,291
------------
19,454,997
------------
Building Systems and Components - 2.9%
Juno Lighting 334,900 7,912,013
Simpson Manufacturing* 235,400 9,092,325
------------
17,004,338
------------
Construction Materials - 5.2%
CalMat 619,500 13,629,000
Florida Rock Industries 587,400 17,144,737
------------
30,773,737
------------
Machinery - 3.2%
Lincoln Electric Holding 585,990 12,965,029
Nordson Corporation 128,400 6,034,800
------------
18,999,829
------------
Paper and Packaging - 0.8%
P. H. Glatfelter Company 301,900 4,773,794
------------
Pumps, Valves and Bearings - 2.2%
Kaydon Corporation 364,700 12,878,469
------------
Specialty Chemicals and Materials - 2.2%
Lilly Industries Cl. A 616,500 13,331,812
------------
Textiles - 1.0%
Unifi 183,900 6,298,575
------------
123,515,551
============
Industrial Services -- 12.3%
Engineering and Construction - 4.3%
Morrison Knudsen Corporation* 1,270,300 17,863,594
Willbros Group* 483,300 7,551,562
------------
25,415,156
------------
Printing - 5.8%
Bowne & Co. 164,000 7,380,000
New England Business Service 507,200 16,357,200
The Standard Register Company 308,800 10,923,800
------------
34,661,000
------------
Transportation and Logistics - 2.2%
AirNet Systems* 311,600 5,024,550
Arnold Industries 548,500 8,090,375
------------
13,114,925
------------
73,191,081
============
</TABLE>
18 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
ROYCE PREMIER FUND JUNE 30, 1998 (unaudited)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Natural Resources -- 4.7%
Oil and Gas - 4.7%
Tom Brown* 871,410 $ 16,393,401
Denbury Resources* 901,772 11,779,397
------------
28,172,798
============
Technology -- 5.1%
Distribution - 2.1%
Marshall Industries* 461,300 12,570,425
------------
Software/Services - 3.0%
National Computer Systems 729,400 17,505,600
------------
30,076,025
============
TOTAL COMMON STOCKS
(Cost $411,418,249) 523,675,502
============
</TABLE>
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT
---------
<S> <C> <C>
U.S. TREASURY OBLIGATIONS -- 5.8%
U.S. Treasury Notes
7.00%, due 4/15/99 $14,000,000 14,157,500
6.25%, due 8/31/00 10,000,000 10,146,900
6.25%, due 8/31/02 10,000,000 10,260,900
------------
TOTAL U.S. TREASURY OBLIGATIONS
(Cost $34,225,158) 34,565,300
============
</TABLE>
<TABLE>
<CAPTION>
VALUE
-----
<S> <C>
REPURCHASE AGREEMENT -- 5.5%
State Street Bank and Trust Company, 5.15%
dated 6/30/98, due 7/01/98, maturity value
$32,804,692 (collateralized by U.S. Treasury
Bonds, 8.375% due 8/15/08 and 7.25% due
5/15/16, valued at $33,458,679)
(Cost $32,800,000) $ 32,800,000
============
TOTAL INVESTMENTS -- 99.4%
(Cost $478,443,407) 591,040,802
CASH AND OTHER ASSETS
LESS LIABILITIES -- 0.6% 3,437,916
------------
NET ASSETS -- 100.0% $594,478,718
============
</TABLE>
- --------------------------------------------------------------------------------
* Non-income producing.
+ American Depository Receipt.
INCOME TAX INFORMATION: The cost of total investments for federal income tax
purposes was $478,443,407. At June 30, 1998, net unrealized appreciation for
all securities was $112,597,395, consisting of aggregate gross unrealized
appreciation of $122,365,054 and aggregate gross unrealized depreciation of
$9,767,659.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 19
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
ROYCE MICRO-CAP FUND JUNE 30, 1998 (unaudited)
- --------------------------------------------------------------------------------
COMMON STOCKS -- 94.4%
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Consumer Products -- 12.5%
Apparel and Shoes - 2.5%
Oshkosh B'Gosh Cl. A 72,900 $ 3,244,050
Weyco Group 80,300 2,097,838
------------
5,341,888
------------
Food/Beverage/Tobacco - 0.4%
800-JR CIGAR* 37,100 732,725
------------
Home Furnishings/Appliances - 4.7%
Bassett Furniture Industries 85,000 2,395,938
Conso Products* 131,275 1,083,019
Fedders Corporation Cl. A 125,400 799,425
Lifetime Hoan Corporation 127,780 1,277,800
Mackie Designs* 69,600 478,500
The Rival Company 55,000 742,500
Velcro Industries 21,700 3,021,725
------------
9,798,907
------------
Publishing - 1.2%
Gibson Greetings* 30,000 750,000
The Topps Company* 584,200 1,807,369
------------
2,557,369
------------
Sports and Recreation - 2.7%
Johnson Worldwide Associates Cl. A* 157,750 1,991,594
Lund International Holdings* 188,250 2,141,344
RockShox* 363,200 1,452,800
------------
5,585,738
------------
Other Consumer Products - 1.0%
Lazare Kaplan International* 59,200 625,300
Pentech International* 82,300 113,162
Toy Biz* 150,200 1,389,350
------------
2,127,812
------------
26,144,439
============
Consumer Services -- 5.6%
Leisure/Entertainment - 2.1%
MovieFone Cl. A* 163,100 1,631,000
PCA International 72,900 1,840,725
Seattle Filmworks* 109,500 845,203
------------
4,316,928
------------
Restaurants/Lodging - 0.5%
Pizza Inn 193,500 1,076,344
------------
Retail - 3.0%
The Bombay Company* 53,000 251,750
Catherines Stores Corporation* 231,200 2,268,650
Lechters* 237,300 1,164,253
Mikasa 70,000 892,500
Suzy Shier 120,000 795,080
Urban Outfitters* 48,000 876,000
------------
6,248,233
------------
11,641,505
============
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Financial Intermediaries -- 8.8%
Banking - 0.6%
Oriental Financial Group 31,150 $ 1,148,656
------------
Insurance - 8.2%
ALLIED Life Financial
Corporation 50 1,444
Capitol Transamerica Corporation 76,300 1,568,919
Chartwell Re Corporation 40,300 1,186,331
Highlands Insurance Group* 67,100 1,241,350
Intercargo Corporation 122,900 1,444,075
Medical Assurance* 65,895 1,828,586
NYMAGIC 45,900 1,256,513
The Navigators Group* 13,700 259,444
Nobel Insurance Limited 33,750 455,625
PXRE Corporation 83,524 2,505,720
Pennsylvania Manufacturers
Corporation Cl. A 135,072 3,106,656
RLI 29,000 1,179,937
Trenwick Group 30,200 1,173,081
------------
17,207,681
------------
18,356,337
============
Financial Services -- 3.5%
Information and Processing - 1.7%
Duff & Phelps Credit Rating Co. 50,400 2,809,800
Investors Financial Services
Corporation 11,774 624,022
------------
3,433,822
------------
Insurance Brokers - 0.3%
E.W. Blanch Holdings 16,600 610,050
------------
Investment Management - 1.5%
Eaton Vance 30,000 1,389,375
Phoenix Investment Partners 174,500 1,515,969
U.S. Global Investors Cl. A* 137,000 274,000
------------
3,179,344
------------
7,223,216
============
Health -- 3.4%
Drugs and Biotech - 1.7%
BioReliance Corporation* 144,800 2,181,050
International Isotopes* 81,400 1,358,363
------------
3,539,413
------------
Health Services - 0.5%
Jenny Craig* 86,800 526,225
Life Technologies 18,800 589,850
------------
1,116,075
------------
</TABLE>
20 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
ROYCE MICRO-CAP FUND JUNE 30, 1998 (unaudited)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Health (continued)
Personal Care - 0.7%
Jean-Philippe Fragrances* 183,000 $ 1,475,438
------------
Surgical Products and Devices - 0.5%
Nitinol Medical Technologies* 151,000 1,132,500
------------
7,263,426
============
Industrial Products -- 22.0%
Aerospace/Defense - 1.8%
Curtiss-Wright Corporation 32,800 1,285,350
Special Metals Corporation* 106,800 1,495,200
Woodward Governor Company 30,448 940,082
------------
3,720,632
------------
Building Systems and Components - 4.7%
Falcon Products 159,600 2,014,950
Holophane Corporation* 13,000 331,500
International Aluminum
Corporation 39,500 1,224,500
Knape & Vogt Manufacturing
Company 16,900 380,250
Simpson Manufacturing* 60,800 2,348,400
Skyline Corporation 4,800 156,600
Thor Industries 73,200 2,026,725
Woodhead Industries 93,300 1,434,487
------------
9,917,412
------------
Construction Materials - 2.0%
Florida Rock Industries 80,700 2,355,431
Puerto Rican Cement Company 37,000 1,748,250
------------
4,103,681
------------
Industrial Components - 0.5%
Lumen Technologies* 110,889 984,140
------------
Machinery - 1.3%
DeVlieg-Bullard* 414,900 933,525
Oshkosh Truck Corporation Cl. B 71,600 1,790,000
------------
2,723,525
------------
Paper and Packaging - 1.7%
PalEx* 220,400 2,093,800
Shorewood Packaging
Corporation* 97,050 1,540,669
------------
3,634,469
------------
Pumps, Valves and Bearings - 1.7%
NN Ball and Roller 107,900 1,288,056
Sun Hydraulics Corporation 137,100 2,193,600
------------
3,481,656
------------
Specialty Chemicals and Materials - 4.5%
Aldila* 256,400 1,698,650
CFC International* 155,600 1,721,325
Chemfab Corporation* 102,200 2,127,037
Hauser* 130,200 756,787
Hawkins Chemical 168,161 2,017,932
Synalloy Corporation 73,700 994,950
------------
9,316,681
------------
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Textiles - 1.1%
Fab Industries 63,200 $ 1,761,700
Thomaston Mills Cl. A 107,000 628,625
------------
2,390,325
------------
Other Industrial Products - 2.7%
BHA Group Holdings 117,302 1,935,483
Landauer 36,200 1,081,475
Mestek* 12,000 256,500
Modern Controls 127,575 956,812
Myers Industries 63,393 1,521,432
------------
5,751,702
------------
46,024,223
============
Industrial Services -- 12.1%
Commercial Services - 2.3%
BHI Corporation* 62,800 2,480,600
+Business Resources Group* 264,600 694,575
Cornell Corrections* 66,900 1,404,900
Open Plan Systems* 75,600 174,825
------------
4,754,900
------------
Engineering and Construction - 3.0%
Devcon International* 62,400 175,500
Insituform Technologies Cl. A* 200,300 2,772,903
+Sevenson Environmental
Services 168,900 1,414,538
Willbros Group* 120,400 1,881,250
------------
6,244,191
------------
Food/Tobacco Processors - 1.4%
Midwest Grain Products* 129,550 1,878,475
Standard Commercial
Corporation* 99,733 1,097,063
------------
2,975,538
------------
Industrial Distribution - 1.0%
Vallen Corporation* 109,300 2,172,337
------------
Printing - 1.7%
Ennis Business Forms 110,500 1,284,562
Merrill Corporation 36,800 811,900
New England Business Service 42,300 1,364,175
------------
3,460,637
------------
Transportation and Logistics - 2.7%
AirNet Systems* 42,200 680,475
Circle International Group 51,300 1,436,400
Frozen Food Express Industries 195,150 1,927,106
Kenan Transport Company 46,730 1,606,344
------------
5,650,325
------------
25,257,928
============
Natural Resources -- 4.5%
Energy Services - 1.0%
Carbo Ceramics 59,000 2,013,375
------------
</TABLE>
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 21
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
ROYCE MICRO-CAP FUND JUNE 30, 1998 (unaudited)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Natural Resources (continued)
Metals and Mining - 0.2%
MK Gold Company* 517,900 $ 485,531
------------
Oil and Gas - 3.3%
Denbury Resources* 168,300 2,198,419
Domain Energy Corporation* 98,800 1,185,600
PetroCorp Incorporated* 185,800 1,416,725
Titan Exploration* 231,600 2,055,450
------------
6,856,194
------------
9,355,100
============
Technology -- 16.9%
Distribution - 3.9%
Jaco Electronics* 111,200 691,525
Perceptron* 162,100 1,945,200
Pioneer-Standard Electronics 151,200 1,455,300
Richardson Electronics 304,000 4,104,000
------------
8,196,025
------------
Hardware - 7.6%
Axiohm Transaction Solutions* 103,436 1,060,219
CEM Corporation* 85,700 1,039,113
Control Devices 28,332 368,316
Electroglas* 127,100 1,660,244
Exar Corporation* 104,200 2,188,200
Industrial Scientific Corporation 45,300 1,109,850
Intevac* 151,800 1,631,850
Kentek Information Systems 73,400 633,075
Newport Corporation 136,700 2,699,825
Penn Engineering and
Manufacturing 73,300 1,832,500
Performance Technologies* 77,000 866,250
Veeco Instruments* 33,600 835,800
------------
15,925,242
------------
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Software/Services - 5.4%
CSP* 102,084 $ 957,038
Kronos Incorporated* 68,300 2,475,875
MacNeal-Schwendler
Corporation* 187,200 1,836,900
Rainbow Technologies* 61,100 1,252,550
+Technical Communications
Corporation* 63,600 321,975
Tyler Corporation* 158,400 1,633,500
VideoServer* 218,800 2,680,300
------------
11,158,138
------------
35,279,405
============
Utilities -- 0.5%
Southern Union Company* 32,261 1,040,417
============
Miscellaneous -- 4.6% 9,608,849
============
TOTAL COMMON STOCKS
(Cost $161,512,680) 197,194,845
============
REPURCHASE AGREEMENT -- 5.4%
State Street Bank and Trust Company,
5.15% dated 6/30/98, due 7/01/98,
maturity value $11,401,631
(collateralized by U.S. Treasury Bonds,
8.375% due 8/15/08 and 7.25%
due 5/15/16,valued at $11,634,283)
(Cost $11,400,000) 11,400,000
============
TOTAL INVESTMENTS -- 99.8%
(Cost $172,912,680) 208,594,845
CASH AND OTHER ASSETS
LESS LIABILITIES -- 0.2% 362,539
------------
NET ASSETS -- 100.0% $208,957,384
============
</TABLE>
- --------------------------------------------------------------------------------
* Non-income producing.
+ 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 $172,912,680. At June 30, 1998, net unrealized appreciation for
all securities was $35,682,165, consisting of aggregate gross unrealized
appreciation of $48,651,556 and aggregate gross unrealized depreciation of
$12,969,391.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
22 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
STATEMENTS OF ASSETS AND LIABILITIES JUNE 30, 1998 (unaudited)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Royce Royce
Premier Fund Micro-Cap Fund
------------ --------------
<S> <C> <C>
ASSETS:
Investments at value (identified cost $445,643,407 and $161,512,680, respectively) $558,240,802 $197,194,845
Repurchase agreements (at cost and value) 32,800,000 11,400,000
Cash 78,137 97,055
Receivable for capital shares sold 5,061,467 547,572
Receivable for dividends and interest 1,384,875 121,277
Receivable for investments sold 191,881 6,875
Prepaid expenses and other assets 31,739 11,826
- ------------------------------------------------------------------------------------------------------------------------
Total Assets 597,788,901 209,379,450
- ------------------------------------------------------------------------------------------------------------------------
LIABILITIES:
Payable for investments purchased 1,488,044 68,175
Payable for capital shares redeemed 1,199,906 89,329
Payable for investment advisory fees 477,459 188,207
Accrued expenses 144,774 76,355
- ------------------------------------------------------------------------------------------------------------------------
Total Liabilities 3,310,183 422,066
- ------------------------------------------------------------------------------------------------------------------------
Net Assets $594,478,718 $208,957,384
========================================================================================================================
ANALYSIS OF NET ASSETS:
Undistributed net investment income (loss) $ 2,407,039 $ (468,354)
Accumulated net realized gain on investments 11,067,370 13,358,034
Net unrealized appreciation on investments 112,597,395 35,682,165
Capital shares 62,998 20,905
Additional paid-in capital 468,343,916 160,364,634
- ------------------------------------------------------------------------------------------------------------------------
Net Assets $594,478,718 $208,957,384
Investment Class $594,478,718 $208,343,955
Consultant Class $ 613,429
========================================================================================================================
SHARES OUTSTANDING:
(unlimited number of $.001 par value shares authorized for each Fund)
Investment Class 62,998,307 20,843,358
Consultant Class 61,445
========================================================================================================================
NET ASSET VALUES (Net Assets [divided by] Shares Outstanding):
Investment Class (offering and redemption price* per share) $ 9.44 $ 10.00
Consultant Class (offering price** per share) $ 9.98
========================================================================================================================
</TABLE>
* Shares redeemed within one year of purchase are subject to a 1% redemption
fee, payable to the Fund.
** Redemption price per share is equal to NAV, less applicable deferred sales
charge.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 23
<PAGE>
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Royce Premier Fund Royce Micro-Cap 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) $ 2,040,027 $ 5,186,475 $ (535,220) $ 66,866
Net realized gain on investments 11,115,243 24,051,632 12,555,307 13,409,911
Net change in unrealized appreciation on investments 31,774,190 33,005,954 249,439 21,410,808
- ------------------------------------------------------------------------------------------------------------------------------
Net increase in net assets from investment operations 44,929,460 62,244,061 12,269,526 34,887,585
- ------------------------------------------------------------------------------------------------------------------------------
DIVIDENDS AND DISTRIBUTIONS:
Net investment income
Investment Class -- (5,132,573) -- --
Consultant Class -- --
Net realized gain on investments
Investment Class -- (26,952,526) -- (14,659,824)
Consultant Class -- --
- ------------------------------------------------------------------------------------------------------------------------------
Total dividends and distributions -- (32,085,099) -- (14,659,824)
- ------------------------------------------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS:
Net proceeds from shares sold
Investment Class 119,292,262 253,092,118 33,277,542 88,285,531
Consultant Class 621,637 --
Dividends reinvested
Investment Class -- 30,221,025 -- 13,665,774
Consultant Class -- --
Cost of shares redeemed
Investment Class (102,884,491) (97,354,274) (36,847,964) (63,871,463)
Consultant Class -- --
- ------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in net assets from capital share
transactions 16,407,771 185,958,869 (2,948,785) 38,079,842
- ------------------------------------------------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS 61,337,231 216,117,831 9,320,741 58,307,603
NET ASSETS:
Beginning of period 533,141,487 317,023,656 199,636,643 141,329,040
- ------------------------------------------------------------------------------------------------------------------------------
End of period (a) $ 594,478,718 $533,141,487 $ 208,957,384 $199,636,643
==============================================================================================================================
CAPITAL SHARE TRANSACTIONS:
Shares sold
Investment Class 12,910,610 28,478,270 3,345,506 9,367,527
Consultant Class 61,445 --
Shares issued for reinvestment of dividends and
distributions
Investment Class -- 3,457,777 -- 1,453,806
Consultant Class -- --
Shares redeemed
Investment Class (11,215,136) (11,226,941) (3,745,480) (6,947,247)
Consultant Class -- --
- ------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in shares outstanding 1,695,474 20,709,106 (338,529) 3,874,086
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Includes undistributed net investment income (loss) of $2,407,039 and
$(468,354) in 1998 and $367,012 and $66,866 in 1997 for Royce Premier Fund
and Royce Micro-Cap Fund, respectively.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
24 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
STATEMENTS OF OPERATIONS SIX MONTHS ENDED JUNE 30, 1998 (unaudited)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Royce Royce
Premier Fund Micro-Cap Fund
============== ===============
INVESTMENT INCOME:
Income:
<S> <C> <C>
Dividends $ 3,674,712 $ 778,505
Interest 1,809,594 220,994
- -----------------------------------------------------------------------------------------
Total Income 5,484,306 999,499
- -----------------------------------------------------------------------------------------
Expenses:
Investment advisory fees 2,800,783 1,544,584
Distribution fees -- 431
Shareholder servicing fees 183,636 74,778
Administrative and office facilities expenses 134,128 50,106
Custodian fees 52,784 41,437
Professional fees 36,629 23,841
Trustees' fees 29,962 11,016
Other expenses 206,357 109,217
- -----------------------------------------------------------------------------------------
Total Expenses 3,444,279 1,855,410
Fees Waived by Investment Adviser -- (320,691)
- -----------------------------------------------------------------------------------------
Net Expenses 3,444,279 1,534,719
- -----------------------------------------------------------------------------------------
Net Investment Income (Loss) 2,040,027 (535,220)
- -----------------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN ON INVESTMENTS:
Net realized gain on investments 11,115,243 12,555,307
Net change in unrealized appreciation on investments 31,774,190 249,439
- -----------------------------------------------------------------------------------------
Net realized and unrealized gain on investments 42,889,433 12,804,746
- -----------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS FROM INVESTMENT OPERATIONS $44,929,460 $12,269,526
=========================================================================================
</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 (LOSS) NET INVESTMENT
OF PERIOD (LOSS) ON INVESTMENTS INCOME
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
ROYCE PREMIER FUND (a)
++ 1998 $ 8.70 $ 0.03 $ 0.71 $ --
1997 7.81 0.09 1.35 (0.09)
1996 7.12 0.10 1.18 (0.10)
1995 6.48 0.10 1.05 (0.09)
1994 6.41 0.06 0.15 (0.05)
1993 5.52 0.02 1.03 (0.02)
ROYCE MICRO-CAP FUND -- INVESTMENT CLASS (b)
++ 1998 $ 9.40 $ 0.03) $ 0.63 $ --
1997 8.14 -- 2.01 --
1996 7.53 (0.01) 1.17 --
1995 6.48 -- 1.24 --
1994 6.47 -- 0.23 --
1993 5.83 -- 1.38 --
ROYCE MICRO-CAP FUND -- CONSULTANT CLASS (c)
++ 1998 $ 10.58 $(0.01) $ (0.59) $ --
- ----------------------------------------------------------------------------------------
<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>
++ $ -- $ 9.44 8.5% $594,479 1.23%* 0.73%* 11% $0.0653
(0.46) 8.70 18.4% 533,141 1.24% 1.20% 18% 0.0608
(0.49) 7.81 18.1% 317,024 1.25% 1.25% 34% 0.0621
(0.42) 7.12 17.8% 302,239 1.25% 1.48% 39% --
(0.09) 6.48 3.3% 202,390 1.38% 1.19% 38% --
(0.14) 6.41 19.0% 47,143 1.50% 0.68% 85% --
++ $ -- $10.00 6.4% $208,344 1.49%* (0.52)%* 21% $0.0613
(0.75) 9.40 24.7% 199,637 1.49% 0.04% 38% 0.0549
(0.55) 8.14 15.5% 141,329 1.79% (0.20)% 70% 0.0476
(0.19) 7.53 19.1% 97,729 1.94% 0.10% 25% --
(0.22) 6.48 3.6% 26,774 1.99% 0.02% 54% --
(0.74) 6.47 23.7% 10,261 1.99% (0.09)% 116% --
++ $ -- $ 9.98 (5.7)% $ 613 2.49%* (1.47)%* 21% $0.0613
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Expense ratios are shown after fee waivers by the investment adviser. For
the periods ended December 31, 1996 and 1993, the expense ratios before
the waivers would have been 1.28% and 1.68%, respectively.
(b) Expense ratios are shown after fee waivers by the investment adviser. 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 1.80%,
1.80%, 1.87%, 1.97%, 2.34% and 2.49%, respectively.
(c) Expense ratios are shown after fee waiver by the investment adviser. For
the period ended June 30, 1998 the expense ratio before the waiver would
have been 5.93%. The Class commenced operations on May 4, 1998.
* Annualized.
+ Beginning in 1996, funds are required to disclose average commission rates
paid per share for purchases and sales of investments.
++ Period ended June 30, 1998 (unaudited).
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 25
<PAGE>
NOTES TO FINANCIAL STATEMENTS (unaudited)
- --------------------------------------------------------------------------------
Summary of Significant Accounting Policies:
Royce Premier Fund and Royce Micro-Cap Fund (the "Fund" or "Funds") are two
series of The Royce Fund (the "Trust"), a diversified open-end management
investment company organized as a Delaware business trust. Royce Premier Fund
and the Investment Class of Royce Micro-Cap Fund commenced operations on
December 31, 1991. The Consultant Class of Royce Micro-Cap Fund commenced
operations on May 4, 1998.
Classes of shares have equal rights as to earnings and assets, except that
each class may bear different net distribution and shareholder servicing fees,
certain other expenses and expense reimbursements. Investment income, realized
and unrealized capital gains or losses on investments and expenses other than
those attributable to a specific class are allocated to each class of shares
based on its relative net assets.
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 that 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.
26 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
- --------------------------------------------------------------------------------
Investment Adviser and Distributor:
Under the Trust's investment advisory agreements with Royce & Associates,
Inc. ("Royce") Royce is entitled to receive management fees which are computed
daily and payable monthly. For the six months ended June 30, 1998, Royce Premier
Fund and Royce Micro-Cap Fund recorded advisory fees of $2,800,783 and
$1,223,893 (net of voluntary waivers of $320,691), respectively. The agreements
provide for advisory fees at an annual rate of 1.0% and 1.5% of the average net
assets of Royce Premier Fund and Royce Micro-Cap Fund, respectively.
Royce Fund Services, Inc. ("RFS"), the distributor of the Trust's shares,
is an affiliate of Royce. For the six months ended June 30, 1998, RFS received
12b-1 distribution fees of $431 from the Consultant Class of Royce Micro-Cap
Fund. The distribution agreement provides for maximum fees of 1.0% per annum of
the average net assets of the Consultant Class of Royce Micro-Cap Fund.
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:
Transactions in 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 Micro-Cap Fund effected the following transactions in
shares of such companies during the six months ended June 30, 1998.
<TABLE>
<CAPTION>
================================================================================
Royce Premier Fund Royce Micro-Cap Fund
-------------------- ---------------------
<S> <C> <C>
Purchases $73,054,134 $48,099,117
- --------------------------------------------------------------------------------
Sales $56,632,811 $42,288,670
================================================================================
</TABLE>
<TABLE>
<CAPTION>
=========================================================================================
Purchases Sales
----------------------- --------------------
Affiliated Realized Dividend
Company Shares Cost Shares Cost Gain Income
- --------------- --------- ----------- -------- --------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
Business
Resources
Group 264,600 $905,474 -- -- -- --
Sevenson
Environmental
Services -- -- 500 $5,664 $426 $11,823
Technical
Communications
Corporation -- -- -- -- -- --
=========================================================================================
</TABLE>
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 27
<PAGE>
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<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
SHAREHOLDER SERVICES E-mail: [email protected]
(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.
