[cover]
Value Investing in Small Companies For Over 20 Years
THE
ROYCE
FUNDS
Pennsylvania Mutual Fund
PMF II
Royce GiftShares Fund
1997 Annual Report
<PAGE>
THE ROYCE FUNDS ROAD MAP
- --------------------------------------------------------------------------------
For over twenty years, Royce & Associates has focused on small and micro-cap
investing. While we offer a variety of funds, we remain committed to a
risk-averse investment style. Currently, the firm devotes its energies to two
portfolio strategies.
[TRIANGLE] TWO CORE PORTFOLIO STRATEGIES
Concentrated Small-Cap Micro-Cap
ROYCE PREMIER ROYCE MICRO-CAP
Small-Cap Orientation Micro-Cap Orientation
Concentrated Portfolio Broadly Diversied Portfolio
Portfolios revolve around two main criteria: capitalization (small or micro-cap)
and concentration. The small-cap universe (companies with market caps between
$300 million and $1 billion) is no longer small, unknown or under-owned;
therefore, we believe that this greater level of efficiency requires greater
portfolio concentration. The micro-cap universe (companies with market caps
between $5 million and $300 million) provides more choices (approximately 6,400
companies), yet greater trading difficulties; therefore, we believe that broad
diversification is required given the liquidity constraints of this sector.
[TRIANGLE] Opportunistic Themes
ROYCE TOTAL RETURN ROYCE LOW-PRICED
Dividend-Paying Securities Stocks Priced Below $15
ROYCE FINANCIAL SERVICES
Financial Companies
We have identified other attributes with the potential for delivering strong
risk-adjusted returns -- one has low-volatility characteristics (dividends), one
has the potential for high returns (low-priced stocks) and one takes specific
sector (financial services) risk. When these attributes are found in stocks we
have selected for our core portfolios, we designate them for our specific theme
funds. Although specific selection criteria differentiate each theme portfolio,
the universe (small and micro-cap companies) from which securities are chosen is
the same. Performance and volatility may be substantially different for each of
these portfolios.
[TRIANGLE] COMBINED PORTFOLIOS - OUR FLAGSHIP APPROACH
PENNSYLVANIA MUTUAL PMF II ROYCE GIFTSHARES
Combine Small and Micro-Cap Companies
The combined portfolios encompass approximately equal weightings of each core
strategy. Two of our portfolios, including our flagship fund Pennsylvania
Mutual, are suitable for both individuals and institutions, while GiftShares
offers a unique gifting and estate planning portfolio.
<PAGE>
ANNUAL REPORT REFERENCE GUIDE
<TABLE>
<S> <C>
"Bring In 'Da Noise, Bring In 'Da Funk," another tip-top, hip-hop year for 2
equities.
Find out how small-cap value went from Off-Broadway to the Great White Way! 4
Pennsylvania Mutual Fund outperformed the small-cap oriented Russell 2000 index 10
for the fourth quarter and full year. The Fund has provided positive
returns in 21 of the last 23 calendar years.
PMF II, with $22 million in net assets, has provided an average annual 12
total return since inception (11/19/96) of 24.0%.
Royce GiftShares Fund, a gifting and estate planning portfolio, provided a 14
26.0% total return for the full year and a 25.7% average annual total
return since its inception on 12/27/95.
New Developments on our Website. 16
Schedules of Investments and other Financial Statements. 18 - 28
Postscript: El Nino, Micro-Mutt & The Year That Wasn't. Inside back cover
</TABLE>
For over twenty years, our risk-averse approach has focused on evaluating a
company's "private worth" -- what we believe an enterprise would sell for in a
private transaction between rational parties. This requires a thorough 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.
- --------------------------------------------------------------------------------
PERFORMANCE RESULTS
<TABLE>
<CAPTION>
JUL-DEC SINCE
FUND (INCEPTION) 1997 1997 INCEPTION*
- ---------------- ----------------------------------------
<S> <C> <C> <C>
Pennsylvania Mutual Fund (6/30/73)+ 10.5% 25.0% 16.5%
- ----------------------------------------------------------------------------------------
PMF II (11/19/96) 9.4% 20.8% 24.0%
- ----------------------------------------------------------------------------------------
Royce GiftShares Fund (12/27/95)+ 12.4% 26.0% 25.7%
- ----------------------------------------------------------------------------------------
</TABLE>
*Average annual total return +Investment Class
<PAGE>
[begin sidebar]
[photo of Charles M. Royce]
Charles M. Royce, President
The turmoil in Southeast Asia should not be viewed as just the problem of the
moment. Obviously, large-cap global companies are feeling the greatest impact
currently. However, when you consider that Southeast Asia is made up of export
countries and that we are, in essence, an import nation, the implications are
far reaching. I believe it represents a once-in-a-decade kind of event and it's
wrong to assume that this is going to disappear in thirty days.
[end sidebar]
LETTER TO OUR SHAREHOLDERS
- --------------------------------------------------------------------------------
[cartoon drawing of three men in conference room followed by caption "Please
pass the crow!"]
Drawing by Hank Blaustein; (c) 1998
BRING IN 'DA NOISE, BRING IN 'DA FUNK
"Bring In 'Da Noise, Bring In 'Da Funk," one of Broadway's most
successful current productions, played equally well on Wall Street in 1997. The
year was both full of noise with the market trumpeting record highs, record
returns and near record IPOs (Initial Public Offerings), and full of funk with
higher market volatility - including a one-day price plummet of over 500 points
on the Dow Jones Industrial Average ("Dow"). As with the show, once the beat was
established in the market, there was virtually no slowing down.
The Dow finished the year up over 20% for an unprecedented third
year in a row, turning in its best 10-year performance period ever! The other
major large-cap index, the S&P 500, was even more impressive, up 33.4% in 1997.
Small-cap stocks, by comparison, were left waiting in the wings, underperforming
their large company counterparts for a fourth straight year. The year's
performance differential is primarily attributable to the first and fourth
quarters, when small-cap indices were in the red versus positive gains for their
large-cap brethren. Small-cap investors (ourselves included) could be
disappointed, but when you consider that the Russell 2000 index of small-cap
issues was up 22.4% for the year, it's only a matter of degree. After all, why
should one feel sorry for "Fiddler On the Roof" because its string of 3,242
performances trails "A Chorus Line's" record of 6,137 shows?
Despite its record-setting performance, the stock market had
its anxious moments, namely the single biggest one-day decline ever of 554
points in the Dow on October 27, the vicious
2 | THE ROYCE FUNDS ANNUAL REPORT 1997
<PAGE>
downturn in technology stocks and the significant increase in overall market
volatility. The Dow recorded 52 days in which the index closed either up or down
more than 100 points. This compares to only 6 days in 1996 and 1 day in 1995.
S&P 500 volatility, as measured by standard deviation, was 50% higher in the
second half of the year than in the first six months. While higher market
volatility can be frustrating for investors, it does allow active managers to
take center stage.
A FUNNY THING HAPPENED [cartoon drawing of a Roman man]
ON THE WAY TO THE FORUM
Conventional wisdom would suggest that the smaller the entity, the
greater the volatility. Inside the two-tiered small-cap universe, however, a
funny thing happened: micro-cap companies (those under $300 million in market
cap) appeared to be less volatile than their upper-tier counterparts in 1997.
Meanwhile, in the small-cap sector, as measured by both Russell
and Wilshire indices, value continued its winning ways over growth,
outperforming in the fourth quarter, the second half, the full year and the
period since the May '96 small-cap peak. We believe that this peak represents a
major small-cap inflection point, a shift to value away from growth within the
sector. The evidence suggests that the trend has momentum, as reflected in the
following charts.
- --------------------------------------------------------------------------------
PERFORMANCE COMPARISON: RUSSELL 2000
VALUE (45.1%) VS. RUSSELL 2000 GROWTH (3.9%)
(May 22, 1996 through December 31, 1997)
- --------------------------------------------------------------------------------
[line chart]
Russell 2000
------------------
Value Growth
----- ------
May-96 -0.30% -0.99%
Jun-96 -1.48% -7.43%
Jul-96 -6.72% -18.73%
Aug-96 -2.67% -12.71%
Sep-96 -0.01% -8.22%
Oct-96 1.15% -12.18%
Nov-96 6.59% -9.73%
Dec-96 10.05% -7.97%
Jan-97 11.75% -5.67%
Feb-97 12.81% -11.37%
Mar-97 9.79% -17.63%
Apr-97 11.40% -18.58%
May-97 20.27% -6.35%
Jun-97 26.35% -3.17%
Jul-97 31.66% 1.79%
Aug-97 33.75% 4.84%
Sep-97 42.65% 13.21%
Oct-97 38.77% 6.41%
Nov-97 40.29% 3.87%
Dec-97 45.05% 3.93%
[end line chart]
PERFORMANCE COMPARISON: RUSSELL 2000
VALUE (14.8%) VS. S&P 500 (10.4%)
(July '97 through December '97)
- --------------------------------------------------------------------------------
[line chart]
Russell
2000
Value S&P 500
----- -------
Jun-97 0.00% 0.00%
Jul-97 4.20% 7.96%
Aug-97 5.86% 1.91%
Sep-97 12.90% 7.50%
Oct-97 9.83% 3.91%
Nov-97 11.03% 8.66%
Dec-97 14.79% 10.37%
[end line chart]
Small-cap value packs a punch vs. small-cap growth and even the S&P 500.
- --------------------------------------------------------------------------------
BEAUTY AND THE BEAST
While we have stated our expectation of lower equity returns in
the last several shareholder reports, we take solace that neither our careers
nor your hard earned money are dependent on our accurately predicting the
direction of, or specific performance prospects for, the overall stock market.
THE ROYCE FUNDS ANNUAL REPORT 1997 | 3
<PAGE>
[sidebar]
I believe that cyclicality will be the norm for large-cap global multinationals
just as it will be for the rest of the equity universe. I think that small-caps
will be net beneficiaries because they are generally less influenced by world
events. Relative performance over the next year or so should reflect this.
I think that the pick-up in volatility is significant regardless of how you
measure it and I think that it will probably be sustained into the foreseeable
future. I believe that higher volatility is a precursor to lower equity returns.
[end sidebar]
[pull quote]
We take solace that
neither our careers
nor your hard
earned money are
dependent on our
accurately predicting
the direction of, or
specific performance
prospects for, the
overall stock market.
[end pull quote]
We learned a long time ago that the best thing we can do for our shareholders is
to stay invested, even during times of uncertainty, and not lose sight of the
real goal - COMPOUNDING WEALTH. We are as mindful of this goal as we are of the
risk necessary for its achievement.
We were pleased with our absolute returns in 1997, especially
since they exceeded the level of return we strive for when selecting companies
for the portfolios (please see pages 10-15 for a summary of each Fund's
performance results). So while it's easy to get caught up in the relative game,
the beast - with comparisons against certain indices or relevant peer groups -
ultimately, it's the compounding of absolute returns, the beauty, that can send
your children to college, provide for your retirement and buy the second home at
the beach.
FROM OFF BROADWAY TO BROADWAY
Trying to compound wealth has always been important to us, going
back to the days when small-cap investing, like an attraction to computers, was
not especially popular. In fact, during the '60s and '70s, anyone who showed too
strong an interest in computers was likely to be branded a nerd by his or her
friends and colleagues. From today's software-dependent vantage point, those
days feel like the technological Stone Age. It was in 1968 that the film 2001: A
Space Odyssey featured a formidably smart and heartless piece of artificial
intelligence as its ostensible villain. A bit later, in 1977, Digital Equipment
Corp. Founder and Chairman Ken Olson was predicting with astounding inaccuracy
that there was no reason why anyone would want a home computer. Few people
grasped the enormous potential of machines that seemed to be the exclusive
province of geeks and mad scientists.
Small company investing, with all its nerdy implications,
resembles the computer business in this respect. When we began managing money in
1973 at Quest Advisory Corp., now known as Royce & Associates, Inc., small-cap
investing was in its infancy. There were few, if any, institutions that devoted
substantial time to small company stocks. Those that
[cartoon drawing of old-time Broadway]
4 | THE ROYCE FUNDS ANNUAL REPORT 1997
<PAGE>
[pull quote]
What had
been obvious to
us and a handful
of others from the
start [was] that
a conservative
risk-averse approach
could be profitably
used in the
small-cap market.
[end pull quote]
did were on the prowl for aggressive start-up firms, not the quietly successful
wallflowers that drew our attention. The sector was not remotely trendy, and
doubts persisted as to how effectively a value style could be applied to the
volatile world of small-cap stocks. Few others were willing to do the kind of
"heavy lifting" of annual reports and balance sheets that came so naturally to
us. In fact, we became accidental pioneers because it was not until the last ten
years that the investment community as a whole began to realize what had been
obvious to us and a handful of others from the start: that a conservative
risk-averse approach could be profitably used in the small-cap market.
While we were not naive enough to believe that small-cap value
stocks would remain as relatively neglected as they were when we began, nothing
could have prepared us (or anyone else for that matter) for the explosion of
interest in small-cap value investing during recent years. Perhaps the growing
popularity of "our" style might be seen as a cause for alarm. Wasn't it easier
to locate attractive stocks when others were not looking for them, too?
Definitely! Don't all small-cap value managers own basically the same set of
stocks? Absolutely not!
Small-cap has always been an extraordinarily broad and diverse
universe, and is likely to remain that way - the sector is home to approximately
8,000 names. With that many companies to choose from, it's quite probable that
multiple managers with the same style will still choose different stocks.
Hard to believe? If you look at the top ten positions in the ten
largest actively managed equity funds in Morningstar's small-cap value category
as of December 31, 1997, you will find 95 different stocks held in the ten funds
with only five common positions among them, meaning minimal duplication among
all of these portfolios. Unlike the home computer industry, where most
successful manufacturers have similar components inside, small-cap value funds
generally have dissimilar moving parts.
[pyramid graphic]
COMPANIES BY MARKET CAPITALIZATION
[top of pyramid]
$1 billion 1,550
$500 mil to $1 bil 845
$300 mil to $500 mil 753
$5 mil to MICRO-CAP SECTOR
$300 mil 6,400 Companies
[end pyramid]
These days, value encompasses a broad array of meanings. We focus
on absolute valuations as we seek to minimize risk while building returns over
the long term. Other managers may share our general outlook, but that does not
mean that we're all looking at the same companies or even that our value
approaches are ultimately very similar. Like the computer industry, small-cap
value investing has come into its own. Unlike the computer industry, there is
ample room for multiple perspectives.
THE ROYCE FUNDS ANNUAL REPORT 1997 | 5
<PAGE>
[sidebar]
I think that May '96 was a major inflection point, a shift to value away from
growth inside of small-cap. Since then, value has dominated, especially during
the down months. I believe that small-cap value further benefits due to its
limited international exposure and its ability to use volatility to its
advantage by buying stocks as they go down and selling them as they go up.
[end sidebar]
WEST SIDE STORY
[pull quote]
The challenge
for all investors
is going to be
dealing with
a lower-return
environment.
[end pull quote]
As many of you know, we are located in midtown Manhattan, smack
in the middle of New York City's prime shopping and hotel area, just a
stone's throw from Broadway. Recently, an investment advisor friend of ours
brought his wife to town for a typical New York City weekend of dinner, a
Broadway show and a visit to our office. The intrepid advisor sat down with
us for the following exchange.
HOW DO YOU VIEW YOUR PERFORMANCE IN 1997?
We were pleased with our results, especially considering our
approach to risk. While recognizing that both our investment approach and our
picking universe will influence returns, ultimately we should be judged in
terms of our ability to produce a successful, and hopefully consistent,
record of long-term returns.
DO YOU ANTICIPATE CHANGING YOUR APPROACH TO RISK TO TAKE ADVANTAGE OF THE
MARKET'S HIGH RETURNS?
No. We remain committed to evaluating both risk and reward
equally, especially given the current environment. We believe one of the
primary tasks of a good money manager is to understand and respect risk,
regardless of how euphoric market conditions may be.
WHAT ROLE WILL HIGHER MARKET VOLATILITY PLAY IN EQUITY INVESTING?
It is our belief that active managers typically perform better
during these volatile periods. Interestingly, small-cap value can frequently
be a market leader in this environment.
[pull quote]
We have never
been against
growth as an
attribute; it's really
about what price
you pay for growth,
not whether
growth is good
or bad.
[end pull quote]
WHAT CHALLENGES DO YOU SEE IN '98
AND BEYOND?
The challenge for all investors is going to be dealing with a
lower-return environment. We know that we have been crying wolf on this issue,
but we continue to believe that the extraordinary market returns of the last
several years are not sustainable. The Dow just concluded its best 10-year
performance period and the S&P 500 its best period of overall performance ever.
We think this is indicative of a peak moment and that lower returns are a given.
That said, we will continue as we always have to invest in small companies with
a risk-averse approach with the goal of above average absolute returns.
6 | THE ROYCE FUNDS ANNUAL REPORT 1997
<PAGE>
HOW DO YOU DISTINGUISH BETWEEN GROWTH AND VALUE COMPANIES?
The words growth and value are not polar opposites and at some
level have become irrelevant. We have never been against growth as an attribute;
it's really about what price you pay for growth, not whether growth is good or
bad.
DO THE FUNDS EVER BUY STOCKS THAT THEY HAVE HELD PREVIOUSLY?
Absolutely. Since we tend to develop deep knowledge bases about
our companies, we think there is nothing better than to return to familiar
territory if the opportunity arises.
WHAT, IF ANYTHING, DO YOU DO TO MAKE YOUR FUNDS MORE TAX EFFICIENT?
We subscribe under normal circumstances to a low portfolio
turnover approach, we focus on generating long-term capital gains and, when
liquidating positions, we sell our highest cost lots first.
THE GRAPES OF "WRISK"
[cartoon drawing of a bunch of grapes]
For many years, we have described our investment style as
"risk-averse," and characterized our work as "risk management." In fact, we have
consistently presented risk information alongside performance returns to
demonstrate our belief that both are equally important. When we examine
companies for potential investment, we consider both risk and reward potential,
and we think that when an investor considers a mutual fund investment, he or she
should consider these factors, too. The idea of giving emphasis to risk remains
central to our style of investment management, but it occurs to us that the time
may be right to clarify exactly what we mean by risk. What, after all, are we
talking about when we talk about risk?
[pull quote]
Our
commitment
to lowering
risk requires
an educated
understanding,
not an
avoidance,
of risk.
[end pull quote]
Regardless of the context we choose, risk is a complicated word.
This may be why one writer recently defined it as "the art and science of
choice." However rationally we behave in the face of uncertainty, however
realistically we define the potential pitfalls and profits, unanswerable
questions always linger. The science of risk involves a great deal of reliance
on the future resembling the past. The past forms a picture from which we make
guesses, however well-educated, about the future. The art of risk lies in the
ability to see what many others cannot.
In our money management work, we stick almost exclusively to
equity investing. Our primary emphasis is to determine
THE ROYCE FUNDS ANNUAL REPORT 1997 | 7
<PAGE>
[sidebar]
I think that it is both appropriate and conservative for investors to consider
doubling or tripling their current small-cap value allocation to 20% - 30%.
[end sidebar]
[pull quote]
Wall Street
and Main Street
do not always
walk hand
in hand.
Therefore,
our approach
must be multi-
dimensional.
[end pull quote]
the margin of safety for a given stock or, in other words, assessing how much
risk we are taking to achieve a certain reward. Our method is both quantitative
and historical, concentrating on two primary factors, business risk and price
risk.
When we analyze a company's business fundamentals, we ask
ourselves several important questions that relate directly to business risk. One
significant measure of a company's financial good health lies in our estimate of
its ability to withstand economic adversity. We want to know what the potential
risk is of "permanent capital impairment," i.e., the likelihood of a business
not being able to generate sustainable returns on assets or, even worse,
becoming insolvent.
Wall Street and Main Street do not always walk hand in hand.
Therefore, our approach must be multi-dimensional. This is where price risk
becomes important. We attempt to reduce this type of risk by buying stocks that
are trading at what we believe are bargain prices; we believe that the price one
pays for an investment makes a significant difference in long-term returns.
Our commitment to lowering risk requires an educated
understanding, not an avoidance, of risk. It is a reality to be lived with, not
escaped from. For us, understanding a company's business risk through the
examination of 10Qs, 10Ks and other documents forms the science of risk
management. The art of risk, and the fun of all this work, comes from
interpreting the subjective and seeking to convert these assessments into
attractive long-term returns. We get a kick out of proving wrong those academics
who assert that high absolute returns are solely the product of high risk.
We are the first to admit that our focus on risk has somewhat
hindered our relative returns over the last several years, but we do not intend
to abandon our approach, especially given the higher levels of volatility in
today's market.
PRELUDE TO A ...
While we have no idea where the Dow Jones Industrial Average will
end in 1998, we do believe that the current backdrop of higher market
volatility, overseas vulnerability, and potential interest rate uncertainty may
result in a favorable investment environment for small-cap value. Higher
volatility usually translates into lower returns - the standard deviation for
the S&P 500 for the six months ended 12/31/97 was 50% higher than the first half
of the year, while total return was approximately half that of the first six
months--and an edge for value because the discipline demands buying stocks as
they decline and selling them as they go up.
8 | THE ROYCE FUNDS ANNUAL REPORT 1997
<PAGE>
By its very nature, small-cap value generally has limited foreign
exposure, an advantage given the current turmoil in Southeast Asia. In our
judgment, it is unlikely that a 25% decline in long-term interest rates and a
125% rise in the S&P 500 will be repeated in the next three years.
We look forward to taking a curtain call for what we hope will be
a "successful run" in 1998 and remain confident about the long-term prospects of
our risk-averse approach.
[photo of Chuck Royce, Whitney George, and Jack Fockler
(c) Gloria Baker
[caption under photo]
Chuck Royce, Whitney George, Jack Fockler
Sincerely,
/s/ Charles M. Royce W. Whitney George Jack E. Fockler, Jr.
Charles M. Royce W. Whitney George Jack E. Fockler, Jr.
President Vice President Vice President
January 26, 1998
PS: Broadway trivia fans will be interested to know that ...
Bring In 'Da Noise, Bring In 'Da Funk made it to Broadway in April 1996 after a
successful Off Broadway run. Savion Glover's rhythmic tribute to tap took home a
Tony in '96 for Best Musical.
Fiddler On The Roof was one of Broadway's all-time winners with 3,242
performances between 1964 and 1972. The play was also made into a successful
film featuring future "Starsky & Hutch" star Paul Michael Glaser in a supporting
role.
A Chorus Line is still the all-time performance leader (what mutual fund manager
wouldn't love to be able to say that) with a record 6,137 performances. "One
Singular Sensation" indeed!
A Funny Thing Happened On The Way To The Forum was one of Broadway's most
successful reruns. The most recent production (April 1996 - January 1998) drew
raves with three different actors in the leading role: Nathan Lane, Whoopi
Goldberg and David Alan Grier.
Beauty And The Beast proved that cartoons can make great plays with one of the
most successful runs of the '90s!
West Side Story showed that Shakespeare could swing on the streets of New York
and remains one of the country's most popular musicals.
The Grapes Of Wrath offered unfortunate evidence that great novels don't always
translate into great dramas - this production endured a brief six-month run from
March through September of 1990.
Prelude To a Kiss, originally featuring Timothy Hutton, did not become a prelude
to box office success when it was made into a film.
THE ROYCE FUNDS ANNUAL REPORT 1997 | 9
<PAGE>
[sidebar]
WHAT WE DO Pennsylvania Mutual Fund ("PMF"), our flagship fund, seeks long-term
capital appreciation by investing in a blended portfolio that combines
approximately equal weightings of small and micro-cap securities.
HOW WE DID Pennsylvania Mutual Fund lagged behind its benchmark, the small-cap
oriented Russell 2000 index, during the second half, but finished ahead of the
index for the full year, returning 25.0% versus 22.4%. We are pleased that PMF
has continued its performance edge since the Fund was restructured to reflect
approximately equal weightings of small and micro-cap stocks in the second
quarter of 1996. In addition, the Fund has provided positive returns in 21 out
of the last 23 calendar years, and its average annual total return for the
24-1/2 years that we have managed the Fund (6/30/73) was 16.5%.
PMF, whose net assets as of December 31, 1997 totaled $660 million, is one
of the oldest small-cap funds available. The market's return to volatility in
1997 makes us confident about the Fund's near and long-term outlook. While PMF's
15 and 20-year returns are above average, its risk profile, as measured by
standard deviation and beta, is lower than its comparable index, the Russell
2000. In fact, PMF has outperformed the Russell 2000 in every down quarter over
the last 15 years. We remain enthused about the long-term prospects for our
flagship fund. We look forward to June 1998 which will mark our 25-year
anniversary as the Fund's manager.
[end sidebar]
PENNSYLVANIA MUTUAL FUND
- --------------------------------------------------------------------------------
TOTAL RETURNS
THROUGH 12/31/97
- ---------------------------------------------------
4th Quarter 1997 -1.9%
- ---------------------------------------------------
Jul-Dec 1997 10.5%
- ---------------------------------------------------
1997 25.0%
- ---------------------------------------------------
3-Year Average Annual 18.7%
- ---------------------------------------------------
5-Year Average Annual 13.1%
- ---------------------------------------------------
10-Year Average Annual 13.8%
- ---------------------------------------------------
15-Year Average Annual 14.4%
- ---------------------------------------------------
20-Year Average Annual 16.2%
- ---------------------------------------------------
Risk/Return Comparison
Fifteen-Year Period Ended 12/31/97
Average Annual Standard
Total Return Deviation RUR
- ---------------------------------------------------------
PMF 14.4% 11.3 1.27
- ---------------------------------------------------------
Russell 2000 13.3% 17.6 0.76
- ---------------------------------------------------------
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.
[pull quote]
Over the last fifteen years,
Pennsylvania Mutual Fund
has outperformed
the Russell 2000 on
BOTH an absolute and
a risk-adjusted basis.
[end pull quote]
PENNSYLVANIA MUTUAL VERSUS RUSSELL 2000 VALUE OF $10,000 INVESTED ON 12/31/82
[typeset representation of line chart]
PMF Russell 2000
Dec-82 10,000 10,000
Mar-83 11,905 11,745
Jun-83 13,836 14,128
Sep-83 13,664 13,436
Dec-83 14,051 12,913
Mar-84 13,565 12,047
Jun-84 13,446 11,684
Sep-84 14,302 12,327
Dec-84 14,492 11,969
Mar-85 16,047 13,634
Jun-85 16,567 14,117
Sep-85 16,518 13,501
Dec-85 18,372 15,684
Mar-86 20,331 17,905
Jun-86 21,476 18,774
Sep-86 19,962 16,474
Dec-86 20,427 15,576
Mar-87 23,397 20,607
Jun-87 23,699 20,461
Sep-87 24,815 21,318
Dec-87 20,708 15,123
Mar-88 23,698 18,007
Jun-88 25,250 19,194
Sep-88 25,591 19,014
Dec-88 25,796 18,888
Mar-89 27,607 20,342
Jun-89 29,216 21,638
Sep-89 30,464 23,099
Dec-89 30,101 21,955
Mar-90 29,836 21,470
Jun-90 30,803 22,299
Sep-90 25,705 16,827
Dec-90 26,628 17,673
Mar-91 32,018 22,929
Jun-91 32,341 22,574
Sep-91 33,631 24,414
Dec-91 35,104 25,812
Mar-92 37,751 27,748
Jun-92 36,789 25,856
Sep-92 37,657 26,595
Dec-92 40,786 30,564
Mar-93 42,874 31,869
Jun-93 42,416 32,563
Sep-93 44,099 35,409
Dec-93 45,374 36,341
Mar-94 44,884 35,374
Jun-94 43,901 33,998
Sep-94 45,538 36,357
Dec-94 45,047 35,681
Mar-95 46,871 37,326
Jun-95 49,913 40,823
Sep-95 53,437 44,857
Dec-95 53,480 45,830
Mar-96 54,592 48,172
Jun-96 56,535 50,581
Sep-96 56,535 50,753
Dec-96 60,352 53,392
Mar-97 60,605 50,626
Jun-97 68,247 58,838
Sep-97 76,908 67,593
Dec-97 75,416 65,328
[end line chart]
Includes reinvestment of distributions.
10 | THE ROYCE FUNDS ANNUAL REPORT 1997
<PAGE>
PERFORMANCE & PORTFOLIO REVIEW
- --------------------------------------------------------------------------------
DOWN MARKET PERFORMANCE COMPARISON
ALL DOWN PERIODS OF 7.5% OR GREATER OVER THE LAST FIFTEEN YEARS
IN PERCENTAGES (%)
[bar chart]
PMF Russell 2000
6/24/83 - -6.0 -24.2
7/25/84
7/3/86 - -8.6 -14.8
9/16/86
8/25/87 - -23.2 -39.1
10/28/87
10/9/89 - -20.9 -32.7
10/30/90
2/12/92 - -2.6 -11.9
7/8/92
3/18/94 - -7.6 -12.4
12/9/94
5/22/96 - -6.5 -15.5
7/24/96
1/22/97 - -2.5 -9.2
4/25/97
10/13/97 - -5.2 -9.7
10/27/97
[end bar chart]
Pennsylvania Mutual's risk-averse investment orientation
has resulted in strong relative returns in down markets.
PORTFOLIO DIAGNOSTICS
- ----------------------------------------------------
Median Market Cap $376 million
- ----------------------------------------------------
Weighted Average P/E Ratio 16.3x
- ----------------------------------------------------
Weighted Average P/B Ratio 1.8x
- ----------------------------------------------------
Weighted Average Yield 1.6%
- ----------------------------------------------------
Net Assets $660 million
- ----------------------------------------------------
Turnover Rate 18%
- ----------------------------------------------------
Symbol Investment Class PENNX
Consultant Class RYPCX
- ----------------------------------------------------
TOP TEN POSITIONS
% OF NET ASSETS
- -------------------------------------
1. CalMat 1.3
- -------------------------------------
2. New England
Business Service 1.3
- -------------------------------------
3. Alleghany Corporation 1.2
- -------------------------------------
4. Velcro Industries 1.1
- -------------------------------------
5. National Computer Systems 1.1
- -------------------------------------
6. Wesco Financial Corporation 1.1
- -------------------------------------
7. The Commerce Group 1.1
- -------------------------------------
8. Stanhome 1.1
- -------------------------------------
9. Lilly Industries Cl. A 1.1
- -------------------------------------
10. Leucadia National
Corporation 1.0
- -------------------------------------
PORTFOLIO SECTOR BREAKDOWN (WITH EXAMPLES) % OF NET ASSETS*
- --------------------------------------------------------------------------------
Industrial Products Textiles, building construction
materials, steel, paper. 22
Financial Intermediaries Banks. insurance, stockbrokers. 18
Consumer Products Apparel, home furnishings, mobile homes. 15
Industrial Services Engineering, trucking, printing,
advertising. 14
Financial Services Investment management, insurance
brokers, credit rating. 8
Technology Electronics, software, distributors. 7
Miscellaneous 5
Consumer Services Restaurants, airlines. 4
Natural Resources Energy, real estate, aggregates. 4
Retail Apparel stores, discount stores, direct
marketing. 2
Health Pharmaceuticals, medical equipment,
health care, biotech. 1
- --------------------------------------------------------------------------------
*excludes cash and cash equivalents.
+ All performance and risk information presented herein is for PMF's Investment
Class. Shares of PMF's Consultant Class, which commenced operations on June
18, 1997, bear an annual distribution expense which is not borne by the
Investment Class.
GOOD IDEAS THAT WORKED
- -----------------------------------------------------
1997 REALIZED AND UNREALIZED GAIN
- -----------------------------------------------------
New England Business Service $3,664,657
- -----------------------------------------------------
Wesco Financial Corporation 3,546,339
- -----------------------------------------------------
Air Express International Corporation 3,474,992
- -----------------------------------------------------
Alleghany Corporation 3,156,477
- -----------------------------------------------------
Fremont General Corporation 3,054,110
- -----------------------------------------------------
Combined Gain $16,896,575
- -----------------------------------------------------
GOOD IDEAS AT THE TIME
- -----------------------------------------------------
1997 REALIZED AND UNREALIZED LOSS
- -----------------------------------------------------
Haemonetics Corporation $1,523,979
- -----------------------------------------------------
Shoney's 1,386,117
- -----------------------------------------------------
The Topps Company 1,366,276
- -----------------------------------------------------
The Talbots 1,322,782
- -----------------------------------------------------
Guy F. Atkinson Company 1,283,145
- -----------------------------------------------------
Combined Loss $6,882,299
- -----------------------------------------------------
During 1997, the companies listed above made the largest positive and
negative contributions in dollar terms to our overall performance. While we are
quite pleased with this year's successes, we have learned over the years that
there is often more wisdom to be drawn from failures. An examination of past
years' winners and losers has taught us that this year's beast can easily be
transformed into next year's beauty. Certain securities whose fundamentals are
intact, but whose recent performance is out of sync, provide us with the
opportunity to buy additional shares at discounted prices. The end result is
that we would not be surprised to find that one of this year's underperformers
becomes a future year's major portfolio success story.
New England Business Service's highly effective management transformed a
sleepy, small mail order company with strong cash flow into a growing company
with increasing stock values. Successful acquisitions, stock repurchases, and
energetic marketing all have contributed to the company's growth.
Haemonetics, a manufacturer of blood collection machines, was hurt by
global exposure, slowness in getting new products to market and a lapse in
management. These factors caused disruptions in short-term earnings; however we
continue to believe in the long-term prospects of the company because of its
solid business fundamentals.
THE ROYCE FUNDS ANNUAL REPORT 1997 | 11
<PAGE>
[sidebar]
WHAT WE DO PMF II, like its older sibling Pennsylvania Mutual Fund, seeks
long-term capital appreciation by investing in a blend of small and micro-cap
stocks. In both funds, we employ a risk-averse, value approach that emphasizes
solid balance sheets and high internal rates of return.
HOW WE DID In the second half and full year, PMF II fell behind its benchmark,
the small-cap oriented Russell 2000 index, returning 9.4% and 20.8%,
respectively, versus 11.0% and 22.4% for the Russell 2000. PMF II currently
represents a more concentrated version of our flagship fund, Pennsylvania
Mutual, and therefore short-term periods of out of sync performance are
possible.
The Fund, with net assets of $22 million as of December 31, 1997, has
provided an average annual total return since inception (11/19/96) of 24.0%. We
believe that a portfolio approach that combines small and micro-cap securities
is capable of delivering attractive absolute and risk-adjusted returns.
We continue to manage PMF II with an eye towards a low-risk profile as
measured by standard deviation and beta. The same risk management style that is
employed by Pennsylvania Mutual Fund has been, and will remain, a major part of
PMF II's investment philosophy.
[end sidebar]
PMF II
- --------------------------------------------------------------------------------
TOTAL RETURNS
THROUGH 12/31/97
- ---------------------------------------------------
4th Quarter 1997 -4.7%
- ---------------------------------------------------
Jul-Dec 1997 9.4%
- ---------------------------------------------------
1997 20.8%
- ---------------------------------------------------
Since Inception (11/19/96) 24.0%
Average Annual
- ---------------------------------------------------
DOWN MARKET PERFORMANCE COMPARISON
ALL DOWN PERIODS OF 7.5% OR GREATER IN PERCENTAGES (%)
[BAR CHART]
PMF II Russell 2000
1/22/97 - -1.2 -9.2
4/25/97
10/13/97 - -4.9 -9.7
10/27/97
[END BAR CHART]
PMFII's risk-averse investment orientation
has resulted in strong relative returns in the
two down markets since its inception.
PMF II VERSUS RUSSELL 2000 VALUE OF $10,000 INVESTED ON 11/20/96
[typeset representation of line chart]
Date PMF II Russell 2000
11/20/96 10,000 10,000
11/30/96 10,260 10,189
12/31/96 10,520 10,456
1/31/97 10,460 10,665
2/28/97 10,580 10,406
3/31/97 10,419 9,915
4/30/97 10,459 9,943
5/31/97 10,998 11,049
6/30/97 11,619 11,523
7/31/97 11,999 12,059
8/31/97 12,439 12,335
9/30/97 13,338 13,238
10/31/97 13,138 12,657
11/30/97 13,019 12,575
12/31/97 12,710 12,795
[end line chart]
Includes reinvestment of distributions.
12 | THE ROYCE FUNDS ANNUAL REPORT 1997
<PAGE>
PERFORMANCE & PORTFOLIO REVIEW
- --------------------------------------------------------------------------------
PORTFOLIO DIAGNOSTICS
- ----------------------------------------------------
Median Market Cap $344 million
- ----------------------------------------------------
Weighted Average P/E Ratio 17.2x
- ----------------------------------------------------
Weighted Average P/B Ratio 1.5x
- ----------------------------------------------------
Weighted Average Yield 1.6%
- ----------------------------------------------------
Net Assets $22 million
- ----------------------------------------------------
Turnover Rate 77%
- ----------------------------------------------------
Symbol RYPNX
- ----------------------------------------------------
TOP TEN POSITIONS
% OF NET ASSETS
- ------------------------------------------
1. National Computer Systems 3.6
- ------------------------------------------
2. Richardson Electronics 3.0
- ------------------------------------------
3. Lilly Industries 2.6
- ------------------------------------------
4. Trenwick Group 2.4
- ------------------------------------------
5. Arnold Industries 2.3
- ------------------------------------------
6. CalMat 2.3
- ------------------------------------------
7. Charming Shoppes 2.3
- ------------------------------------------
8. Standard Commercial
Corporation 2.2
- ------------------------------------------
9. Pennsylvania Manufacturers
Corporation Cl. A 2.1
- ------------------------------------------
10. Lawyers Title Corporation 2.1
- ------------------------------------------
PORTFOLIO SECTOR BREAKDOWN (WITH EXAMPLES) % OF NET ASSETS*
- --------------------------------------------------------------------------------
Consumer Products Apparel, home furnishings, mobile homes. 16
Industrial Products Textiles, building construction
materials, steel, paper. 16
Industrial Services Engineering, trucking,
printing, advertising. 15
Financial Intermediaries Banks. insurance, stockbrokers. 13
Financial Services Investment management, insurance
brokers, credit rating. 11
Retail Apparel stores, discount stores, direct marketing. 7
Technology Electronics, software, distributors. 7
Natural Resources Energy, real estate, aggregates. 5
Consumer Services Restaurants, airlines. 4
Miscellaneous 4
Health Pharmaceuticals, medical equipment,
health care, biotech. 2
- --------------------------------------------------------------------------------
*excludes cash and cash equivalents.
GOOD IDEAS THAT WORKED
- ----------------------------------------------------
1997 REALIZED AND UNREALIZED GAIN
- ----------------------------------------------------
Oshkosh B'Gosh $324,794
- ----------------------------------------------------
Richardson Electronics 202,325
- ----------------------------------------------------
National Computer Systems 181,649
- ----------------------------------------------------
Rykoff-Sexton 168,708
- ----------------------------------------------------
CalMat 166,988
- ----------------------------------------------------
Combined Gain $1,044,464
- ----------------------------------------------------
GOOD IDEAS AT THE TIME
- --------------------------------------------------
1997 REALIZED AND UNREALIZED LOSS
- --------------------------------------------------
Guy F. Atkinson Company $207,100
- --------------------------------------------------
The Topps Company 165,325
- --------------------------------------------------
Rush Enterprises 105,000
- --------------------------------------------------
Tom Brown 95,588
- --------------------------------------------------
Haemonetics Corporation 85,981
- --------------------------------------------------
Combined Loss $658,994
- --------------------------------------------------
During 1997, the companies listed above made the largest positive and
negative contributions in dollar terms to our overall performance. While we are
quite pleased with this year's successes, we have learned over the years that
there is often more wisdom to be drawn from failures. An examination of past
years' winners and losers has taught us that this year's beast can easily be
transformed into next year's beauty. Certain securities whose fundamentals are
intact, but whose recent performance is out of sync, provide us with the
opportunity to buy additional shares at discounted prices. The end result is
that we would not be surprised to find that one of this year's underperformers
becomes a future year's major portfolio success story.
Oshkosh B'Gosh remains, in our opinion, a very solid company whose
management has begun to concentrate more closely on their core business of
clothing manufacturing, has shed non-core operations and has applied excess
capital to stock repurchases. All of these activities led to growth in earnings
and stock price.
Guy F. Atkinson Company was a case of our badly misjudging management as
the stock of this heavy construction contractor went from a $10 per share book
value to bankruptcy virtually overnight in spite of a solid balance sheet. This
provides a good example of the importance of portfolio diversification.
THE ROYCE FUNDS ANNUAL REPORT 1997 | 13
<PAGE>
[sidebar]
WHAT WE DO
Royce GiftShares Fund ("RGF") is a blended portfolio of primarily small and
micro-cap securities with an investment objective of long-term capital
appreciation. GiftShares is designed for investors who want to make gifts for
college funding, long-term financial security or estate planning.
HOW WE DID Royce GiftShares Fund followed up its strong first half by
outperforming its benchmark, the small-cap oriented Russell 2000 index, for the
second half and full year. The Fund posted returns of 12.4% and 26.0% for the
second half and full year, respectively, versus returns of 11.0% and 22.4% for
the Russell 2000. The Fund also holds a performance edge over the Russell 2000
in its since inception (12/27/95) period. Average annual total return for the
Fund was 25.7% versus 19.8% for the Russell 2000.
We are pleased with these early performance results for the Fund. A
portfolio that invests in a limited number of common stocks and convertible
securities and combines our core small and micro-cap strategies is one which we
believe is capable of providing high absolute and risk-adjusted returns.
Although risk statistics are not yet calculated for the portfolio given its
young age, our goal is to provide a low risk profile in addition to building
above average long-term returns.
RGF is not a typical mutual fund in that it is one of the few portfolios
whose use is exclusively for gifting and estate planning.
[end sidebar]
ROYCE GIFTSHARES FUND
- --------------------------------------------------------------------------------
TOTAL RETURNS
THROUGH 12/31/97
- ---------------------------------------------------
4th Quarter 1997 1.5%
- ---------------------------------------------------
Jul-Dec 1997 12.4%
- ---------------------------------------------------
1997 26.0%
- ---------------------------------------------------
Since Inception (12/27/95) 25.7%
Average Annual
- ---------------------------------------------------
DOWN MARKET PERFORMANCE COMPARISON
ALL DOWN PERIODS OF 7.5% OR GREATER IN PERCENTAGES (%)
[BAR CHART]
RGF Russell 2000
5/22/96 - -3.5 -15.5
7/24/96
1/22/97 - -0.5 -9.2
4/25/97
10/13/97 - -3.8 -9.7
10/27/97
[END BAR CHART]
Royce GiftShares' risk-averse investment orientation
has resulted in strong relative returns in the
three down markets since its inception.
ROYCE GIFTSHARES FUND VS. RUSSELL 2000 VALUE OF $10,000 INVESTED ON 12/27/95
[typeset representation of line chart]
Date RGF Russell 2000
---- --- ------------
12/27/95 10,000 10,000
12/31/95 10,020 10,100
3/31/96 10,600 10,616
6/30/96 11,500 11,147
9/30/96 11,600 11,185
12/31/96 12,580 11,766
3/31/97 12,645 11,157
6/30/97 14,111 12,967
9/30/97 15,621 14,896
12/31/97 15,854 14,397
[end line chart]
Includes reinvestment of distributions.
14 | The Royce Funds Annual Report 1997
<PAGE>
PERFORMANCE & PORTFOLIO REVIEW
- --------------------------------------------------------------------------------
PORTFOLIO DIAGNOSTICS
- ----------------------------------------------------
Median Market Cap $344 million
- ----------------------------------------------------
Weighted Average P/E Ratio 18.4x
- ----------------------------------------------------
Weighted Average P/B Ratio 1.6x
- ----------------------------------------------------
Weighted Average Yield 0.9%
- ----------------------------------------------------
Net Assets $3.7 million
- ----------------------------------------------------
Turnover Rate 64%
- ----------------------------------------------------
Symbol Investment Class RGFAX
Consultant Class RGFCX
- ----------------------------------------------------
TOP TEN POSITIONS
% OF NET ASSETS
- ------------------------------------------
1. Affiliated Managers Group 3.0
- ------------------------------------------
2. CalMat 3.0
- ------------------------------------------
3. New England Business Service 2.7
- ------------------------------------------
4. Young Innovations 2.7
- ------------------------------------------
5. The Commerce Group 2.6
- ------------------------------------------
6. Charming Shoppes 2.5
- ------------------------------------------
7. National Computer Systems 2.4
- ------------------------------------------
8. BHI Corporation 2.2
- ------------------------------------------
9. Tom Brown 2.2
- ------------------------------------------
10. Pennsylvania Manufacturers
Corporation Cl. A 2.1
- ------------------------------------------
PORTFOLIO SECTOR BREAKDOWN (WITH EXAMPLES) % OF NET ASSETS*
- --------------------------------------------------------------------------------
Financial Intermediaries Banks. insurance, stockbrokers. 18
Technology Electronics, software, distributors. 17
Industrial Services Engineering, trucking, printing, advertising. 15
Consumer Products Apparel, home furnishings, mobile homes. 9
Financial Services Investment management, insurance brokers,
credit rating. 7
Industrial Products Textiles, building construction
materials, steel, paper. 7
Natural Resources Energy, real estate, aggregates. 7
Retail Apparel stores, discount stores, direct marketing. 7
Health Pharmaceuticals, medical equipment, health
care, biotech. 6
Miscellaneous 5
Consumer Services Restaurants, airlines. 2
- --------------------------------------------------------------------------------
*excludes cash and cash equivalents.
+ All performance and risk information presented herein is for RGF's Investment
Class. Shares of RGF's Consultant Class, which commenced operations on
September 26, 1997, bear an annual distribution expense and are subject to a
deferred sales charge, which is not borne by the Investment Class.
GOOD IDEAS THAT WORKED
- --------------------------------------------------
1997 REALIZED AND UNREALIZED GAIN
- --------------------------------------------------
Weyco Group $43,460
- --------------------------------------------------
Young Innovations 33,000
- --------------------------------------------------
CalMat 30,668
- --------------------------------------------------
Oshkosh B'Gosh Cl. A 27,432
- --------------------------------------------------
Faroudja 21,875
- --------------------------------------------------
Combined Gain $156,435
- --------------------------------------------------
GOOD IDEAS AT THE TIME
- -------------------------------------------------
1997 REALIZED AND UNREALIZED LOSS
- -------------------------------------------------
The Topps Company $20,115
- -------------------------------------------------
Xylan Corporation 11,849
- -------------------------------------------------
Tom Brown 11,587
- -------------------------------------------------
Rush Enterprises 11,277
- -------------------------------------------------
MacNeal-Schwendler Corporation 10,966
- -------------------------------------------------
Combined Loss $65,794
- -------------------------------------------------
During 1997, the companies listed above made the largest positive and
negative contributions in dollar terms to our overall performance. While we are
quite pleased with this year's successes, we have learned over the years that
there is often more wisdom to be drawn from failures. An examination of past
years' winners and losers has taught us that this year's beast can easily be
transformed into next year's beauty. Certain securities whose fundamentals are
intact, but whose recent performance is out of sync, provide us with the
opportunity to buy additional shares at discounted prices. The end result is
that we would not be surprised to find that one of this year's underperformers
becomes a future year's major portfolio success story.
Weyco, an extremely well-run shoe manufacturer with a pristine balance
sheet, is a consistent stock repurchaser. This stock's solid characteristics are
apparently catching on with more investors who are recognizing what we have
known for a long time.
Topps unfortunately has not lived up to its name recently. With their main
competitors in the athletic card market now bankrupt, we believe that the future
looks bright even though earnings recovery has not yet materialized.
THE ROYCE FUNDS ANNUAL REPORT 1997 | 15
<PAGE>
UPDATES & NOTES TO PERFORMANCE AND RISK INFORMATION
- --------------------------------------------------------------------------------
NOTICE TO SHAREHOLDERS
If you are a shareholder of our Funds through one of the mutual
fund supermarkets such as Charles Schwab, Fidelity, Jack White, etc. and
would like to be kept apprised directly of what's going on with The Royce
Funds, please drop us a line or an e-mail at "[email protected]" with your
name, address, telephone number and the name of the Fund you hold.
[graphic of computer with the words "The Royce Fund" on screen]
NEW ON OUR WEBSITE
Royce Funds' shareholders can now have PC access to account information and
perform transactions online through Royce Online Account Access (ROAA)!
A new section dedicated to our unique gifting and estate planning fund,
Royce GiftShares Fund, has also been added.
ROYCE PORTFOLIOS NOW IN A VARIABLE ANNUITY
Royce & Associates has contracted with IL Annuity and Insurance Company, a
wholly-owned subsidiary of the Indianapolis Life Group of Companies, rated A
(excellent) by A.M. Best, to offer our micro-cap approach in a variable annuity
format in the Indianapolis "Visionary Choice" Variable Annuity. To receive a
prospectus, which includes fees and expenses, call IL Annuity and Insurance
Company toll-free at 1-888-232-6486. Please read the prospectus carefully before
investing.
We have also contracted with American General Life, one of the country's
largest distributors of insurance products, to offer our premier and total
return approaches in a variable annuity format in their newly-developed "Select
Reserve" Variable Annuity Insurance Contract in February 1998. To receive a
prospectus, which includes fees and expenses, call 1-800-829-5046. Please read
the prospectus carefully before investing.
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. This report is
not authorized for distribution unless preceded or accompanied by a current
prospectus. Please read the prospectus carefully before investing or sending
money.
Morningstar proprietary risk ratio measures a fund's downside volatility
relative to all equity funds, which have an average score of 1.00. The average
risk score for the 324 funds in the small-cap objective category was 1.49 for
the three years ended 12/31/97. The lower the risk ratio, the lower a fund's
downside volatility has been. The risk scores for Royce Premier, Royce Total
Return, and Pennsylvania Mutual Fund for this period were 0.67, 0.20 and 0.70,
respectively. Standard deviation is a statistical measure within which a fund's
total returns have varied over time. The greater the standard deviation, the
greater a fund's volatility. The Russell 2000, Russell 2000 Value, Russell 2000
Growth, S&P 500 and Dow Jones Industrial Average are unmanaged indices of
domestic common stocks. The Royce Funds and Royce GiftShares Fund are service
marks of The Royce Funds.
16 | The Royce Funds Annual Report 1997
<PAGE>
[background graphic of mutual fund listings from newspaper with Royce Funds
circled]
FINANCIAL STATEMENTS
Schedules of Investments 18-22
Statements of Assets and Liabilities 23
Statements of Changes in Net Assets 24
Statements of Operations and 25
Financial Highlights
Notes to Financial Statements 26-27
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
PENNSYLVANIA MUTUAL FUND DECEMBER 31, 1997
- --------------------------------------------------------------------------------
COMMON STOCKS -- 94.6%
SHARES VALUE
------ -----
Consumer Products -- 14.1%
Bassett Furniture Industries,
Incorporated 167,275 $ 5,018,250
Burnham Corporation Cl. A 43,876 1,996,358
Burnham Corporation Cl. B 4,040 183,820
Conso Products* 144,225 1,099,716
+800-JR CIGAR* 65,200 1,630,000
Fedders Corporation Cl. A 71,700 439,162
Flexsteel Industries 88,600 1,251,475
Garan Incorporated 221,700 5,708,775
Gibson Greetings* 236,100 5,164,687
Haggar 49,800 784,350
J & J Snack Foods* 43,000 704,125
Johnson Worldwide Associates Cl. A* 130,370 2,297,771
Juno Lighting 294,500 5,153,750
K-Swiss Cl. A 106,700 1,733,875
La-Z-Boy 94,500 4,075,313
Lazare Kaplan International* 181,700 2,452,950
Liberty Homes Cl. A 93,350 904,328
Liberty Homes Cl. B 21,950 219,500
Lifetime Hoan Corporation 346,599 3,422,665
Lund International Holdings* 93,700 1,112,687
Matthews International
Corporation Cl. A 54,900 2,415,600
Oakley* 206,100 1,867,781
Oshkosh B'Gosh Cl. A 116,200 3,834,600
The Rival Company 180,100 2,363,813
Semi-Tech Corporation Cl. A* 83,100 57,131
Skyline Corporation 196,800 5,412,000
Stanhome 276,700 7,107,731
Sturm, Ruger & Company 207,200 3,820,250
Thomaston Mills Cl. A 195,400 1,807,450
Thor Industries 184,800 6,340,950
The Topps Company* 940,700 2,087,178
Velcro Industries 78,400 7,526,400
Weyco Group 137,100 3,101,887
------------
93,096,328
------------
Consumer Services -- 3.4%
ASA Holdings 63,100 1,794,406
Bowl America Incorporated Cl. A 86,800 732,375
Buffets* 333,400 3,125,625
+Jenny Craig* 239,100 1,808,194
International Dairy Queen Cl. A* 156,400 4,188,588
International Dairy Queen Cl. B* 33,600 907,200
The Marcus Corporation 52,875 974,883
PCA International 100,100 2,102,100
Plenum Publishing Corporation 115,450 5,339,562
+Shoney's* 367,582 1,171,668
------------
22,144,601
------------
Financial Intermediaries -- 16.6%
Alleghany Corporation* 26,803 7,632,154
ALLIED Group 184,612 5,284,519
ALLIED Life Financial Corporation 37,400 818,125
+BHI Corporation 81,100 2,493,825
Baker Boyer Bancorp 31,300 1,314,600
SHARES VALUE
------ -----
Baldwin & Lyons Cl. B 125,678 $ 3,031,982
The Commerce Group 222,642 7,263,695
Community Banks 41,700 1,751,400
F & M Bancorporation 13,800 696,900
Farmers & Merchants Bank of
Long Beach 1,306 3,376,010
Fremont General Corporation 92,770 5,079,157
Gryphon Holdings* 202,500 3,391,875
Hanmi Bank* 23,018 414,324
Highlands Insurance Group* 164,000 4,653,500
Intercargo Corporation 77,900 1,032,175
Lawyers Title Corporation 162,400 5,105,450
Leucadia National Corporation 200,128 6,904,416
Medical Assurance* 199,922 5,622,806
National Bancorp of Alaska 14,265 1,804,523
Nobel Insurance Limited 74,400 976,500
Oriental Financial Group 63,625 1,880,914
Orion Capital Corporation 70,786 3,287,125
PXRE Corporation 186,541 6,190,829
Pennsylvania Manufacturers
Corporation Cl. A 301,350 4,821,600
Piper Jaffray Companies 96,700 3,523,506
RLI Corp. 27,825 1,386,033
Trenwick Group 178,800 6,727,350
Wesco Financial Corporation 24,300 7,290,000
Zenith National Insurance 231,000 5,948,250
------------
109,703,543
------------
Financial Services -- 7.8%
E.W. Blanch Holdings 160,000 5,510,000
Crawford & Company Cl. A 302,625 5,749,875
Duff & Phelps Credit Rating Co. 110,299 4,480,897
Eaton Vance 162,200 6,123,050
Arthur J. Gallagher & Co. 192,500 6,629,219
Hilb, Rogal & Hamilton Company 203,300 3,926,231
Investors Financial Services
Corporation 58,404 2,686,584
The John Nuveen Company Cl. A 67,800 2,373,000
New England Investment
Companies, L.P. 56,000 1,603,000
Phoenix Duff & Phelps
Corporation 271,400 2,171,200
The Pioneer Group 214,500 6,032,812
+Willis Corroon Group ADR[dbldag] 356,400 4,388,175
------------
51,674,043
------------
Health -- 1.1%
Haemonetics Corporation* 319,400 4,471,600
Life Technologies 77,960 2,592,170
------------
7,063,770
------------
Industrial Products -- 20.8%
Ash Grove Cement Company 48,018 3,313,242
BHA Group Holdings 132,870 2,590,965
Blessings Corporation* 198,500 2,927,875
Carbo Ceramics 90,400 2,892,800
Cascade 136,000 2,312,000
CLARCOR 75,450 2,235,206
18 | THE ROYCE FUNDS ANNUAL REPORT 1997
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
PENNSYLVANIA MUTUAL FUND DECEMBER 31, 1997
- --------------------------------------------------------------------------------
SHARES VALUE
------ -----
Industrial Products -- (continued)
Curtiss-Wright Corporation 188,200 $ 6,834,013
Delta Woodside Industries 168,736 822,588
DeVlieg-Bullard* 38,000 144,875
Fab Industries 162,732 5,065,033
Falcon Products 166,500 2,362,219
Fansteel* 27,800 236,300
P. H. Glatfelter Company 194,200 3,616,975
C. H. Heist* 88,512 608,520
International Aluminum
Corporation 153,500 4,796,875
Kaydon Corporation 196,000 6,394,500
Kimball International Cl. B 198,000 3,650,625
LeaRonal 108,557 2,551,090
Lilly Industries Cl. A 344,261 7,100,383
The Lincoln Electric Company Cl. A 124,690 4,488,840
Liqui-Box Corporation 110,500 4,447,625
MacDermid, Incorporated 28,077 2,383,035
Midwest Grain Products* 287,400 3,592,500
Myers Industries 188,732 3,220,240
Nordson Corporation 33,300 1,527,637
The Oilgear Company 13,400 311,550
Oregon Steel Mills 115,700 2,465,856
Oshkosh Truck Corporation Cl. B 253,500 4,578,844
Penn Engineering and
Manufacturing 221,750 5,322,000
Penn Engineering and
Manufacturing Cl. A 49,550 1,232,556
Preformed Line Products Company 94,893 4,554,864
Puerto Rican Cement Company 135,600 6,805,425
Quaker Chemical Corporation 51,064 967,025
Robroy Industries Cl. A 94,535 1,677,996
Simpson Manufacturing* 180,900 6,026,231
The Standard Register Company 176,610 6,137,198
Synalloy Corporation 82,100 1,210,975
Tecumseh Products Company Cl. A 67,000 3,266,250
Todd Shipyards Corporation* 101,850 426,497
Unifi 93,800 3,816,488
Woodward Governor Company 153,072 4,955,706
Zero Corporation 108,900 3,226,162
------------
137,097,584
------------
Industrial Services -- 13.1%
ABM Industries Incorporated 96,600 2,952,338
Aceto Corporation 79,364 1,626,962
Air Express International
Corporation 192,630 5,875,215
Arnold Industries 371,548 6,409,203
Bowne & Co. 116,900 4,661,387
Circle International Group 248,074 5,690,197
Devcon International* 59,500 290,063
Devon Group* 15,400 708,400
Ennis Business Forms 229,600 2,123,800
Farmer Bros. 31,675 5,923,225
Frozen Food Express Industries 414,867 3,733,803
Grey Advertising 12,031 3,946,168
Insituform Technologies Cl. A* 27,000 209,250
SHARES VALUE
------ -----
Kenan Transport Company 70,800 $ 2,593,050
Lufkin Industries 61,200 2,187,900
Merrill Corporation 191,800 4,459,350
Morrison Knudsen Corporation* 186,500 1,818,375
New England Business Service 250,600 8,457,750
The Olsten Corporation 55,000 825,000
Pittston Burlington Group 50,900 1,336,125
**Sevenson Environmental Services 294,600 3,608,850
Standard Commercial Corporation* 250,776 4,153,477
Stone & Webster 88,800 4,162,500
TBC Corporation* 118,277 1,131,024
True North Communications 8,300 205,425
Vallen Corporation* 248,000 5,146,000
Werner Enterprises 2,700 55,350
Willbros Group* 138,900 2,083,500
------------
86,373,687
------------
Natural Resources -- 3.9%
Alico 29,676 689,967
Barrett Resources* 25,900 783,475
Tom Brown* 214,300 4,125,275
CalMat 310,300 8,649,612
Consolidated-Tomoka Land 51,800 938,875
FRP Properties* 85,900 2,695,113
Florida Rock Industries 289,200 6,579,300
The Newhall Land and Farming
Company 30,700 921,000
------------
25,382,617
------------
Retail -- 2.1%
Cato Corporation Cl. A 73,000 647,875
Charming Shoppes* 708,000 3,318,750
Family Dollar Stores 20,550 602,372
Lillian Vernon Corporation 10,500 174,563
Mikasa 153,000 2,228,063
Sotheby's Holdings Cl. A 249,500 4,615,750
+The Talbots 138,800 2,515,750
------------
14,103,123
------------
Technology -- 6.5%
Adobe Systems Incorporated 45,500 1,876,875
+Axiohm Transaction Solutions* 134,562 2,287,554
BGS Systems 128,200 4,487,000
CEM Corporation* 70,000 767,812
Dionex Corporation* 65,638 3,298,310
Exar Corporation* 127,100 2,097,150
Hach Company 54,361 686,308
Hach Company Cl. A 54,361 509,634
ILC Technology* 56,700 823,922
MacNeal-Schwendler Corporation* 95,600 920,150
Marshall Industries* 197,600 5,928,000
Modern Controls 83,400 917,400
National Computer Systems 211,903 7,469,581
+Newport Corporation 138,900 1,953,281
Richardson Electronics 202,862 2,256,840
Scitex Corporation Limited* 271,900 3,279,794
Woodhead Industries 64,250 1,204,687
+Xylan Corporation 145,000 2,193,125
------------
42,957,423
------------
THE ROYCE FUNDS ANNUAL REPORT 1997 | 19
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
PENNSYLVANIA MUTUAL FUND DECEMBER 31, 1997
- --------------------------------------------------------------------------------
SHARES VALUE
------ -----
Utilities -- 0.3%
Southern Union Company* 87,282 $ 2,083,858
------------
Miscellaneous -- 4.9% 32,222,527
------------
TOTAL COMMON STOCKS
(Cost $376,683,666) 623,903,104
------------
PREFERRED STOCK -- 0.1%
Bird Corp. $1.85 Conv.
(Cost $477,513) 32,700 506,850
------------
REPURCHASE AGREEMENT -- 5.5%
State Street Bank and Trust Company,
5.15% dated 12/31/97, due 1/02/98,
maturity value $36,310,386
(collaterized by U.S. Treasury Notes,
5.875% due 10/31/98, valued at $37,028,969)
(Cost $36,300,000) 36,300,000
------------
VALUE
-----
TOTAL INVESTMENTS -- 100.2%
(Cost $413,461,179) $660,709,954
LIABILITIES LESS CASH AND
OTHER ASSETS -- (0.2)% (1,126,588)
------------
NET ASSETS -- 100.0% $659,583,366
------------
- --------------------------------------------------------------------------------
* Non-income producing.
** At December 31, 1997, the Fund owned 5% or more of the Company's outstanding
shares thereby making the Company an Affiliated Company as that term is
defined in the Investment Company Act of 1940.
+ A portion of these securities are on loan at December 31, 1997. Total market
value of all securities on loan is $8,158,462, for which the Fund received
$8,716,400 as collateral.
++ American Depository Receipt.
Income Tax Information: The cost of total investments for federal income tax
purposes was $415,224,271. At December 31, 1997, net unrealized appreciation for
all securities was $245,485,683, consisiting of aggregate gross unrealized
appreciation of $261,199,433 and aggregate gross unrealized depreciation of
$15,713,750. The Fund designated $76,540,945 as a capital gain dividend for
purposes of the dividend paid deduction.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS.
20 | THE ROYCE FUNDS ANNUAL REPORT 1997
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
PMF II DECEMBER 31, 1997
- --------------------------------------------------------------------------------
COMMON STOCKS -- 94.5%
SHARES VALUE
------ -----
Consumer Products -- 15.0%
Bassett Furniture Industries,
Incorporated 14,300 $ 429,000
Garan Incorporated 5,500 141,625
Gibson Greetings* 15,800 345,625
Jean-Philippe Fragrances* 26,600 182,875
Johnson Worldwide Associates Cl. A* 25,650 452,081
Lund International Holdings* 33,900 402,562
Oshkosh B'Gosh Cl. A 10,700 353,100
Skyline Corporation 13,000 357,500
Stanhome 17,800 457,237
The Topps Company* 95,000 210,781
-----------
3,332,386
-----------
Consumer Services -- 3.7%
Buffets* 19,600 183,750
MovieFone Cl. A* 60,000 405,000
PCA International 11,200 235,200
-----------
823,950
-----------
Financial Intermediaries -- 12.2%
The Commerce Group 13,400 437,175
Lawyers Title Corporation 14,700 462,131
Old Guard Group 19,000 363,375
Pennsylvania Manufacturers
Corporation Cl. A 29,000 464,000
Resurgence Properties* 45,000 78,750
Trenwick Group 14,100 530,513
Zenith National Insurance 15,100 388,825
-----------
2,724,769
-----------
Financial Services -- 10.7%
Affiliated Managers Group* 9,000 261,000
Crawford & Company Cl. A 18,000 342,000
Duff & Phelps Credit Rating Co. 10,000 406,250
Arthur J. Gallagher & Co. 9,100 313,381
Phoenix Duff & Phelps Corporation 35,000 280,000
The Pioneer Group 13,100 368,438
Willis Corroon Group ADR+ 32,400 398,925
-----------
2,369,994
-----------
Health -- 1.9%
Haemonetics Corporation* 30,000 420,000
-----------
Industrial Products -- 15.0%
American Buildings Company* 10,000 252,500
Curtiss-Wright Corporation 12,400 450,275
Lilly Industries Cl. A 27,600 569,250
Midwest Grain Products* 29,200 365,000
PalEx* 30,000 356,250
Penn Engineering and Manufacturing 18,200 436,800
Puerto Rican Cement Company 8,000 401,500
SHARES VALUE
------ -----
The Standard Register Company 9,900 $ 344,025
Unifi 4,000 162,750
-----------
3,338,350
-----------
Industrial Services -- 13.8%
Arnold Industries 30,000 517,500
Ennis Business Forms 34,900 322,825
Frozen Food Express Industries 37,000 333,000
Insituform Technologies Cl. A* 50,300 389,825
The Olsten Corporation 22,000 330,000
Sevenson Environmental Services 23,640 289,590
Standard Commercial Corporation* 29,653 491,128
Stone & Webster 5,000 234,375
Vallen Corporation* 7,800 161,850
-----------
3,070,093
-----------
Natural Resources -- 5.2%
Tom Brown* 22,000 423,500
CalMat 18,300 510,113
Florida Rock Industries 9,300 211,575
-----------
1,145,188
-----------
Retail -- 6.4%
Catherines Stores Corporation* 56,800 397,600
Charming Shoppes* 1 08,000 506,250
Lechters* 54,000 273,375
The Talbots 14,000 253,750
-----------
1,430,975
-----------
Technology -- 6.7%
National Computer Systems 23,000 810,750
Richardson Electronics 60,000 667,500
-----------
1,478,250
-----------
Miscellaneous -- 3.9% 876,838
- -----------
TOTAL COMMON STOCKS
(Cost $18,894,871) 21,010,793
-----------
REPURCHASE AGREEMENT -- 5.4%
State Street Bank & Trust Company,
5.15% dated 12/31/97, due 1/02/98,
maturity value $1,200,343
(collaterized by U.S. Treasury Bonds,
10.75% due 5/15/03, valued at $1,226,428)
(Cost $1,200,000) 1,200,000
-----------
TOTAL INVESTMENTS -- 99.9%
(Cost $20,094,871) 22,210,793
CASH AND OTHER ASSETS
LESS LIABILITIES -- 0.1% 32,707
-----------
NET ASSETS -- 100.0% $22,243,500
-----------
- --------------------------------------------------------------------------------
* Non-income producing.
+ American Depository Receipt.
Income Tax Information: The cost of total investments for federal income tax
purposes was $20,094,871. At December 31, 1997, net unrealized appreciation for
all securities was $2,115,922, consisting of aggregate gross unrealized
appreciation of $3,092,661 and aggregate gross unrealized depreciation of
$976,739.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS.
THE ROYCE FUNDS ANNUAL REPORT 1997 | 21
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
ROYCE GIFTSHARES FUND DECEMBER 31, 1997
- --------------------------------------------------------------------------------
COMMON STOCKS -- 73.3%
SHARES VALUE
------ -----
Consumer Products -- 6.7%
Bassett Furniture Industries,
Incorporated 1,000 $ 30,000
Johnson Worldwide Associates Cl. A* 1,500 26,438
Lifetime Hoan Corporation 1,650 16,294
Lund International Holdings* 5,000 59,375
Oshkosh B'Gosh Cl. A 1,500 49,500
Stanhome 1,600 41,100
The Topps Company* 11,500 25,516
----------
248,223
----------
Consumer Services -- 1.8%
MovieFone Cl. A* 10,000 67,500
----------
Financial Intermediaries -- 12.9%
BHI Corporation 2,700 83,025
The Commerce Group 3,000 97,875
Lawyers Title Corporation 2,000 62,875
Leucadia National Corporation 1,000 34,500
Medical Assurance* 1,600 45,000
Nobel Insurance Limited 2,000 26,250
Old Guard Group 1,600 30,600
Pennsylvania Manufacturers
Corporation Cl. A 4,900 78,400
Zenith National Insurance 800 20,600
----------
479,125
----------
Financial Services -- 5.2%
Affiliated Managers Group* 3,900 113,100
Arthur J. Gallagher & Co. 1,000 34,437
Phoenix Duff & Phelps Corporation 2,000 16,000
Willis Corroon Group ADR+ 2,500 30,781
----------
194,318
----------
Health -- 4.6%
Healthworld Corporation* 6,000 72,375
Young Innovations* 5,500 99,000
----------
171,375
----------
Industrial Products -- 5.0%
BHA Group Holdings 330 6,435
Kaydon Corporation 1,000 32,625
Lilly Industries Cl. A 2,600 53,625
Midwest Grain Products* 2,000 25,000
Penn Engineering and Manufacturing 1,500 36,000
Woodward Governor Company 1,000 32,375
----------
186,060
----------
Industrial Services -- 10.8%
Arnold Industries 2,000 34,500
SHARES VALUE
------ -----
Frozen Food Express Industries 5,500 $ 49,500
Insituform Technologies Cl. A* 8,000 62,000
Kenan Transport Company 1,000 36,625
New England Business Service 3,000 101,250
Sevenson Environmental Services 4,280 52,430
Standard Commercial Corporation* 4,020 66,581
----------
402,886
----------
Natural Resources -- 5.2%
Tom Brown* 4,200 80,850
CalMat 4,000 111,500
----------
192,350
----------
Retail -- 4.9%
Catherines Stores Corporation* 3,900 27,300
Charming Shoppes* 0,000 93,750
Sotheby's Holdings Cl. A 2,000 37,000
The Talbots 1,300 23,562
----------
181,612
----------
Technology -- 12.3%
BGS Systems 800 28,000
Exar Corporation* 900 14,850
Faroudja* 5,000 51,875
MacNeal-Schwendler Corporation* 5,000 48,125
Marshall Industries* 600 18,000
National Computer Systems 2,500 88,125
Richardson Electronics 6,600 73,425
Unitrode Corporation* 3,500 75,250
Xylan Corporation* 4,000 60,500
----------
458,150
----------
Miscellaneous -- 3.9% 146,500
----------
TOTAL COMMON STOCKS
(Cost $2,429,674) 2,728,099
----------
REPURCHASE AGREEMENT -- 21.5%
State Street Bank & Trust Company,
5.15% dated 12/31/97, due 1/02/98,
maturity value $800,229
(collaterized by U.S. Treasury Bonds,
10.75% due 5/15/03, valued at $817,619)
(Cost $800,000) 800,000
----------
TOTAL INVESTMENTS -- 94.8%
(Cost $3,229,674) 3,528,099
CASH AND OTHER ASSETS
LESS LIABILITIES -- 5.2% 193,064
----------
NET ASSETS -- 100.0% $3,721,163
----------
- --------------------------------------------------------------------------------
* Non-income producing.
+ American Depository Receipt.
Income Tax Information: The cost of total investments for federal income tax
purposes was $3,229,674. At December 31, 1997, net unrealized appreciation for
all securities was $298,425, consisting of aggregate gross unrealized
appreciation of $387,119 and aggregate gross unrealized depreciation of $88,694.
The Fund designated $60,711 as a capital dividend for purposes of the dividend
paid deduction.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS.
22 | THE ROYCE FUNDS ANNUAL REPORT 1997
<PAGE>
STATEMENTS OF ASSETS AND LIABILITIES DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PENNSYLVANIA ROYCE
MUTUAL FUND PMF II GIFTSHARES FUND
ASSETS: ------------------ ---------------- ----------------
<S> <C> <C> <C>
Investments at value (identified cost $377,161,179, $18,894,871, and
$2,429,674, respectively) $ 624,409,954 $ 21,010,793 $ 2,728,099
Repurchase agreements (at cost and value) 36,300,000 1,200,000 800,000
Cash 78,718 228,507 111,951
Collateral from brokers on securities loaned 8,716,400 -- --
Receivable for investments sold 13,272 -- --
Receivable for capital shares sold 260,248 15,228 78,700
Receivable for dividends and interest 996,807 25,389 2,917
Prepaid expenses and other assets 9,959 19,357 11,768
- ------------------------------------------------------------------------- -------------- ------------ -----------
Total Assets 670,785,358 22,499,274 3,733,435
- ------------------------------------------------------------------------- -------------- ------------ -----------
LIABILITIES:
Payable for collateral on securities loaned 8,716,400 -- --
Payable for investments purchased 1,545,425 224,261 --
Payable for capital shares redeemed 238,541 -- --
Payable for investment advisory fees 435,526 12,980 --
Accrued expenses 266,100 18,533 12,272
- ------------------------------------------------------------------------- -------------- ------------ -----------
Total Liabilities 11,201,992 255,774 12,272
- ------------------------------------------------------------------------- -------------- ------------ -----------
Net Assets $ 659,583,366 $ 22,243,500 $ 3,721,163
- ------------------------------------------------------------------------- -------------- ------------ -----------
ANALYSIS OF NET ASSETS:
Undistributed net investment income $ 266,266 $ -- $ --
Accumulated net realized gain on investments 1,298,961 578,211 11,586
Net unrealized appreciation on investments 247,248,775 2,115,922 298,425
Capital shares 84,380 3,759 539
Additional paid-in capital 410,684,984 19,545,608 3,410,613
- ------------------------------------------------------------------------- -------------- ------------ -----------
Net Assets $ 659,583,366 $ 22,243,500 $ 3,721,163
Investment Class $ 507,634,865 $ 3,614,012
Consultant Class $ 151,948,501 $ 107,151
- ------------------------------------------------------------------------- -------------- -----------
SHARES OUTSTANDING:
(unlimited number of $.001 par value shares authorized for each Fund) 3,758,557
Investment Class 64,923,801 523,297
Consultant Class 19,456,671 15,567
- ------------------------------------------------------------------------- -------------- -----------
NET ASSET VALUE:
(offering and redemption price* per share) $5.92
Investment Class (offering and redemption price* per share) $7.82 $6.91
Consultant Class (offering price** per share) $7.81 $6.88
- ------------------------------------------------------------------------- -------------- -----------
</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 THE FINANCIAL STATEMENTS.
THE ROYCE FUNDS ANNUAL REPORT 1997 | 23
<PAGE>
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
-------------------------------------------
PENNSYLVANIA MUTUAL FUND
-------------------------------------------
YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31,
1997 1996
INVESTMENT OPERATIONS: --------------------- ---------------------
<S> <C> <C>
Net investment income (loss) $ 4,409,053 $ 5,687,395
Net realized gain (loss) on investments 57,122,461 107,094,818
Net change in unrealized appreciation
on investments 59,891,240 (50,091,647)
- ------------------------------------------------ -------------- --------------
Net increase in net assets from
investment operations 121,422,754 62,690,566
- ------------------------------------------------ -------------- --------------
DIVIDENDS AND DISTRIBUTIONS:
Net investment income
Investment Class (3,514,299) (5,996,455)
Consultant Class (658,502) --
Net realized gain on investments
Investment Class (57,918,964) (78,458,463)
Consultant Class (17,311,988) --
- ------------------------------------------------ -------------- --------------
Total dividends and distributions (79,403,753) (84,454,918)
- ------------------------------------------------ -------------- --------------
CAPITAL SHARE TRANSACTIONS:
Net proceeds from shares sold
Investment Class 60,713,483 42,163,541
Consultant Class 1,297,520 --
Value of shares issued in connection
with the merger of Royce Value Fund
Consultant Class 144,531,292 --
Distributions reinvested
Investment Class 55,324,790 75,355,767
Consultant Class 17,180,389 --
Cost of shares redeemed
Investment Class (108,160,769) (269,005,617)
Consultant Class (10,190,290) --
- ------------------------------------------------ -------------- --------------
Net increase (decrease) in net assets
from capital share transactions 160,696,415 (151,486,309)
- ------------------------------------------------ -------------- --------------
NET INCREASE (DECREASE)
IN NET ASSETS 202,715,416 (173,250,661)
NET ASSETS:
Beginning of period 456,867,950 630,118,611
- ------------------------------------------------ -------------- --------------
End of period $ 659,583,366(b) $ 456,867,950(b)
- ------------------------------------------------ -------------- --------------
CAPITAL SHARE TRANSACTIONS:
Shares sold
Investment Class 7,452,126 5,372,907
Consultant Class 156,892 --
Shares issued in connection
with the merger of Royce Value Fund
Consultant Class 18,295,100 --
Shares issued for reinvestment of
dividends and distributions
Investment Class 7,101,539 10,873,360
Consultant Class 2,205,442 --
Shares redeemed
Investment Class (13,880,141) (33,697,985)
Consultant Class (1,200,763) --
- ------------------------------------------------ -------------- --------------
Net increase (decrease) in shares outstanding 20,130,195 (17,451,718)
- ------------------------------------------------ -------------- --------------
</TABLE>
<TABLE>
<CAPTION>
----------------------------------------------------------------------
PMF II ROYCE GIFTSHARES FUND
----------------------------------------- ----------------------------
YEAR ENDED PERIOD ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1997 1996(a) 1997 1996
INVESTMENT OPERATIONS: -------------------- -------------------- -------------- -------------
<S> <C> <C> <C> <C>
Net investment income (loss) $ 245,395 $ 10,136 $ (6,040) $ (289)
Net realized gain (loss) on investments 1,811,059 (2,872) 192,176 68,063
Net change in unrealized appreciation
on investments 1,644,420 471,502 221,469 76,117
- ------------------------------------------------ ------------- ------------- ---------- ----------
Net increase in net assets from
investment operations 3,700,874 478,766 407,605 143,891
- ------------------------------------------------ ------------- ------------- ---------- ----------
DIVIDENDS AND DISTRIBUTIONS:
Net investment income (271,235) --
Investment Class -- --
Consultant Class -- --
Net realized gain on investments (1,220,556) --
Investment Class (184,608) (53,781)
Consultant Class (3,935) --
- ------------------------------------------------ ---------- ----------
Total dividends and distributions (1,491,791) -- (188,543) (53,781)
- ------------------------------------------------ ------------- ------------- ---------- ----------
CAPITAL SHARE TRANSACTIONS:
Net proceeds from shares sold 3,475,010 17,511,040
Investment Class 2,172,160 418,047
Consultant Class 105,710 --
Value of shares issued in connection
with the merger of Royce Value Fund
Consultant Class
Distributions reinvested 1,388,651 --
Investment Class 184,794 53,593
Consultant Class 3,935 --
Cost of shares redeemed (2,686,425) (133,625)
Investment Class (27,676) --
Consultant Class (411) --
- ------------------------------------------------ ---------- ----------
Net increase (decrease) in net assets
from capital share transactions 2,177,236 17,377,415 2,438,512 471,640
- ------------------------------------------------ ------------- ------------- ---------- ----------
NET INCREASE (DECREASE)
IN NET ASSETS 4,386,319 17,856,181 2,657,574 561,750
NET ASSETS:
Beginning of period 17,857,181 1,000 1,063,589 501,839
- ------------------------------------------------ ------------- ------------- ---------- ----------
End of period $ 22,243,500(c) $ 17,857,181(c) $3,721,163 $1,063,589
- ------------------------------------------------ ------------- ------------- ---------- ----------
CAPITAL SHARE TRANSACTIONS:
Shares sold 603,433 3,419,221
Investment Class 317,894 72,903
Consultant Class 15,046 --
Shares issued in connection
with the merger of Royce Value Fund
Consultant Class
Shares issued for reinvestment of
dividends and distributions 232,216 --
Investment Class 27,216 9,402
Consultant Class 581 --
Shares redeemed (470,991) (25,522)
Investment Class (4,318) --
Consultant Class (60) --
- ------------------------------------------------ ---------- ----------
Net increase (decrease) in shares outstanding 364,658 3,393,699 356,359 82,305
- ------------------------------------------------ ------------- ------------- ---------- ----------
</TABLE>
(a) PMF II commenced operations on November 19, 1996.
(b) Includes undistributed net investment income of $266,266 in 1997 and $0 in
1996.
(c) Includes undistributed net investment income of $0 in 1997 and $10,978
in 1996.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE FINANCIAL STATEMENTS.
24 | THE ROYCE FUNDS ANNUAL REPORT 1997
<PAGE>
STATEMENTS OF OPERATIONS YEAR ENDED DECEMBER 31, 1997
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PENNSYLVANIA ROYCE
MUTUAL FUND PMF II GIFTSHARES FUND
INVESTMENT INCOME: --------------- ------------- ----------------
<S> <C> <C> <C>
Income:
Dividends $ 8,939,040 $ 397,058 $ 21,610
Interest 1,828,629 45,208 157
- ------------------------------------------------------- ------------ ---------- ---------
Total Income 10,767,669 442,266 21,767
- ------------------------------------------------------- ------------ ---------- ---------
Expenses:
Investment advisory fees 4,379,842 199,251 19,859
Distribution fees 824,272 -- 3,389
Custodian and shareholder servicing fees 485,407 48,718 15,556
Administrative and office facilities expenses 269,202 10,081 867
Professional fees 97,208 19,652 9,653
Trustees' fees 92,360 4,060 259
Other expenses 491,891 29,617 24,498
- ------------------------------------------------------- ------------ ---------- ---------
Total Expenses 6,640,182 311,379 74,081
Fees Waived by Investment Adviser and Distributor (281,566) (114,508) (23,125)
Expenses Reimbursed by Investment Adviser -- -- (23,149)
- ------------------------------------------------------- ------------ ---------- ---------
Net Expenses 6,358,616 196,871 27,807
- ------------------------------------------------------- ------------ ---------- ---------
Net Investment Income (Loss) 4,409,053 245,395 (6,040)
- ------------------------------------------------------- ------------ ---------- ---------
REALIZED AND UNREALIZED GAIN ON INVESTMENTS:
Net realized gain on investments 57,122,461 1,811,059 192,176
Net change in unrealized appreciation on investments 59,891,240 1,644,420 221,469
- ------------------------------------------------------- ------------ ---------- ---------
Net realized and unrealized gain on investments 117,013,701 3,455,479 413,645
- ------------------------------------------------------- ------------ ---------- ---------
NET INCREASE IN NET ASSETS FROM INVESTMENT OPERATIONS $121,422,754 $3,700,874 $ 407,605
- ------------------------------------------------------- ------------ ---------- ---------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE 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>
PENNSYLVANIA MUTUAL FUND -- INVESTMENT CLASS (a)
1997 $7.11 $ 0.07 $ 1.70 $(0.06)
1996 7.71 0.11 0.84 (0.11)
1995 7.41 0.11 1.27 (0.11)
1994 8.31 0.12 (0.18) (0.11)
1993 8.00 0.11 0.79 (0.11)
PENNSYLVANIA MUTUAL FUND -- CONSULTANT CLASS (b)
1997 $7.90 $ 0.02 $ 0.93 $(0.04)
PMF II (c)
1997 $5.26 $ 0.07 $ 1.03 $(0.08)
1996 5.00 -- 0.26 --
ROYCE GIFTSHARES FUND -- INVESTMENT CLASS (d)
1997 $5.83 $(0.01) $ 1.52 $ --
1996 5.01 -- 1.27 --
1995 5.00 -- 0.01 --
ROYCE GIFTSHARES FUND -- CONSULTANT CLASS (e)
1997 $7.21 $(0.01) $ 0.11 $ --
<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>
PENNSYLVANIA MUTUAL FUND -- INVESTMENT CLASS (a)
1997 $(1.00) $7.82 25.0% $507,635 1.05% 0.88% 18% $0.0629
1996 (1.44) 7.11 12.8% 456,868 0.99% 1.05% 29% 0.0588
1995 (0.97) 7.71 18.7% 630,119 0.98% 1.18% 10% --
1994 (0.73) 7.41 (0.7)% 771,417 0.98% 1.33% 17% --
1993 (0.48) 8.31 11.3% 1,022,161 0.98% 1.23% 24% --
PENNSYLVANIA MUTUAL FUND -- CONSULTANT CLASS (b)
1997 $(1.00) $7.81 12.0% $151,948 1.65%* 0.29%* 18% $0.0629
PMF II (c)
1997 $(0.36) $5.92 20.8% $ 22,244 0.99% 1.23% 77% $0.0564
1996 -- 5.26 5.2% 17,857 0.97%* 0.83%* 1% 0.0586
ROYCE GIFTSHARES FUND -- INVESTMENT CLASS (d)
1997 $(0.43) $6.91 26.0% $ 3,614 1.49% (0.32)% 64% $0.0558
1996 (0.45) 5.83 25.6% 1,064 1.49% (0.05)% 93% 0.0566
1995 -- 5.01 0.2% 502 0.70%* 0.00%* 0% --
ROYCE GIFTSHARES FUND -- CONSULTANT CLASS (e)
1997 $(0.43) $6.88 1.5% $ 107 2.49%* (1.35)%* 64% $0.0558
</TABLE>
(a) Expense ratios are shown after fee waivers by the investment adviser. For
the years ended December 31, 1996 and 1995, the expense ratios before the
waivers would have been 1.03% and .99%, respectively.
(b) Expense ratio is shown after fee waivers by the distributor. For the period
ended December 31, 1997, the expense ratio before the waiver would have been
2.00%. The Class commenced operations on June 18, 1997.
(c) Expense ratios are shown after fee waivers by the investment adviser. For
the periods ended December 31, 1997 and 1996, the expense ratios before the
waivers would have been 1.56% and 1.97%, respectively. The Fund commenced
operations on November 19, 1996.
(d) Expense ratios are shown after fee waivers and expense reimbursements by the
investment adviser and distributor. For the periods ended December 31, 1997,
1996 and 1995, the expense ratios before the waivers and reimbursements
would have been 3.82%, 6.53% and 1.95%, respectively. The Fund commenced
operations on December 27, 1995.
(e) Expense ratios are shown after fee waivers and expense reimbursements by the
investment adviser. For the period ended December 31, 1997, the expense
ratio before the waivers and reimbursements would have been 30.28%. The
Class commenced operations on September 26, 1997. Total returns do not
deduct contingent deferred sales charge.
* Annualized.
+ Beginning in 1996, the Fund is required to disclose its average commission
rate paid per share for purchases and sales of investments.
THE ROYCE FUNDS ANNUAL REPORT 1997 | 25
<PAGE>
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Summary of Significant Accounting Policies:
Pennsylvania Mutual Fund, PMF II and Royce GiftShares Fund ("Fund" or
"Funds") are three series of The Royce Fund (the "Trust"). The Trust, a
Delaware business trust, is a diversified open-end management investment
company. PMF II and Royce GiftShares Fund--Investment Class commenced
operations on November 19, 1996 and December 27, 1995, respectively. The
Consultant Classes of Pennsylvania Mutual Fund and Royce GiftShares Fund
commenced operations on June 18, 1997 and September 26, 1997, respectively.
The Investment Class and Consultant Class of shares have equal rights as to
earnings and assets except that each class bears different distribution and
shareholder servicing fees, certain other expenses and expense reimbursements,
as well as fees waived by the Distributor, if any. Investment income, realized
and unrealized capital gains or losses on investments, expenses (other than
expenses attributable to a specific class) and investment advisory fee
waivers 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 and dividend
income is recorded on the ex-dividend date. Interest income is recorded on the
accrual basis. Realized gains and losses from investment transactions and
unrealized appreciation and depreciation are determined on the basis of
identified cost for book and tax purposes.
Expenses:
Expenses directly attributable to each Fund are charged to that Fund's
operations, while expenses applicable to more than one series of the Trust are
allocated in an equitable manner.
Taxes:
As qualified regulated investment companies under Subchapter M of the
Internal Revenue Code, the Funds are not subject to income taxes to the extent
that each Fund distributes substantially all of its taxable income for its
fiscal year. The Schedules of Investments include information regarding income
taxes under the caption "Income Tax Information."
Distributions:
Any dividend and capital gain distributions are recorded on the ex-dividend
date and paid annually in December. These distributions are determined in
accordance with income tax regulations which may differ from generally
accepted accounting principles. Permanent book and tax basis differences
relating to shareholder distributions will result in 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 distributed
in the following year.
Repurchase agreements:
The Funds enter into repurchase agreements with respect to portfolio
securities solely with State Street Bank and Trust Company ("SSB&T"), the
custodian of the Funds' assets. Each Fund restricts repurchase agreements to
maturities of no more than seven days. Securities pledged as collateral for
repurchase agreements are held by SSB&T until maturity of the repurchase
agreements. Repurchase agreements could involve certain risks in the event of
default or insolvency of SSB&T, including possible delays or restrictions upon
the ability of each Fund to dispose of its underlying securities.
Security lending:
Pennsylvania Mutual Fund loans securities to qualified institutional
investors for the purpose of realizing additional income. This income is
included in interest income. Collateral on all securities loaned for
Pennsylvania Mutual Fund is accepted in cash and is invested temporarily in a
money market fund by the custodian. The collateral is equal to at least 100%
of the current market value of the loaned securities.
26 | THE ROYCE FUNDS ANNUAL REPORT 1997
<PAGE>
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
- --------------------------------------------------------------------------------
Investment Adviser and Distributor:
Under the Trust's investment advisory agreements with Royce & Associates,
Inc. ("Royce") (formerly Quest Advisory Corp.), Royce is entitled to receive
management fees which are computed daily and payable monthly. For the year
ended December 31, 1997, Pennsylvania Mutual Fund and PMF II recorded advisory
fees of $4,379,842 and $84,743 (net of voluntary waivers of $114,508),
respectively. Royce voluntarily waived advisory fees of $19,859 and
voluntarily reimbursed expenses of $23,149 for Royce GiftShares Fund. The
agreements provide for advisory fees for Pennsylvania Mutual Fund equal to
1.0% per annum of the first $50 million of the Fund's average net assets,
0.875% per annum of the next $50 million of such net assets and 0.75% per
annum of additional amounts of average net assets, and for PMF II and Royce
GiftShares Fund 1.0% per annum of average net assets. Prior to June 13, 1997,
Royce was entitled to receive advisory fees for Royce GiftShares Fund equal to
1.25% per annum of average net assets.
Royce Fund Services, Inc. ("RFS") (formerly Quest Distributors, Inc.), the
distributor of the Trust's shares, is an affiliate of Royce. For the period
ended December 31, 1997, RFS received 12b-1 distribution fees of $542,706 (net
of voluntary waivers of $281,566) and $123 from the Consultant Classes of
Pennsylvania Mutual Fund and Royce GiftShares Fund, respectively. RFS
voluntarily waived the distribution fees of $3,266 from the Investment Class
of Royce GiftShares Fund. The distribution agreement provides for maximum fees
of 1.0% per annum of each Fund's Consultant Class average net assets and,
effective June 13, 1997, .25% per annum of Royce GiftShares Fund--Investment
Class' average net assets.
Purchases and Sales of Investment Securities:
For the year ended December 31, 1997, the cost of purchases and the
proceeds from sales of investment securities, other than short-term
securities, were as follows:
- ----------------------------------------------------------------
PENNSYLVANIA ROYCE
MUTUAL FUND PMF II GIFTSHARES FUND
-------------- -------------- ----------------
Purchases $ 83,537,080 $15,819,627 $2,604,358
- ----------- ------------ ----------- ----------
Sales $136,061,312 $14,230,335 $ 941,848
- ----------------------------------------------------------------
Transactions in Affiliated Companies:
An "Affiliated Company", as defined in the Investment Company Act of 1940,
is a company in which the Fund owns at least 5% of the company's outstanding
voting securities. Pennsylvania Mutual Fund effected the following
transactions in shares of such companies for the year ended December 31, 1997.
- ----------------------------------------------------------------------------
PURCHASES SALES
----------------------- ---------------
AFFILIATED REALIZED DIVIDEND
COMPANY SHARES COST SHARES COST GAIN/LOSS INCOME
- -------------- --------- ------------- -------- ------ ----------- ---------
Sevenson
Environmental
Services 103,500 $1,506,760 -- -- -- $31,508
- -----------------------------------------------------------------------------
Merger Information:
On June 17, 1997, Pennsylvania Mutual Fund acquired all of the assets and
assumed all of the liabilities of Royce Value Fund. Based on the opinion of
Fund counsel, the acquisition, which was approved by the shareholders of Royce
Value Fund on May 28, 1997, qualifies as a tax-free reorganization for federal
income tax purposes with no gain or loss recognized to the Funds or their
shareholders. Royce Value Fund's net assets, including $40,233,294 of
unrealized appreciation, were combined with Pennsylvania Mutual Fund for total
net assets after the acquisition of $604,764,550. Costs associated with the
acquisition were borne by the Investment Adviser.
THE ROYCE FUNDS ANNUAL REPORT 1997 | 27
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
- --------------------------------------------------------------------------------
To the Board of Trustees of The Royce Fund and the Shareholders of Pennsylvania
Mutual Fund, PMF II and Royce GiftShares Fund:
We have audited the accompanying statements of assets and liabilities of
Pennsylvania Mutual Fund, PMF II and Royce GiftShares Fund, including the
schedules of investments, as of December 31, 1997, the related statements of
operations for the year then ended, the statements of changes in net assets
for each of the periods indicated therein, and the financial highlights of
Pennsylvania Mutual Fund Investment Class and Consultant Class, PMF II, Royce
GiftShares Fund Investment Class and Consultant Class for each of the periods
indicated therein. These financial statements and financial highlights are the
responsibility of the funds' management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements and
financial highlights are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements and financial highlights. Our procedures included
confirmation of securities owned as of December 31, 1997 by correspondence
with the custodian and brokers. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred
to above present fairly, in all material respects, the financial position of
Pennsylvania Mutual Fund, PMF II and Royce GiftShares Fund as of December 31,
1997, the results of their operations for the year then ended, the changes in
their net assets for each of the periods indicated therein, and the financial
highlights of Pennsylvania Mutual Fund Investment Class and Consultant Class,
PMF II, Royce GiftShares Fund Investment Class and Consultant Class for each
of the periods indicated therein, in conformity with generally accepted
accounting principles.
COOPERS & LYBRAND L.L.P.
Boston, Massachusetts
February 10, 1998
28 | THE ROYCE FUNDS ANNUAL REPORT 1997
<PAGE>
[sidebar]
Unlike the
Hale-Bopp comet,
El Nino or
George Soros,
we were not
held directly
responsible for
a single
global crisis,
economic or
otherwise.
[end sidebar]
POSTSCRIPT
- --------------------------------------------------------------------------------
EL NINO, MICRO-MUTT & THE YEAR THAT WASN'T
It has become commonplace over the years for Wall Street to look back on
the past 365 days in order to say a few words about "How the Market Imitates
Life." 1997 at first seems a natural choice for such a statement; it was a year
full of tumult and extremes both inside and outside of the world of mutual
funds. Yet rather than attempt labored analogies about the past or create
optimistic scenarios about the future, we have instead compiled a list of events
that did not take place in our corner of the world during this last year.
After nearly twenty-five years in the business, not a single employee or
shareholder has ever tried to choke a portfolio manager or bite one on the ear!
Of course, employees of the firm never have to worry about facing Michael Jordan
or Evander Holyfield.
In addition, none of us received offers to play a dashing secret agent in
one of those synergistic, multiple endorsement deals for BMW cars and
motorcycles, Breitling watches and Absolut vodka to go along with a new movie
(the last we heard, a similar deal did go to an obscure bureaucrat working for
the British government - good luck, "00"-whatever your name is).
Unlike the Hale-Bopp comet, El Nino or George Soros, we were not held
directly responsible for a single global crisis, economic or otherwise.
Certain officers of the firm acquired new pets this year, but somehow were
not hounded by the media as they struggled to come up with interesting names. Of
course, unlike someone who shall remain nameless, no one here would ever dream
of taking weeks to name a dog only to settle on "Buddy." We'd pick names like
"Micro-Mutt" or "Premier Pooch."
We have not yet had to deal with anyone in the firm giving birth to
septuplets and the ensuing paperwork necessary to open Royce GiftShares Fund
accounts.
Based on all this, we're dispensing with the metaphors and analogies, the
compare-and-contrasts, and all of the prognostications. Why set ourselves up to
be proved completely wrong, and then find that we have to hire Dick Morris to
help with spin control? After putting down the balance sheets, shutting off the
computers and taking a look at the year that was, we saw how little real life
resembled the humble happenings here at Royce & Associates. So we decided not to
play the philosopher or the prophet, remembering that predictions are for show
and portfolios are for dough.
<PAGE>
[back cover]
================================================================================
Why Value Investors Rely on
THE ROYCE FUNDS
[triangle] 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 over $2.5 billion in
total assets under management, Royce & Associates remains an
independent firm committed to the same principles that have served us
well for twenty-four years.
[triangle] 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.
[triangle] REALISTIC EXPECTATIONS & 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.
[triangle] 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 $34 million invested in The Royce Funds.
================================================================================
VALUE INVESTING IN SMALL COMPANIES FOR OVER 20 YEARS
============================
General Information Advisor Services
Additional Report Copies For Fund Materials, Performance Updates,
& Prospectus Inquiries Transactions or Account Inquiries
(800) 221-4268 (800) 33-ROYCE (337-6923)
Shareholder Services Automated Telephone Services
(800) 841-1180 (800) 78-ROYCE (787-6923)
E-mail: [email protected]
Web address: www.roycefunds.com
The Royce Funds 1414 Avenue of the Americas New York, NY 10019
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.
