Value Investing in
Small Companies for 25 Years
THE
ROYCE
FUNDS
PENNSYLVANIA MUTUAL FUND
PMF II
ROYCE GIFTSHARES FUND
1998 Semi-Annual Report
www.roycefunds.com
<PAGE>
THE ROYCE FUNDS ROAD MAP
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TWO PORTFOLIO STRATEGIES
[Blue bar] Small-Cap
[Yellow bar] Micro-Cap
For 25 years, Royce & Associates has utilized a disciplined value approach to
select small and micro-cap companies. Our strategies focus on capitalization
(small or micro-cap) and portfolio construction (concentrated or diversified)
considerations.
- -------------------------------------------------------------------------------
CORE FUNDS
<TABLE>
<S> <C>
The small-cap universe (companies with market caps [Blue bar]
between $300 million and $1 billion) is no longer ROYCE PREMIER
small, unknown or under-owned; therefore, we believe Small-Cap Orientation
that this greater level of efficiency requires Concentrated Portfolio
greater portfolio concentration.
The micro-cap universe (companies with market caps [Yellow bar]
between $5 million and $300 million) provides more ROYCE MICRO-CAP
choices (approximately 6,400 companies), yet greater Micro-Cap Orientation
trading difficulties; therefore, we believe that broad Diversified Portfolio
diversification is required given the liquidity
constraints of this sector.
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COMBINED FUNDS
These portfolios combine our two core strategies and [Blue bar]
represent our flagship approach. Two of our combined [Yellow bar]
portfolios, Pennsylvania Mutual and PMF II, are designed PENNSYLVANIA MUTUAL
for both individuals and institutions, while Royce Diversified Small and
GiftShares offers one of the few gifting and estate- Micro-Cap Portfolio
planning portfolios.
[Blue bar]
[Yellow bar]
PMF II
Diversified Small and
Micro-Cap Portfolio
[Blue bar]
[Yellow bar]
ROYCE GIFTSHARES
Concentrated Small and
Micro-Cap Portfolio
- -------------------------------------------------------------------------------
THEME FUNDS [Blue bar]
[Yellow bar]
Theme funds contain stocks primarily found in the ROYCE TOTAL RETURN
core portfolios that have special attributes. One Dividend-Paying Securities
has low-volatility characteristics (dividends), one
has the potential for higher returns and volatility ROYCE LOW-PRICED
(low-priced stocks) and one takes specific sector Stocks Priced Below $15
(financial services) risk. Performance and volatility
may be substantially different for each of these ROYCE FINANCIAL SERVICES
portfolios. Financial Services
Companies
</TABLE>
<PAGE>
THE ROYCE FUNDS
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SEMI-ANNUAL REPORT REFERENCE GUIDE
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<TABLE>
<S> <C>
"Curiouser and Curiouser": The Equity Markets. 2
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Investing "Through the Looking Glass": 5
Finding Value in an Overvalued Market.
- -------------------------------------------------------------------------------
Pennsylvania Mutual Fund marked its 25th anniversary 12
under our management on June 30, 1998. The Fund has
provided positive returns in 21 out of the last 24 calendar years.
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PMF II, under the portfolio management of Buzz Zaino 14
since April 1, 1998, outperformed its benchmark index,
the small-cap oriented Russell 2000, for the first six months
and the one-year period ended June 30, 1998.
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Royce GiftShares Fund, our special-purpose gifting and 16
estate-planning fund, was up 13.2% in the first half.
The Fund has provided an average annual total return of
26.2% since inception (12/27/95) through June 30, 1998.
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Updates and Notes: Our New and Improved Website (www.roycefunds.com). 18
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Schedules of Investments and Other Financial Statements. 19
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Postscript: Hang Time. Inside Back Cover
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</TABLE>
[Pull Quote]
For 25 years, our value approach has focused on evaluating a company's private
worth--what we believe an enterprise would sell for in a private transaction
between rational and well-informed parties. This requires a thorough analysis of
the financial and operating dynamics of a business, as though we were purchasing
the entire company. The price we will pay for a security must be significantly
lower than our appraisal of its private worth.
[End Pull Quote]
[graphic: looking through magnifying glass at The Royce Funds listing in
newspaper]
AVERAGE ANNUAL TOTAL RETURNS Through June 30, 1998
<TABLE>
<CAPTION>
YEAR-TO-DATE SINCE
FUND (INCEPTION) 1998* 1-YEAR INCEPTION
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Pennsylvania Mutual Fund (6/30/73)+ 8.8% 20.3% 16.6%
- -------------------------------------------------------------------------------
PMF II (11/19/96) 7.6 17.7 21.5
- -------------------------------------------------------------------------------
Royce GiftShares Fund (12/27/95) 13.2 27.1 26.2
- -------------------------------------------------------------------------------
</TABLE>
* Not annualized. + Investment Class.
<PAGE>
[sidebar]
[photo: Charles M. Royce]
Charles M. Royce, President
Many people argue that as long as the U.S. economy remains as robust as it has
been, the stock market should continue to rise. We believe, however, that the
factors that drive the stock market are very complex, and the notion that a
strong economy guarantees a strong market greatly oversimplifies the issue.
Markets will fluctuate.
[end sidebar]
LETTER TO OUR SHAREHOLDERS
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[cartoon graphic: Alice in Wonderland with Queen of Hearts, Mad Hatter and
Rabbit looking at chart of S&P 500 returns (Drawn in the style of Tenniel)]
Drawing by Hank Blaustein; -C- 1998
"CURIOUSER AND CURIOUSER"
Alice's wide-eyed response to Wonderland reflects our own take on the current
equity markets. Returns continued their ascent as all major stock market indices
reached record highs during 1998's first six months. Like the bully at the
playground, the "biggest" companies enjoyed the biggest rewards. The large-cap
indices -- S&P 500 and Dow Jones Industrial Average ("DJIA") -- along with the
technology driven Nasdaq Composite, each posted six-month results well in excess
of their average historic 12-month returns. We expect that most investors never
imagined investing would be so easy. As Berkshire Hathaway Vice Chairman Charlie
Munger once quipped, "If successful investing required merely extrapolating
history (and especially recent market returns), the Forbes 400 would consist
entirely of librarians."
Even more curious are the level and convergence of long and short-term
returns. We looked at quarter-end return periods for the S&P 500 over the last
52 years. We found that the time-weighted composite of one, three, five, 10, 15
and 20-year results ended June 30, 1998 was surpassed only by 1998's first
quarter-ending results. While the short-term returns were exceptional, the
long-term results were even more surprising. We could not help looking at the
median and worst performance periods, as well. Two of the bottom three
performance periods ended shortly after we began to manage Pennsylvania Mutual
Fund 25 years ago. We are all Alices living in Wonderland now.
2 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
For the first six months of 1998, the S&P 500 and DJIA were up 17.7% and
14.2%, respectively, while the Nasdaq Composite was up an even more amazing
20.7%. While it would be easy to declare, as Alice's Dodo did, "Everybody has
won, and all must have prizes," further investigation of first-half results
reveals a telling insight. According to statistics published by FactSet Data,
the S&P 500's 50 largest companies rose nearly 26% in the first half, while the
other 450 gained just 9.5%. Investors' preferences for the biggest and most
well-known companies stem from concerns about a potential economic slowdown,
global economic unrest and liquidity (the ability to easily buy and sell
securities). We find this ironic in that we believe that many of the companies
most likely to be affected by global problems are precisely the ones whose share
prices are rising the fastest.
Small-cap relative returns were affected by both the sector's significantly
higher level of volatility and by the substantial strength of the large-cap
market. For 1998's first half, the Russell 2000 was up an uninspiring 4.9%. As
good as the first quarter was for the index (+10.0%), it was not able to sustain
the pace, dropping 4.7% in the second quarter. As small-cap managers, we are
frequently asked, "if relative valuations and earnings growth for your sector
are better than for large-caps, when will small-cap stock prices reflect this?"
We do not know.
ROLLING RETURN OF THE S&P 500 over 1,3,5,10, 15 AND 20-YEAR PERIODS
Ranked by Time-Weighted Score for 210 Periods Ended 3/31/46 Through 6/30/98
<TABLE>
<CAPTION>
Composite
Quarter 1-Year 3-Year 5-Year 10-Year 15-Year 20-Year Return Rank
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Mar-98 48.0% 32.8% 22.4% 19.9% 17.8% 17.7% 20.1% 1
- ---------------------------------------------------------------------------------------
Jun-98 30.0 30.2 23.1 18.6 17.2 17.4 19.1 2
- ---------------------------------------------------------------------------------------
Dec-97 33.3 31.1 20.2 18.0 17.5 16.6 18.6 3
- ---------------------------------------------------------------------------------------
Mar-67 4.7 7.9 10.2 11.1 13.3 14.3 12.5 104
- ---------------------------------------------------------------------------------------
Dec-86 18.6 18.4 19.8 13.8 10.8 10.2 12.5 105
- ---------------------------------------------------------------------------------------
Dec-90 -3.1 14.1 13.1 13.9 13.9 11.1 12.5 106
- ---------------------------------------------------------------------------------------
Jun-49 -9.5 -3.0 7.1 8.6 8.1 2.3 5.0 208
- ---------------------------------------------------------------------------------------
Dec-74 -26.3 -9.2 -2.4 1.2 4.3 6.9 2.7 209
- ---------------------------------------------------------------------------------------
Sep-74 -38.8 -10.6 -4.2 0.5 4.1 7.0 2.1 210
- ---------------------------------------------------------------------------------------
</TABLE>
Note: Composite return percentages were derived by time-weighting the returns of
each of the performance periods allotted by proportion of overall time period
vs. each period (e.g., the total of 1, 3, 5, 10, 15 and 20 is 54. The return for
the 20-year period is weighted 37% {20 (divided by) 54}).
"WHICH WAY? WHICH WAY?"
Alice's question about which direction to follow upon arriving in Wonderland
aptly reflects investor sentiment regarding recent small-cap underperformance.
First the good news. Since the trough in October 1990, small-cap stocks, as
measured by the Russell 2000, have provided a 21.4% average annual total return.
And now the bad news. Since the May 1996 peak, the Russell 2000 has generated a
12.7% average annual total return. What's so bad about a 12.7% average annual
total return? Nothing, until you compare it to the large-cap S&P 500, which over
the same period compounded at a 29.9% average annual rate. Contributing to this
substantial performance disparity were more frequent and severe declines within
the small-cap sector. In fact, since the May 1996 small-cap peak, the Russell
2000 has undergone three separate 10%+ declines, while the S&P 500 has endured
only one. As we have suggested in past letters, higher volatility generally
precedes lower returns and, in our opinion,
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 3
<PAGE>
[sidebar]
We think that the market has recently benefited from the economic misfortune of
other countries, such as Japan, and a superbly profitable moment in the U.S.
economy accompanied by a significant decline in interest rates. None of these
features are permanent and none are likely to continue to have the same
enormously positive impact.
[end sidebar]
provides an edge for value. Performance results for the "growth" and "value"
segments of the Russell 2000 bore this out. From the May 22, 1996 peak through
June 30, 1998, the Russell 2000 Value Index was up 51.5% versus a gain of only
9.6% for the Russell 2000 Growth Index.
SMALL CAP: REVERSAL OF FORTUNE
<TABLE>
<CAPTION>
Total Returns of Russell 2000 vs. S&P 500
From Small-Cap Trough in 1990 and Peak in 1996
- --------------------------------------------------------------------------------
10/31/90- 5/31/96-
5/31/96 6/30/98
- --------------------------------------------------------------------------------
<S> <C> <C>
Russell 2000 233.9% 29.9%
S&P 500 158.7% 75.8%
</TABLE>
CAUSE: MORE FREQUENT AND
SEVERE DECLINES
[bar chart]
<TABLE>
<S> <C> <C>
S&P 500 10/7/97 - -10.8%
10/27/97
Russell 2000 5/22/96 - -15.5%
7/24/96
10/13/97 - -11.5%
1/12/98
4/21/98 - -11.6%
6/15/98
</TABLE>
Since the small-cap peak in May '96, small-caps have undergone three separate
10%+ declines, while the S&P 500 has had only one.
[end bar chart]
We believe that small-cap's higher level of volatility may have
implications for large-cap stocks as well -- though many investors tend to look
at this the other way around and insist that large-caps lead small-caps. To us,
however, the small-cap world is more indicative of the "average" stock, so that
at some point, large-cap stocks will take their cues from small-cap's higher
volatility and overall performance. A period of high returns (similar to recent
market experience) -- when accompanied by continued performance divergence --
often precedes a substantial market correction. We believe that this may occur
in the months ahead.
[cartoon graphic: school of small fish chasing large fish with caption "The
next cycle?"]
REASONABLE INVESTORS IN UNREASONABLE TIMES
As we sit back and assess our own six-month results, we are reminded of a
simple, yet important, premise -- while we can control our investment process,
we cannot control our relative investment results, especially over the short
term. We believe that a well-planned and consistently applied approach will
result in attractive long-term returns, even when compared to appropriate
indices and peers. In the short term, however, anything can happen, and usually
does. Thus, when we report our semi-
[pull quote]
By not focusing on what we
can't control, our relative results,
we are able to focus on what is
important -- understanding risk
and reward while maintaining
a long-term perspective.
[end pull quote]
4 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
annual performance results, we try to temper our enthusiasm when things have
gone well and to keep our chins up when they have not. By not focusing on what
we can't control, our relative results, we are able to focus on what is
important -- understanding risk and reward while maintaining a long-term
perspective.
Our investment approach provided a short-term advantage in this period of
higher volatility for small-cap stocks. For 1998's first six months, our
results, while reflecting the small-cap and micro-cap universe in which we
invest, were better than that of our small-cap benchmark index, the Russell
2000. The same performance relationship also has held true since the May 1996
small-cap peak. For a complete review and discussion of our results and our risk
profiles, please see pages 12-17.
RECENT PERFORMANCE RESULTS
<TABLE>
<CAPTION>
Year-to-date 5/22/96 -
1998 6/30/98
- -----------------------------------------------------------------------
<S> <C> <C>
Pennsylvania Mutual Fund 8.8% 42.7%
PMF II 7.6 N/A
Royce GiftShares Fund 13.2 56.3
Russell 2000 4.9 28.7
</TABLE>
THROUGH THE LOOKING GLASS:
FINDING VALUE IN AN OVERVALUED MARKET
Traditional measures of market value in large-cap stocks, such as
price/earnings, price/book and price/dividends ratios, are at their highest
levels in history. This suggests that we may be approaching fully valued
territory for equity markets overall. We are inclined to agree, and on one level
view the seemingly endless ascent of the market with great concern. On the other
hand, our business buyer's perspective points us in a different direction,
namely that we work in a market of stocks, not a stock market. Successful
investors have always emphasized the importance of a long-term view, one that
centers on understanding the nature of a company's business. It is an idea that
we have utilized throughout our 25 years of investing, one that we think enables
us to find value in an overvalued market, in spite of this apparent paradox.
Overvaluation relates directly to expectations. Many investors are chasing
performance, particularly in large-cap stocks. The current investment standard
is to continue investing in what has worked, not what will work. This is akin to
driving while using only the rear-view mirror. Our practice has always been to
mine low-expectation areas. Currently, we are finding opportunities, especially
in the micro-cap sector. Micro-caps represent the largest domestic equity market
in terms of names and often show little correlation with the large-cap market.
We believe that this sector of the market, which may be higher in risk than the
large-cap market, represents undervalued opportunity, especially in light of the
high expectations and short attention spans of investors in other areas.
"What do you mean by that," said Alice's Caterpillar sternly. "Explain
yourself!" By way of explanation, consider the vast size in our stock-selection
universe -- close to 8,000 public companies currently have market
capitalizations of less than $1 billion.
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 5
<PAGE>
[sidebar]
A question we often hear is "why aren't small-caps doing better if the
valuations are so attractive?" It is worth remembering that valuations may have
nothing to do with performance in the short run. Very often performance comes
well after attractive valuations are present. Patience is critical.
[end sidebar]
The size and diversity of the small-cap and micro-cap sectors allow for any
number of companies to escape the attention of both individual and institutional
investors. Even in a world where information travels across the globe in
seconds, interpretations remain imperfect, due in part to the sheer volume of
data and in part to more human factors. We are still finding well-managed,
financially sound companies that are either unnoticed by, or out of favor with,
the larger investment community. So while equal access to information exists,
you must know where to look and what to do with what you find.
Working in this fashion means that we still believe in market cycles and in
the importance of attempting to reduce risk. Of course, there are those
dissenting voices who insist that we have entered a "new era" of investing where
concepts such as "market cycle," "risk" and "negative return" are the quaint
relics of a distant past. These people insist that markets now move
sequentially, not cyclically, and offer a wildly optimistic view of the market's
future. We must take issue with this argument. What value investing pioneer
Professor David Dodd said many years ago has seldom been more true than it is
today: "There are no new eras, only new errors."
[pull quote]
What value investing pioneer Professor
David Dodd said many years ago has
seldom been more true than it is today:
"There are no new eras, only new
errors."
[end pull quote]
"THE TIME HAS COME, THE WALRUS SAID, TO TALK OF MANY THINGS"
Having enjoyed his first visit so much that he could not manage to stay away for
long, our investment advisor friend recently returned to midtown Manhattan for a
long weekend getaway that included fireworks, a poetry slam, an outdoor swing
concert at Lincoln Center and a stop at our office. The intrepid advisor arrived
with an array of questions. As Alice reminds us, "What is the use of a book
without pictures or conversations?"
When you are looking at a given company, how do the portfolio managers and
analysts interact?
We have substantial interaction between our six analysts and our four
portfolio managers. Our analysts are involved in every step of the stock
selection process. When we are interested in a company, we run a very
systematic "fire drill" on the company's basics. We examine the balance
sheet and income statement history, cash flows, and comments from
management to quickly assemble a snapshot of the company. We insist on
having multiple sets of eyes viewing every company.
6 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
After the "fire drill," what is the next step?
Quantitative information, now available to everybody instantly, is a commodity
today. This access is no longer an edge in and of itself. The next step is
dealing with non-quantitative research activity. When we first look at a given
company, one or two analysts work with a portfolio manager. Once we have decided
to follow through on an idea and begin the strategic analysis process, we test
our idea using the Socratic method. We ask ourselves questions that force us to
delve deeply. This format is critical because it brings together all of the
information we have gathered and opens our eyes to the kinds of risks we are
considering.
[pull quote]
This format is critical because
it brings together all of the
information we have gathered
and opens our eyes to the kinds
of risks we are considering.
[end pull quote]
Do portfolio managers do any of their own research or is that left to the
analysts?
Everybody takes an active part in the research process, including both grunt
work and strategic analysis. We all wade through financial statements. We meet
with management. We speak to the company's customers, suppliers and competitors.
The kind of research we do is labor-intensive and time-consuming.
How do you track a company once you own it?
We stay in touch with management, we continue to carefully examine the financial
statements when they are published on a quarterly basis and we look for
developments both within the company and in the economy as a whole that may
affect the company's or its sector's business. Contrary to what people think,
companies do not change very much on a quarter-to-quarter basis. Prices, on the
other hand, change constantly, and we watch them every day.
Are there any advantages you have as an institutional trader that an individual
investor does not enjoy?
We deal with over 100 broker-dealers, which certainly gives us an advantage.
Today's electronic trading systems are a great help. We also attempt to trade
within the spreads, between the bid and ask, in a way that would be difficult
for an individual.
[pull quote]
Contrary to what people think,
companies do not change very
much on a quarter-to-quarter
basis. Prices, on the other hand,
change constantly, and we watch
them every day.
[end pull quote]
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 7
<PAGE>
[sidebar]
We think of value investing as planting before the harvest. As confident as we
may feel, we cannot predict when, or even if, harvest time will come.
[end sidebar]
What is the time frame between discovering a company and buying its stock?
It can take hours, days or even months, depending on the situation. The initial
purchase in which we take a small position in a stock is often done quickly and
follows the "fire drill" process. These small positions then "incubate" while we
move through a longer, more complicated strategic analysis that may entail
weeks, or months, of research. It takes a long time for us to gain a high enough
level of confidence to want to build our position in a stock. We generally set a
price that we are willing to pay, and it often requires a lot of patience and
discipline to wait for a stock to arrive at that price. We are looking for
companies trading at discounts of about 50% to our estimate of their value as a
business. It can be frustrating when, during the course of our research, these
attractive discounts disappear, but in order to keep an eye on risk, we cannot
afford a rush to judgment.
SAVING HUMPTY DUMPTY: THE RIGHT BALANCE
Unlike Alice, who followed the Rabbit down the hole "never once considering how
in the world she was to get out again," we view risk management as critical.
Historically, we have focused on five categories of risk as we analyze a
company: financial, business strategy, valuation, market and portfolio. Of
these, financial risk is probably the most important. Small companies, by virtue
of their size, are generally more fragile than large companies, which makes
strong financial condition a paramount concern for us.
How do we specifically attempt to reduce the financial risk inherent in
investing in equities? One of the most important steps involves the careful
scrutiny of the balance sheet. It gives us an x-ray of a company's financial
infrastructure and allows us to check its overall health and well being. The
process entails a number of subjective measures in addition to more objective,
quantifiable ones. It is not simply the numbers that tell the story, but one's
interpretation of their significance. This evaluation is an art. Renaissance
portrait painters sought to convey the essence and personality of their subjects
so that the viewer would see the whole person, not just the face and figure. A
careful reading of a balance sheet should yield similar results.
[graphic: pages from a financial report]
Presented only for illustration.
8 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
Rather than concentrate on traditional ratios such as debt and working
capital, we look at leverage globally: how much equity supports total assets? We
measure leverage by looking at the ratio of assets to stockholders' equity. (Our
bias is toward lower-leveraged companies; typically, in our portfolios, the
average ratio is less than two to one.) Using this method allows us to monitor
changes in all liabilities, not only changes in debt. Items that can have an
adverse affect on a company, such as short-term debt and payables, will give us
clues as to the direction of overall leverage. This paints a more complete
picture than simple debt analysis.
[pull quote]
There is a big difference between a
good balance sheet that is the result
of stock offerings and one that is
the result of doing business the old-
fashioned way -- through earnings.
[end pull quote]
A conservatively capitalized company can better weather storms because it
has the necessary financial reserves. A company with too much debt, on the other
hand, runs a greater risk that stormy weather will turn into a hurricane. In
essence, we seek companies that we believe possess a substantial "margin of
safety" that these reserves can provide. In the spirit of "the best offense is a
good defense," we also view financially strong companies as well positioned to
grow. All reserves are not created equal. We target companies that have grown
their book value through retained earnings, rather than paid in capital; they
have demonstrated their ability to grow from their own success as a business.
At this point, one may well ask, "But don't all portfolio managers read
balance sheets?" Many do, but depending on their investment style or their
experience, they may be more focused on the income statement. Our obsession
takes us into the arcane world of bad debt reserves, inventory policy, warranty
liabilities, pending litigation, pension obligations, pollution and product
liabilities, etc. All of these factors may have a bearing on a company's -- and
by extension a Fund's -- exposure to risk. We look for changes from period to
period that can tell us about a company's direction. If we like the balance
sheet, we want to know how it got there. There is a big difference between a
good balance sheet that is the result of stock offerings and one that is the
result of doing business the old-fashioned way -- through earnings.
The process of balance sheet analysis can be long, is seldom exciting and
certainly never glamorous. It is critical, however, in our search to find the
kind of healthy small-cap companies that have been our mainstay for 25 years.
[pull quote]
In essence, we seek companies that
we believe possess a substantial
"margin of safety" that these
reserves can provide.
[end pull quote]
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 9
<PAGE>
[sidebar]
In our investment approach, we strongly believe in the importance of using
volatility to our advantage. Volatility can drive prices to considerable lows
just as easily as it can push them to unreasonable highs. This creates potential
opportunities for us.
[end sidebar]
AND NOW THE TALE IS DONE, AND HOME WE STEER, A
MERRY CREW, BENEATH THE SETTING SUN
As we look to 1998's second half, we are encouraged about the relative prospects
for both our investment universe and investment style.
Relative valuations, as reflected by average P/E ratios and earnings growth
prospects, should favor the small-cap sector. In addition, significant
divergence between large-cap and small-cap performance has historically not been
sustained over long periods (the Russell 2000 just concluded its second worst
two-year relative performance period vis-a-vis the S&P 500 based on quarterly
trailing returns). The worst two-year period, which ended in the fourth quarter
of 1990 (and preceded small-cap's reemergence in 1991-1993), was accompanied by
a general market correction, similar to what we believe is happening now. It is
our belief that this performance divergence has negative implications for the
market as a whole.
A higher level of volatility, present since the small-cap peak in May 1996,
in our opinion favors a value style of investing. The current level of interest
rates should also benefit value, at least in a relative sense. Growth managers,
who seek the expansion of price multiples, rely heavily on falling interest
rates to drive their investment process. (P/E multiples and interest rates act
inversely to each other, i.e., as interest rates decline, P/E multiples tend to
expand.) Therefore, a more neutral interest rate environment should put value on
an equal footing. The momentum investing crowd also remains very involved in
small-cap (Internet stocks and cutting edge technology, in particular), which
only increases the sector's vulnerability and volatility.
[cartoon graphic: portfolio managers in a "police line-up"
with caption "Guilty as Charged: Attempting to manage risk."]
10 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
[photo: Jack Fockler, Whitney George, Chuck Royce, Charlie Dreifus, Buzz Zaino]
(l-r) Jack Fockler, Whitney George, Chuck Royce, Charlie Dreifus, Buzz Zaino
We remain committed to the same principles that have served us well over
the last 25 years. We believe that our focus on managing risk within the more
volatile small-cap and micro-cap sectors is especially appropriate at this
juncture in the market. We appreciate your continued support of our work and
welcome your questions and comments. Happy summer days.
Sincerely,
/s/ Charles M. Royce /s/ W. Whitney George /s/ Jack E. Fockler, Jr.
Charles M. Royce W. Whitney George Jack E. Fockler, Jr.
President Vice President Vice President
July 20, 1998
PS We wanted to take this opportunity to introduce you to the two newest members
of our Senior Staff, Charlie Dreifus and Buzz Zaino.
Charlie, who joined the firm on February 1, 1998, was formerly with Lazard
Freres, where he was the Portfolio Manager for the Lazard Special Equity Fund.
He brings 29 years of experience to Royce & Associates, 18 of them as a
small-cap and micro-cap value portfolio manager. Charlie, who will be involved
in our research efforts, began managing a new portfolio, Royce Special Equity
Fund, on May 1, 1998.
Buzz comes to us from Trust Company of the West where he was Group Managing
Director in charge of the company's small-cap value offerings. He has 30 years
of investment management experience, including 21 years as a small-cap value
portfolio manager. Buzz became the portfolio manager of PMF II on April 1, 1998.
We are very excited to have such seasoned professionals working with us.
PPS This report's excursion into Wonderland was inspired by the extraordinary
market activity of the past few years, which to our eyes resembles the surreal
surroundings brought to life in Lewis Carroll's two classics, Alice's Adventures
in Wonderland and Through the Looking Glass. For those of you made "curiouser
and curiouser" by our "Saving Humpty Dumpty: The Right Balance" heading, the
title refers to the need to keep Humpty Dumpty "balanced" on the wall to prevent
his great fall.
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 11
<PAGE>
[sidebar]
WHAT WE DO
Pennsylvania Mutual Fund ("PMF"), our flagship fund, seeks long-term capital
appreciation by investing primarily in small and micro-cap securities using a
value approach.
HOW WE DID
Pennsylvania Mutual Fund finished the first half up 8.8%, well ahead of its
benchmark index, the small-cap oriented Russell 2000, which was up 4.9%. PMF's
best-performing sectors for this period were financial and consumer stocks. The
Fund also outperformed the Russell 2000 for the one-year period ended June 30,
1998, up 20.3% versus 16.4% for the index, and since the May 1996 small-cap
peak. PMF has provided positive returns in 21 out of the last 24 calendar years.
The Fund's average annual total return since inception through June 30, 1998 was
16.6%.
PMF, whose total net assets as of June 30, 1998 were $666 million, is one of the
oldest small-cap funds available. The Fund also enjoys the distinction of being
one of Morningstar's lowest risk small-cap funds as measured by the Morningstar
risk ratio for the three-year period ended 6/30/98. We remain excited about the
long-term prospects for our flagship fund.
We are happy to report that June 30, 1998 marked our 25th anniversary as the
Fund's manager. This event was commemorated in a recent article in Mutual Funds
magazine entitled "25 Years of Lessons."
[end sidebar]
PENNSYLVANIA MUTUAL FUND+
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS (Through 6/30/98)
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
Year-to-date 8.8%
- --------------------------------------------------------------------------------
1-Year 20.3
- --------------------------------------------------------------------------------
3-Year 18.0
- --------------------------------------------------------------------------------
5-Year 14.1
- --------------------------------------------------------------------------------
10-Year 12.5
- --------------------------------------------------------------------------------
25-Year (Since Inception-6/30/73) 16.6
- --------------------------------------------------------------------------------
</TABLE>
- --------------------------------------------------------------------------------
RISK/RETURN COMPARISON 15-Year Period Ended 6/30/98
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Average Annual Standard
Total Return Deviation RUR
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
PMF 12.6% 11.1 1.14
- --------------------------------------------------------------------------------
Russell 2000 11.1% 17.5 0.63
- --------------------------------------------------------------------------------
</TABLE>
RUR = Return per Unit of Risk: Average annual total return divided by the
annualized standard deviation over a designated time period. Please read the
prospectus for a more complete discussion of risk.
Over the last 15 years, Pennsylvania Mutual Fund has outperformed the Russell
2000 on BOTH an absolute and a risk-adjusted basis.
- --------------------------------------------------------------------------------
RECENT MARKET PERFORMANCE
- --------------------------------------------------------------------------------
PEAK 5/22/96 PEAK 10/31/97
- ------------------------ ------------------------
5/22/96 - 6/30/98 10/13/97 - 6/30/98
- ------------------------ ------------------------
PMF 42.7% PMF 5.0%
- ------------------------ ------------------------
Russell 2000 28.7% Russell 2000 -1.3%
- ------------------------ ------------------------
[Line chart]
[data points for Russell 2000]
<TABLE>
<S> <C>
Dec-95 0.00%
Jan-96 -0.11%
Feb-96 3.01%
Mar-96 5.11%
Apr-96 10.73%
May-96 15.09%
Jun-96 10.36%
Jul-96 0.73%
Aug-96 6.58%
Sep-96 10.75%
Oct-96 9.04%
Nov-96 13.54%
Dec-96 16.51%
Jan-97 18.84%
Feb-97 15.95%
Mar-97 10.48%
Apr-97 10.79%
May-97 23.12%
Jun-97 28.40%
Jul-97 34.37%
Aug-97 37.45%
Sep-97 47.51%
Oct-97 41.04%
Nov-97 40.12%
Dec-97 42.57%
Jan-98 40.32%
Feb-98 50.69%
Mar-98 56.90%
Apr-98 57.76%
May-98 49.26%
Jun-98 49.57%
</TABLE>
[end line chart]
Pennsylvania Mutual has provided strong absolute and relative performance from
the small-cap peak in May 1996.
- --------------------------------------------------------------------------------
PENNSYLVANIA MUTUAL VS. RUSSELL 2000 Value of $10,000 invested on 6/30/83
- --------------------------------------------------------------------------------
[Line chart]
<TABLE>
<CAPTION>
Date PMF Russell 2000
---- --- ------------
<S> <C> <C>
Jun-83 10,000 10,000
Sep-83 9,876 9,510
Dec-83 10,155 9,140
Mar-84 9,804 8,527
Jun-84 9,718 8,270
Sep-84 10,337 8,725
Dec-84 10,474 8,472
Mar-85 11,598 9,650
Jun-85 11,974 9,992
Sep-85 11,938 9,556
Dec-85 13,279 11,102
Mar-86 14,694 12,674
Jun-86 15,522 13,288
Sep-86 14,427 11,660
Dec-86 14,763 11,733
Mar-87 16,910 14,586
Jun-87 17,128 14,483
Sep-87 17,935 15,089
Dec-87 14,967 10,704
Mar-88 17,128 12,746
Jun-88 18,250 13,586
Sep-88 18,496 13,458
Dec-88 18,644 13,369
Mar-89 19,953 14,399
Jun-89 21,116 15,316
Sep-89 22,018 16,350
Dec-89 21,756 15,540
Mar-90 21,564 15,197
Jun-90 22,263 15,783
Sep-90 18,579 11,910
Dec-90 19,245 12,509
Mar-91 23,141 16,230
Jun-91 23,374 15,978
Sep-91 24,307 17,280
Dec-91 25,372 18,270
Mar-92 27,285 19,641
Jun-92 26,589 18,301
Sep-92 27,217 18,825
Dec-92 29,478 21,633
Mar-93 30,988 22,557
Jun-93 30,656 23,049
Sep-93 31,873 25,063
Dec-93 32,794 25,722
Mar-94 32,440 25,038
Jun-94 31,730 24,064
Sep-94 32,913 25,734
Dec-94 32,558 25,255
Mar-95 33,876 26,420
Jun-95 36,075 28,895
Sep-95 38,622 31,750
Dec-95 38,652 32,439
Mar-96 39,456 34,097
Jun-96 40,861 35,802
Sep-96 40,861 35,923
Dec-96 43,619 37,791
Mar-97 43,802 35,834
Jun-97 49,326 41,646
Sep-97 55,585 47,843
Dec-97 54,507 46,240
Mar-98 59,734 50,887
Jun-98 59,316 48,511
</TABLE>
Includes reinvestment of distributions.
[end line chart]
12 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
PERFORMANCE AND PORTFOLIO REVIEW
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
DOWN MARKET PERFORMANCE COMPARISON
All Down Periods of 7.5% or Greater Over the Last 15 Years, in Percentages (%)
- --------------------------------------------------------------------------------
[bar chart]
<TABLE>
<CAPTION>
6/24/83- 7/3/86- 8/25/87- 10/9/89- 2/12/92- 3/18/94- 5/22/96- 1/22/97- 10/13/97- 4/21/98-
7/25/84 9/16/86 10/28/87 10/30/90 7/8/92 12/9/94 7/24/96 4/25/97 1/12/98 6/15/98
---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
PMF -6.0 -8.6 -23.2 -20.9 -2.6 -7.6 -6.5 -2.5 -7.5 -5.7
Russell 2000 -24.2 -14.8 -39.1 -32.7 -11.9 -12.4 -15.5 -9.2 -11.5 -11.6
</TABLE>
[end bar chart]
Pennsylvania Mutual has outperformed the Russell 2000 during all 10 major
downturns over the last 15 years.
- ---------------------------------------
PORTFOLIO DIAGNOSTICS
- ---------------------------------------
<TABLE>
<S> <C>
Median Market Cap. $413 million
- ---------------------------------------
Weighted Average P/E Ratio 17.2x
- ---------------------------------------
Weighted Average P/B Ratio 2.0x
- ---------------------------------------
Weighted Average Yield 1.4%
- ---------------------------------------
Net Assets $666 million
- ---------------------------------------
Turnover Rate 11%
- ---------------------------------------
Symbol Investment Class: PENNX
Consultant Class: RYPCX
- ---------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ---------------------------------------
TOP 10 POSITIONS % of Net Assets
- ---------------------------------------
<S> <C>
Velcro Industries 1.6
- ---------------------------------------
Wesco Financial Corporation 1.3
- ---------------------------------------
National Computer Systems 1.3
- ---------------------------------------
Florida Rock Industries 1.3
- ---------------------------------------
Enesco Group 1.2
- ---------------------------------------
Arthur J. Gallagher & Co. 1.2
- ---------------------------------------
The Commerce Group 1.2
- ---------------------------------------
Eaton Vance 1.1
- ---------------------------------------
Curtiss-Wright Corporation 1.1
- ---------------------------------------
Thor Industries 1.1
- ---------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------
PORTFOLIO SECTOR BREAKDOWN With Examples % of Net Assets*
- ----------------------------------------------------------------------------------------------------
<S> <C>
- ---------------------------------------------------------------------------------------------------
Industrial Products Building Systems and Components, Construction Materials,
Specialty Chemicals and Materials 25
- ---------------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------------
Industrial Services Transportation and Logistics, Printing, Engineering and Construction 17
- -----------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------
Financial Intermediaries Insurance, Banking, Brokerage 16
- ----------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------
Consumer Products Home Furnishings/Appliances, Apparel and Shoes, Publishing 12
- ---------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------
Technology Hardware, Software/Services, Distribution, Telecommunications 9
- -------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------
Financial Services Insurance Brokers, Investment Management, Information and Processing 9
- -------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------
Consumer Services Retail, Restaurants/Lodging, Leisure/Entertainment 5
- -----------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------
Natural Resources Oil and Gas, Energy Services, Real Estate 4
- ----------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------
Health Surgical Products and Devices, Drugs and Biotech, Health Services 2
- ---------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------
Utilities 1
- --------------------------------------------------------------------------------------
</TABLE>
* Excludes cash and short-term investments.
+ 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
Realized and Unrealized Gain
Year-To-Date Through 6/30/98
- -------------------------------------------
<TABLE>
<S> <C>
LandAmerica Financial Group $ 3,865,465
- -------------------------------------------
Velcro Industries 3,393,036
- -------------------------------------------
Plenum Publishing Corporation 2,984,479
- -------------------------------------------
National Computer Systems 2,635,081
- -------------------------------------------
Level 3 Communications 2,203,324
- -------------------------------------------
Combined Gain $15,081,385
- -------------------------------------------
</TABLE>
- -------------------------------------------
GOOD IDEAS AT THE TIME
Realized and Unrealized Loss
Year-To-Date Through 6/30/98
- -------------------------------------------
<TABLE>
<S> <C>
Dimon Incorporated $2,598,523
- -------------------------------------------
Unitrode Corporation 2,175,092
- -------------------------------------------
CalMat 1,715,185
- -------------------------------------------
Standard Commercial Corporation 1,513,885
- -------------------------------------------
Highlands Insurance Group 1,480,138
- -------------------------------------------
Combined Loss $9,482,823
- -------------------------------------------
</TABLE>
During 1998's first half, the companies listed above made the largest
positive and negative contributions in dollar terms to our performance. Our top
five Good Ideas That Worked contributed 27% to the Fund's total net realized and
unrealized gain for the period. While we are pleased with our successes, we have
learned over the years that there is often more wisdom to be drawn from
failures. An examination of past winners and losers has taught us that this
year's beast can easily be transformed into next year's beauty.
LandAmerica Financial Group -- This title insurance company came about
from the merger of Lawyers' Title and Commonwealth Title and is part of an
industry many investors seem to be discovering for the first time. Its recent
good fortune is directly tied to the current real estate boom.
DIMON Incorporated and Standard Commercial Corporation -- These
tobacco-leaf processors each suffered a downturn in the business cycle in what
was already an admittedly unpopular business. While not currently involved in
any tobacco litigation, the jury is still out on this investment idea.
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 13
<PAGE>
[sidebar]
WHAT WE DO
PMF II seeks long-term capital appreciation by using a value approach to invest
in a blend of small and micro-cap companies. Buzz Zaino became the Fund's
primary portfolio manager effective April 1, 1998.
HOW WE DID
PMF II was up 7.6% for the first half, finishing ahead of the small-cap oriented
Russell 2000, its benchmark index. Portfolio companies in the consumer and
financial sectors provided the largest gains. PMF II also outperformed the
Russell 2000 for the one-year period ended June 30, 1998, with a return of 17.7%
versus 16.4% for the index. The Fund's average annual total return since its
inception on 11/19/96 through June 30, 1998 was 21.5%.
Since April 1, 1998, Mr. Zaino has made a number of changes in the Fund's
portfolio, which currently includes several new positions. PMF II is no longer
run as a sibling of Pennsylvania Mutual Fund. While the Fund is not restricted
in terms of stock market capitalization, it will continue to focus on small and
micro-cap stocks. Mr. Zaino will manage PMF II using a value approach, in an
effort to reduce risk in the often volatile small and micro-cap universe. Total
net assets have increased, and as of June 30, 1998 were $30 million. Mr. Zaino
has 30 years of investment experience and 21 as a small-cap value manager, most
recently as Managing Director in charge of Trust Company of the West's small-cap
value offerings.
We believe that PMF II's blend of small and micro-cap stocks is capable of
providing above-average long-term returns. This coming November, the Fund will
have two years of performance history.
[end sidebar]
PMF II
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS (Through 6/30/98)
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
Year-to-date 7.6%
- -----------------------------------------------------------------------
1-Year 17.7
- -----------------------------------------------------------------------
Since Inception (11/19/96) 21.5
- -----------------------------------------------------------------------
</TABLE>
- --------------------------------------------------------------------------------
RECENT MARKET PERFORMANCE
- --------------------------------------------------------------------------------
PEAK 1/22/97 PEAK 10/31/97
- ------------------------ ------------------------
1/22/97 - 6/30/98 10/13/97 - 6/30/98
- ------------------------ ------------------------
PMF II 30.3% PMF II 1.2%
- ------------------------ ------------------------
Russell 2000 25.2% Russell 2000 -1.3%
- ------------------------ ------------------------
[line chart]
[Data points for Russell 2000 from 12/31/95 - 6/30/98]
<TABLE>
<S> <C>
Dec-96 0.00%
Jan-97 2.00%
Feb-97 -0.48%
Mar-97 -5.18%
Apr-97 -4.91%
May-97 5.67%
Jun-97 10.21%
Jul-97 15.33%
Aug-97 17.97%
Sep-97 26.61%
Oct-97 21.05%
Nov-97 20.26%
Dec-97 22.37%
Jan-98 20.43%
Feb-98 29.33%
Mar-98 34.66%
Apr-98 35.40%
May-98 28.10%
Jun-98 28.37%
</TABLE>
[end line chart]
PMF II has provided a performance edge from the January 1997 small-cap peak.
[line chart]
- --------------------------------------------------------------------------------
PMF II VS. RUSSELL 2000 Value of $10,000 invested on 11/19/96
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Date PMFII Russell 2000
---- ----- ------------
<S> <C> <C>
11/19/96 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
</TABLE>
[end line chart]
Includes reinvestment of distributions.
14 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
PERFORMANCE AND PORTFOLIO REVIEW
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
DOWN MARKET PERFORMANCE COMPARISON
All Down Periods of 7.5% or Greater, in Percentages (%)
- --------------------------------------------------------------------------------
[bar chart]
<TABLE>
<CAPTION>
1/22/97 - 10/13/97 - 4/21/98 -
4/25/97 1/12/98 6/15/98
------- ------- -------
<S> <C> <C> <C>
PMF II -1.1 -10.1 -8.5
Russell 2000 -9.2 -11.5 -11.6
</TABLE>
[end bar chart]
PMF II has outperformed the Russell 2000 in all three down market periods since
its inception.
- ---------------------------------------
PORTFOLIO DIAGNOSTICS
- ---------------------------------------
<TABLE>
<S> <C>
Median Market Cap. $361 million
- ---------------------------------------
Weighted Average P/E Ratio 20.9x
- ---------------------------------------
Weighted Average P/B Ratio 1.9x
- ---------------------------------------
Weighted Average Yield 1.1%
- ---------------------------------------
Net Assets $30 million
- ---------------------------------------
Turnover Rate 46%
- ---------------------------------------
Symbol RYPNX
- ---------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ---------------------------------------
TOP 10 POSITIONS % of Net Assets
- ---------------------------------------
<S> <C>
Sea Containers Cl. A 2.3
- ---------------------------------------
Richardson Electronics 1.8
- ---------------------------------------
Curtiss-Wright Corporation 1.6
- ---------------------------------------
Enesco Group 1.6
- ---------------------------------------
Insituform Technologies Cl. A 1.4
- ---------------------------------------
Haemonetics Corporation 1.3
- ---------------------------------------
Cirrus Logic 1.3
- ---------------------------------------
Lund International Holdings 1.3
- ---------------------------------------
Tom Brown 1.3
- ---------------------------------------
Arnold Industries 1.2
- ---------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------
PORTFOLIO SECTOR BREAKDOWN With Examples % of Net Assets*
- -----------------------------------------------------------------------------------------------
<S> <C>
- -----------------------------------------------------------------------------------------------
Industrial Services Transportation and Logistics, Printing, Engineering and Construction 19
- -----------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------
Industrial Products Building Systems and Components, Construction Materials,
Specialty Chemicals and Materials 17
- ----------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------
Technology Hardware, Software/Services, Distribution, Telecommunications 17
- ----------------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------------
Consumer Products Home Furnishings/Appliances, Apparel and Shoes, Publishing 13
- --------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------
Consumer Services Retail, Restaurants/Lodging, Leisure/Entertainment 8
- -----------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------
Health Surgical Products and Devices, Drugs and Biotech, Health Services 8
- -----------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------
Financial Services Insurance Brokers, Investment Management, Information
and Processing 7
- ---------------------------------------------------------------------------------------
- --------------------------------------------------------------------------------------
Financial Intermediaries Insurance, Banking, Brokerage 6
- --------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------
Natural Resources Oil and Gas, Energy Services, Real Estate 5
- -------------------------------------------------------------------------------------
</TABLE>
*Excludes cash and short-term investments.
- -------------------------------------------
GOOD IDEAS THAT WORKED
Realized and Unrealized Gain
Year-To-Date Through 6/30/98
- -------------------------------------------
<TABLE>
<S> <C>
LandAmerica Financial Group $262,243
- -------------------------------------------
Insituform Technologies Cl. A 259,946
- -------------------------------------------
National Computer Systems 246,567
- -------------------------------------------
MovieFone Cl. A 215,254
- -------------------------------------------
Catherines Stores Corporation 154,410
- -------------------------------------------
Combined Gain $1,138,420
- -------------------------------------------
</TABLE>
- -------------------------------------------
GOOD IDEAS AT THE TIME
Realized and Unrealized Loss
Year-To-Date Through 6/30/98
- -------------------------------------------
<TABLE>
<S> <C>
Golden Books Family Entertainment $236,681
- -------------------------------------------
Johnson Worldwide Associates Cl. A 118,090
- -------------------------------------------
Guy F. Atkinson Company 115,322
- -------------------------------------------
HMT Technology Corporation 95,581
- -------------------------------------------
Sevenson Environmental Services 91,605
- -------------------------------------------
Combined Loss $657,279
- -------------------------------------------
</TABLE>
During 1998's first half, the companies listed above made the largest
positive and negative contributions in dollar terms to our performance. Our top
five Good Ideas That Worked contributed 78% to the Fund's total net realized and
unrealized gain for the period. While we are pleased with our successes, we have
learned over the years that there is often more wisdom to be drawn from
failures. An examination of past winners and losers has taught us that this
year's beast can easily be transformed into next year's beauty.
LandAmerica Financial Group -- This title insurance company came about from
the merger of Lawyers' Title and Commonwealth Title and is part of an industry
many investors seem to be discovering for the first time. Its recent good
fortune is directly tied to the current real estate boom.
Golden Books Family Entertainment -- Sales failed to meet expectations as a
new CEO with a reputation for effective management has not yet produced a
hoped-for turnaround. We have reduced our position, but have not given up hope
yet.
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 15
<PAGE>
[sidebar]
WHAT WE DO
Royce GiftShares Fund ("RGF") uses a value approach to invest in a limited
portfolio of small and micro-cap securities. The Fund 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 outperformed its benchmark index, the small-cap oriented
Russell 2000, in the first half, finishing the period up 13.2% versus a gain of
4.9% for the Russell 2000. Portfolio holdings in the consumer products and
financial intermediaries and services sectors made the most significant
contributions to the Fund's performance. The Fund enjoyed a performance edge
over the Russell 2000 for the one-year period ended June 30, 1998 as well, up
27.1% versus 16.4% for the index. RGF's average annual total return since
inception (12/27/95) was 26.2%.
We are pleased with the Fund's performance results, especially taking into
account the increased volatility exhibited by small-cap stocks during the second
quarter. RGF remains one of the few mutual funds specifically designed for
gifting and estate-planning purposes. The Fund had $6.5 million in total net
assets as of June 30, 1998. December will mark its third full year of operation.
[end sidebar]
ROYCE GIFTSHARES FUND+
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS (Through 6/30/98)
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
Year-to-date 13.2%
- --------------------------------------------------------------------------------
1-Year 27.1
- --------------------------------------------------------------------------------
2-Year 24.9
- --------------------------------------------------------------------------------
Since Inception (12/27/95) 26.2
- --------------------------------------------------------------------------------
</TABLE>
- --------------------------------------------------------------------------------
RECENT MARKET PERFORMANCE
- --------------------------------------------------------------------------------
PEAK 5/22/96 PEAK 10/13/97
- ------------------------ ------------------------
5/22/96 - 6/30/98 10/13/97 - 6/30/98
- ------------------------ ------------------------
RGF 56.3% RGF 12.8%
- ------------------------ ------------------------
Russell 2000 28.7% Russell 2000 -1.3%
- ------------------------ ------------------------
[line chart]
[Data points for Russell 2000 from 12/31/95-6/30/98]
<TABLE>
<S> <C>
Dec-95 0.00%
Jan-96 -0.11%
Feb-96 3.01%
Mar-96 5.11%
Apr-96 10.73%
May-96 15.09%
Jun-96 10.36%
Jul-96 0.73%
Aug-96 6.58%
Sep-96 10.75%
Oct-96 9.04%
Nov-96 13.54%
Dec-96 16.51%
Jan-97 18.84%
Feb-97 15.95%
Mar-97 10.48%
Apr-97 10.79%
May-97 23.12%
Jun-97 28.40%
Jul-97 34.37%
Aug-97 37.45%
Sep-97 47.51%
Oct-97 41.04%
Nov-97 40.12%
Dec-97 42.57%
Jan-98 40.32%
Feb-98 50.69%
Mar-98 56.90%
Apr-98 57.76%
May-98 49.26%
Jun-98 49.57%
</TABLE>
[end line chart]
Royce GiftShares has provided strong absolute and relative performance from the
small-cap peak in May 1996.
- --------------------------------------------------------------------------------
ROYCE GIFTSHARES FUND VS. RUSSELL 2000 Value of $10,000 invested on 12/27/95
- --------------------------------------------------------------------------------
[line chart]
<TABLE>
<CAPTION>
Date RGF Russell 2000
---- --- ------------
<S> <C> <C>
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
3/31/98 18,034 15,844
6/30/98 17,942 15,104
</TABLE>
[end line chart]
Includes reinvestment of distributions.
16 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
PERFORMANCE AND PORTFOLIO REVIEW
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
DOWN MARKET PERFORMANCE COMPARISON
All Down Periods of 7.5% or Greater, in Percentages (%)
- --------------------------------------------------------------------------------
[bar chart]
<TABLE>
<CAPTION>
5/22/96 - 1/22/97 - 10/13/97 - 4/21/98 -
7/24/96 4/25/97 1/12/98 6/15/98
------- ------- ------- -------
<S> <C> <C> <C> <C>
RGF -3.5 -0.5 -3.8 -7.0
Russell 2000 -15.5 -9.2 -11.5 -11.6
</TABLE>
[end bar chart]
Royce GiftShares has outperformed the Russell 2000 in all four down market
periods since its inception.
- ---------------------------------------
PORTFOLIO DIAGNOSTICS
- ---------------------------------------
<TABLE>
<S> <C>
Median Market Cap. $345 million
- ---------------------------------------
Weighted Average P/E Ratio 20.8x
- ---------------------------------------
Weighted Average P/B Ratio 1.9x
- ---------------------------------------
Weighted Average Yield 1.1%
- ---------------------------------------
Net Assets $6.5 million
- ---------------------------------------
Turnover Rate 53%
- ---------------------------------------
Symbol Investment Class: RGFAX
Consultant Class: RGFCX
- ---------------------------------------
</TABLE>
- ---------------------------------------
TOP 10 POSITIONS % of Net Assets
- ---------------------------------------
<TABLE>
<CAPTION>
<S> <C>
Lincoln Electric Holding Co. 5.4
- ---------------------------------------
Enesco Group 5.1
- ---------------------------------------
Richardson Electronics 3.0
- ---------------------------------------
Kronos Incorporated 2.8
- ---------------------------------------
Tom Brown 2.7
- ---------------------------------------
Kenan Transport Company 2.6
- ---------------------------------------
Denbury Resources 2.4
- ---------------------------------------
Charming Shoppes 2.3
- ---------------------------------------
PalEx 2.2
- ---------------------------------------
Lund International Holdings 2.0
- ---------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------
PORTFOLIO SECTOR BREAKDOWN With Examples % of Net Assets*
- -------------------------------------------------------------------------------------------
<S> <C>
- -------------------------------------------------------------------------------------------
Technology Hardware, Software/Services, Distribution, Telecommunications 22
- -------------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------------
Industrial Services Transportation and Logistics, Printing, Engineering
and Construction 18
- -----------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------
Financial Intermediaries Insurance, Banking, Brokerage 15
- ---------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------
Industrial Products Building Systems and Components, Construction Materials,
Specialty Chemicals and Materials 14
- -------------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------
Consumer Products Home Furnishings/Appliances, Apparel and Shoes,
Publishing 11
- -----------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------
Natural Resources Oil and Gas, Energy Services, Real Estate 8
- ---------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Consumer Services Retail, Restaurants/Lodging, Leisure/Entertainment 6
- --------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
Financial Services Insurance Brokers, Investment Management,
Information and Processing 4
- -------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
Health Surgical Products and Devices, Drugs and Biotech, Health Services 2
- ------------------------------------------------------------------------------
</TABLE>
* Excludes cash and short-term investments.
+ 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 are not borne by the
Investment Class.
- -------------------------------------------
GOOD IDEAS THAT WORKED
Realized and Unrealized Gain
Year-To-Date Through 6/30/98
- -------------------------------------------
<TABLE>
<S> <C>
BHI Corporation $87,693
- -------------------------------------------
MovieFone Cl. A 57,418
- -------------------------------------------
LandAmerica Financial Group 51,626
- -------------------------------------------
Insituform Technologies Cl. A 48,750
- -------------------------------------------
Ritchie Brothers Auctioneers 46,542
- -------------------------------------------
Combined Gain $292,029
- -------------------------------------------
</TABLE>
- -------------------------------------------
GOOD IDEAS AT THE TIME
Realized and Unrealized Loss
Year-To-Date Through 6/30/98
- -------------------------------------------
<TABLE>
<S> <C>
Perceptron $41,169
- -------------------------------------------
Standard Commercial Corporation 37,359
- -------------------------------------------
Denbury Resources 36,870
- -------------------------------------------
Pioneer-Standard Electronics 27,998
- -------------------------------------------
Sybase 27,616
- -------------------------------------------
Combined Loss $171,012
- -------------------------------------------
</TABLE>
During 1998's first half, the companies listed above made the largest
positive and negative contributions in dollar terms to our performance. Our top
five Good Ideas That Worked contributed 47% to the Fund's total net realized and
unrealized gain for the period. While we are pleased with our successes, we have
learned over the years that there is often more wisdom to be drawn from
failures. An examination of past winners and losers has taught us that this
year's beast can easily be transformed into next year's beauty.
BHI Corporation -- CEO Michael Ashcroft and his team, best known for their
success at ADT, are in the process of transforming this financial holding
company with assets in Central America into a dominant provider of janitorial
and other commercial services here in North America through the acquisition of
ISS. So far, this new venture of Ashcroft's has been highly successful.
Perceptron -- A company that manufactures three-dimensional image units for
automobile-inspection robots saw its stock price drop precipitously, a decline
which unfortunately continued after we bought. A product transition cycle
contributed to the dismal performance.
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 17
<PAGE>
UPDATES AND NOTES TO PERFORMANCE AND RISK INFORMATION
- --------------------------------------------------------------------------------
NEW AND IMPROVED...www.roycefunds.com
Visit our newly redesigned website. The site includes both organizational
and navigational changes in an effort to create a more user-friendly interface.
New featured sections include Res Praecipua ("special features") and a weekly
What's New area.
[graphic: desktop computer, "THE ROYCE FUNDS" displayed on the screen]
While we changed the look of our site, and included additional information
for you, we retained the online services that have been popular with our
computer savvy shareholders. Online account access allows our shareholders to
check account values and share balances at their convenience, whenever they
choose. With authorization, shareholders can also purchase additional shares,
make exchanges between Royce Funds or request redemptions. Call Shareholder
Services today to set up your account for online access -- (800) 841-1180.
GIVING A GIFT OR LEAVING A LEGACY -- IT'S YOUR CHOICE!
The dilemma when making a gift is often whether the desire to be generous
outweighs the concern over how the gift will be spent. Will the gift that you
thought would fund a college education rust away in the driveway after a few
years?
Royce GiftShares Fund may be the solution to your gifting concerns. When
you set up a GiftShares account, you establish a trust for your beneficiary. As
the donor, you choose when the beneficiary will have access to the assets by
selecting the termination date of the trust. If you would like the beneficiary
to be able to use the assets before the termination date to pay college
expenses, you may structure the trust so that the Trustee will pay the college
expenses directly to the educational institution. No Porsche payment here! And
while you are enjoying this new form of gifting, you may be able to take
advantage of some tax and estate-planning benefits as well. To receive a
prospectus, which includes fees and expenses, call (800) 221-4268. Please read
the prospectus and Trust Adoption Agreement carefully before investing or
sending money.
NOTES TO PERFORMANCE AND RISK INFORMATION
All performance information is presented on a total return basis and
reflects the reinvestment of distributions. Past performance is no guarantee of
future results. Investment return and principal value will fluctuate, so that
shares may be worth more or less than their original cost when redeemed. The
Royce Funds invest primarily in securities of small-cap and/or micro-cap
companies that may involve considerably more risk than investments in securities
of larger-cap companies (see "Investment Risks" in the prospectus).
Morningstar proprietary risk ratio measures a fund's downside volatility
relative to all equity funds, which have an average score of 1.00. The average
score for the 349 funds in the small-cap objective category with a three-year
history was 1.50 for the three years ended 6/30/98. The lower the risk ratio,
the lower a fund's downside volatility has been. The risk scores for Royce
Premier Fund, Royce Total Return Fund and Pennsylvania Mutual Fund for this
period were 0.74, 0.27 and 0.75, respectively. Standard deviation is a
statistical measure within which a fund's total returns have varied over time.
The greater the standard deviation, the greater a fund's volatility. The Russell
2000, Russell 2000 Value and Russell 2000 Growth are unmanaged indices of
small-cap domestic common stocks and the S&P 500 and Dow Jones Industrial
Average are unmanaged indices of large-cap domestic common stocks. The Royce
Funds and Royce GiftShares Fund are service marks of The Royce Funds.
18 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
PENNSYLVANIA MUTUAL FUND JUNE 30, 1998 (unaudited)
- --------------------------------------------------------------------------------
COMMON STOCKS -- 96.0%
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Consumer Products -- 12.4%
Apparel and Shoes - 2.7%
Garan Incorporated 154,700 $ 4,196,238
Haggar 40,000 510,000
K-Swiss Cl. A 106,700 2,093,987
**Oakley* 174,700 2,336,613
Oshkosh B'Gosh Cl. A 118,500 5,273,250
Weyco Group 137,100 3,581,737
------------
17,991,825
------------
Collectibles - 1.3%
Enesco Group 269,900 8,299,425
------------
Food/Beverage/Tobacco - 0.3%
**800-JR CIGAR* 74,000 1,461,500
J & J Snack Foods* 40,700 849,613
------------
2,311,113
------------
Home Furnishings/Appliances - 4.5%
Bassett Furniture Industries 159,275 4,489,564
Burnham Corporation Cl. A 44,576 2,056,068
Burnham Corporation Cl. B 4,442 204,887
Conso Products* 159,925 1,319,381
Fedders Corporation Cl. A 71,700 457,087
Flexsteel Industries 86,200 1,206,800
La-Z-Boy 68,900 3,892,850
Lifetime Hoan Corporation 368,199 3,681,990
The Rival Company 180,100 2,431,350
Velcro Industries 75,400 10,499,450
------------
30,239,427
------------
Publishing - 2.0%
Gibson Greetings* 218,700 5,467,500
Plenum Publishing Corporation 64,350 4,713,638
The Topps Company* 940,700 2,910,291
------------
13,091,429
------------
Sports and Recreation - 0.9%
Johnson Worldwide
Associates Cl. A* 144,370 1,822,671
Lund International Holdings* 93,700 1,065,837
Sturm, Ruger & Company 171,900 2,879,325
------------
5,767,833
------------
Other Consumer Products - 0.7%
Lazare Kaplan International* 181,700 1,919,206
Matthews International
Corporation Cl. A 109,800 2,696,963
------------
4,616,169
------------
82,317,221
============
Consumer Services -- 3.7%
Leisure/Entertainment - 0.4%
PCA International 100,100 2,527,525
------------
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Restaurants/Lodging - 0.8%
Buffets* 252,400 $ 3,959,525
The Marcus Corporation 52,875 945,141
Shoney's* 106,294 372,029
------------
5,276,695
------------
Retail - 2.5%
Catherines Stores Corporation* 75,000 735,937
Cato Corporation Cl. A 48,800 849,425
Charming Shoppes* 857,300 4,072,175
Mikasa 201,600 2,570,400
Sotheby's Holdings Cl. A 181,800 4,067,775
Talbots 163,900 4,292,131
------------
16,587,843
------------
24,392,063
============
Financial Intermediaries -- 14.2%
Banking - 1.5%
Baker Boyer Bancorp 31,300 1,439,800
Community Banks 62,550 1,516,838
F & M Bancorporation 13,800 752,100
Farmers & Merchants Bank of
Long Beach 1,306 3,669,860
Hanmi Bank* 25,089 482,963
Oriental Financial Group 63,625 2,346,172
------------
10,207,733
------------
Insurance - 12.7%
Alleghany Corporation* 23,303 5,435,425
ALLIED Life Financial
Corporation 37,400 1,079,925
Baldwin & Lyons Cl. B 125,678 2,922,013
Capitol Transamerica Corporation 129,745 2,667,882
The Commerce Group 202,642 7,852,378
Fremont General Corporation 54,170 2,935,337
Highlands Insurance Group* 147,500 2,728,750
Intercargo Corporation 108,900 1,279,575
LandAmerica Financial Group 88,600 5,072,350
Leucadia National Corporation 200,128 6,616,732
Medical Assurance* 209,918 5,825,224
NYMAGIC 25,000 684,375
Nobel Insurance Limited 74,400 1,004,400
Orion Capital Corporation 41,786 2,334,793
PXRE Corporation 186,541 5,596,230
Pennsylvania Manufacturers
Corporation Cl. A 301,350 6,931,050
RLI 34,781 1,415,152
Trenwick Group 178,800 6,945,263
Wesco Financial Corporation 22,580 8,828,780
Zenith National Insurance 231,000 6,511,312
------------
84,666,946
------------
94,874,679
============
</TABLE>
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 19
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
PENNSYLVANIA MUTUAL FUND JUNE 30, 1998 (unaudited)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Financial Services -- 8.1%
Information and Processing - 1.2%
Duff & Phelps Credit Rating Co. 99,299 $ 5,535,919
Investors Financial Services
Corporation 42,904 2,273,912
------------
7,809,831
------------
Insurance Brokers - 3.9%
E.W. Blanch Holdings 131,300 4,825,275
**Crawford & Company Cl. A 302,625 5,674,219
Arthur J. Gallagher & Co. 182,500 8,166,875
Hilb, Rogal & Hamilton Company 183,300 2,864,063
Willis Corroon Group ADR + 357,000 4,484,812
------------
26,015,244
------------
Investment Management - 3.0%
Eaton Vance 162,100 7,507,256
The John Nuveen Company Cl. A 67,800 2,690,813
NVEST L.P. 56,000 1,781,500
Phoenix Investment Partners 271,400 2,357,787
The Pioneer Group 214,500 5,644,031
------------
19,981,387
------------
53,806,462
============
Health -- 1.4%
Health Services - 0.6%
**Jenny Craig* 239,100 1,449,544
Life Technologies 85,660 2,687,582
------------
4,137,126
------------
Personal Care - 0.1%
Jean-Philippe Fragrances* 28,400 228,975
------------
Surgical Products and Devices - 0.7%
Diagnostic Products Corporation 24,500 705,906
Haemonetics Corporation* 287,400 4,598,400
------------
5,304,306
------------
9,670,407
============
Industrial Products -- 23.3%
Aerospace/Defense - 2.3%
Curtiss-Wright Corporation 188,200 7,375,088
Special Metals Corporation* 208,300 2,916,200
Woodward Governor Company 157,072 4,849,598
------------
15,140,886
------------
Building Systems and Components - 6.6%
Falcon Products 186,700 2,357,087
International Aluminum
Corporation 147,200 4,563,200
Juno Lighting 264,500 6,248,813
Kimball International Cl. B 178,000 3,226,250
++Preformed Line Products
Company 189,786 5,883,366
Simpson Manufacturing* 180,900 6,987,262
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Skyline Corporation 196,800 $ 6,420,600
Thor Industries 257,200 7,121,225
Woodhead Industries 64,250 987,844
------------
43,795,647
------------
Construction Materials - 3.9%
Ash Grove Cement Company 50,018 4,476,611
Ash Grove Cement Company Cl. B 5,000 447,500
CalMat 289,500 6,369,000
Florida Rock Industries 289,200 8,441,025
Puerto Rican Cement Company 135,600 6,407,100
------------
26,141,236
------------
Machinery - 2.4%
Atchison Casting Corporation* 79,700 1,424,638
DeVlieg-Bullard* 81,600 183,600
Fansteel* 27,800 243,250
Lincoln Electric Holding Co. 249,380 5,517,532
Nordson Corporation 36,500 1,715,500
Oshkosh Truck Corporation Cl. B 199,900 4,997,500
Tecumseh Products Company Cl. A 43,800 2,313,188
------------
16,395,208
------------
Paper and Packaging - 1.8%
CLARCOR 63,175 1,326,675
P. H. Glatfelter Company 194,200 3,070,788
Liqui-Box Corporation 108,500 5,140,187
PalEx* 257,900 2,450,050
------------
11,987,700
------------
Pumps, Valves and Bearings - 1.4%
Kaydon Corporation 158,900 5,611,156
NN Ball and Roller 177,500 2,118,906
Robroy Industries Cl. A 94,535 1,441,659
------------
9,171,721
------------
Specialty Chemicals and Materials - 2.4%
Aceto Corporation 24,546 398,873
Aldila* 182,100 1,206,412
CFC International* 58,000 641,625
Chemfab Corporation* 15,000 312,188
**Hach Company 54,361 674,416
Hach Company Cl. A 56,361 612,926
LeaRonal 88,557 2,114,298
Lilly Industries Cl. A 251,561 5,440,007
MacDermid, Incorporated 84,231 2,379,526
Quaker Chemical Corporation 51,064 967,024
Synalloy Corporation 82,100 1,108,350
------------
15,855,645
------------
Textiles - 1.4%
Delta Woodside Industries 168,736 875,318
Fab Industries 162,732 4,536,154
**Thomaston Mills Cl. A 195,400 1,147,975
Unifi 78,800 2,698,900
------------
9,258,347
------------
</TABLE>
20 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
PENNSYLVANIA MUTUAL FUND JUNE 30, 1998 (unaudited)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Industrial Products (continued)
Other Industrial Products - 1.1%
BHA Group Holdings 146,157 $ 2,411,591
Modern Controls 93,400 700,500
Myers Industries 188,732 4,529,568
------------
7,641,659
------------
155,388,049
============
Industrial Services -- 16.1%
Advertising - 0.7%
Grey Advertising 11,431 4,526,676
------------
Commercial Services - 1.6%
ABM Industries Incorporated 96,600 2,692,725
BHI Corporation* 95,300 3,764,350
CDI* 30,200 807,850
Cornell Corrections* 86,500 1,816,500
The Olsten Corporation 115,000 1,286,562
------------
10,367,987
------------
Engineering and Construction - 2.1%
Devcon International* 35,900 100,969
Insituform Technologies Cl. A* 27,000 373,781
Liberty Homes Cl. A 93,350 1,050,187
Liberty Homes Cl. B 21,950 246,938
Morrison Knudsen Corporation* 186,500 2,622,656
++Sevenson Environmental Services 294,600 2,467,275
Stone & Webster 97,400 3,859,475
**Todd Shipyards Corporation* 51,850 288,416
Willbros Group* 188,300 2,942,187
------------
13,951,884
------------
Food/Tobacco Processors - 2.5%
DIMON Incorporated 211,200 2,376,000
Farmer Bros. 28,475 6,805,525
Midwest Grain Products* 304,700 4,418,150
Standard Commercial
Corporation* 275,776 3,033,536
------------
16,633,211
------------
Industrial Distribution - 1.1%
Rush Enterprises* 132,400 1,373,650
TBC Corporation* 118,277 783,585
**Vallen Corporation* 269,400 5,354,325
------------
7,511,560
------------
Printing - 3.5%
Bowne & Co. 104,900 4,720,500
Ennis Business Forms 229,600 2,669,100
Merrill Corporation 191,800 4,231,588
New England Business Service 210,100 6,775,725
The Standard Register Company 139,510 4,935,166
------------
23,332,079
------------
Transportation and Logistics - 4.6%
ASA Holdings 43,100 2,138,838
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Air Express International
Corporation 172,130 $ 4,604,478
AirNet Systems* 131,700 2,123,662
Arnold Industries 371,548 5,480,333
Circle International Group 248,074 6,946,072
Comair Holdings 47,500 1,466,562
Frozen Food Express Industries 418,867 4,136,312
Kenan Transport Company 70,800 2,433,750
Pittston BAX Group 85,700 1,333,706
------------
30,663,713
------------
106,987,110
============
Natural Resources -- 3.8%
Energy Services - 0.7%
Carbo Ceramics 99,000 3,378,375
Lufkin Industries 44,700 1,475,100
------------
4,853,475
------------
Oil and Gas - 2.4%
Barrett Resources* 112,500 4,211,719
Tom Brown* 295,300 5,555,331
**Denbury Resources* 288,200 3,764,613
**Devon Energy Corporation 86,800 3,032,575
------------
16,564,238
------------
Real Estate - 0.7%
Alico 12,800 262,400
Consolidated-Tomoka Land 51,800 900,025
FRP Properties* 97,500 3,168,750
Resurgence Properties* 66,700 50,025
------------
4,381,200
------------
25,798,913
============
Technology -- 8.4%
Distribution - 1.2%
Marshall Industries* 187,600 5,112,100
Richardson Electronics 202,862 2,738,637
------------
7,850,737
------------
Hardware - 4.7%
Axiohm Transaction Solutions* 134,562 1,379,261
CEM Corporation* 50,000 606,250
Dallas Semiconductor
Corporation 24,500 759,500
Dionex Corporation* 155,676 4,105,954
Electroglas* 215,300 2,812,356
Exar Corporation* 182,700 3,836,700
Helix Technology Corporation 43,000 645,000
Newport Corporation 141,200 2,788,700
Penn Engineering and
Manufacturing 210,750 5,268,750
**Penn Engineering and
Manufacturing Cl. A 49,550 1,015,775
Scitex Corporation Limited* 271,900 3,551,694
Unitrode Corporation* 370,300 4,258,450
**Veeco Instruments* 7,100 176,613
------------
31,205,003
------------
</TABLE>
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 21
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
PENNSYLVANIA MUTUAL FUND JUNE 30, 1998 (unaudited)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Technology (continued)
Software/Services - 1.8%
MacNeal-Schwendler
Corporation* 159,600 $ 1,566,075
National Computer Systems 365,006 8,760,144
Tyler Corporation* 25,000 257,813
**VideoServer* 135,600 1,661,100
------------
12,245,132
------------
Telecommunications - 0.7%
Level 3 Communications* 65,000 4,810,000
------------
56,110,872
============
Utilities -- 0.5%
Southern Union Company* 95,382 3,076,069
============
Miscellaneous -- 4.1% 27,317,821
============
TOTAL COMMON STOCKS
(Cost $385,966,630) 639,739,666
============
</TABLE>
<TABLE>
<CAPTION>
VALUE
-----
<S> <C>
REPURCHASE AGREEMENT -- 3.7%
State Street Bank and Trust Company, 5.15%
dated 6/30/98, due 7/01/98, maturity value
$24,603,519 (collateralized by U.S. Treasury
Bonds, 8.375% due 8/15/08 and 7.25% due
5/15/16, valued at $25,099,858)
(Cost $24,600,000) $ 24,600,000
============
TOTAL INVESTMENTS -- 99.7%
(Cost $410,566,630) 664,339,666
CASH AND OTHER ASSETS
LESS LIABILITIES -- 0.3% 1,977,977
------------
NET ASSETS -- 100.0% $666,317,643
============
</TABLE>
- --------------------------------------------------------------------------------
* Non-income producing.
** A portion of these securities were on loan at June 30, 1998. Total market
value of all securities on loan at June 30, 1998 was $7,096,318, for which
the Fund had received $7,677,700 as collateral.
+ American Depository Receipt.
++ At June 30, 1998, the Fund owned 5% or more of the Company's outstanding
voting securities thereby making the Company an Affiliated Company as that
term is defined in the Investment Company Act of 1940.
INCOME TAX INFORMATION: The cost of total investments for federal income tax
purposes was $410,566,630. At June 30, 1998, net unrealized appreciation for
all securities was $253,773,036, consisting of aggregate gross unrealized
appreciation of $272,941,258 and aggregate gross unrealized depreciation of
$19,168,222.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
22 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
PMF II JUNE 30, 1998 (unaudited)
- --------------------------------------------------------------------------------
COMMON STOCKS -- 89.9%
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Consumer Products -- 9.5%
Apparel and Shoes - 0.5%
Garan Incorporated 5,500 $ 149,188
------------
Collectibles - 1.6%
Enesco Group 15,600 479,700
------------
Home Furnishings/Appliances - 1.9%
Bassett Furniture Industries 6,700 188,856
Nimbus CD International* 9,000 102,375
Toro 8,700 297,975
------------
589,206
------------
Publishing - 3.4%
Gibson Greetings* 14,000 350,000
Golden Books Family
Entertainment* 22,000 84,563
Houghton Mifflin Company 9,100 288,925
The Topps Company* 95,000 293,906
------------
1,017,394
------------
Sports and Recreation - 2.1%
Johnson Worldwide
Associates Cl. A* 20,000 252,500
Lund International Holdings* 33,900 385,612
------------
638,112
------------
2,873,600
============
Consumer Services -- 12.6%
Direct Marketing - 1.2%
Spiegel Cl A* 50,100 360,094
------------
Leisure/Entertainment - 3.3%
Hollywood Park* 22,800 287,850
King World Productions* 12,000 306,000
MovieFone Cl. A* 15,000 150,000
Spelling Entertainment Group* 27,700 259,687
------------
1,003,537
------------
Restaurants/Lodging - 1.7%
Cooker Restaurant Corporation 26,100 254,475
Rock Bottom Restaurants* 40,000 255,000
------------
509,475
------------
Retail - 6.4%
The Bombay Company* 50,900 241,775
Catherine Stores Corporation* 29,300 287,506
Charming Shoppes* 50,800 241,300
The Good Guys* 20,400 274,763
InterTAN* 44,000 236,500
Lechters* 25,000 122,656
Little Switzerland* 17,200 77,400
Loehmann's* 32,100 154,481
Talbots 2,500 65,469
Tops Appliance City* 58,000 235,625
------------
1,937,475
------------
3,810,581
============
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Financial Intermediaries -- 3.8%
Insurance - 3.8%
LandAmerica Financial Group 3,000 $ 171,750
Old Guard Group 16,000 297,000
Pennsylvania Manufacturers
Corporation Cl. A 9,000 207,000
Trenwick Group 4,900 190,334
Zenith National Insurance 10,000 281,875
------------
1,147,959
============
Financial Services -- 4.8%
Information and Processing - 1.0%
Duff & Phelps Credit Rating Co. 5,200 289,900
------------
Insurance Brokers - 2.8%
Crawford & Company Cl. A 17,000 318,750
Arthur J. Gallagher & Co. 6,500 290,875
Willis Corroon Group ADR+ 19,100 239,944
------------
849,569
------------
Investment Management - 1.0%
Phoenix Investment Partners 20,800 180,700
The Pioneer Group 4,100 107,881
------------
288,581
------------
1,428,050
============
Health -- 4.3%
Health Services - 0.6%
Jenny Craig* 30,100 182,481
------------
Personal Care - 1.5%
Jean-Philippe Fragrances* 26,600 214,462
Weider Nutrition International 14,500 246,500
------------
460,962
------------
Surgical Products and Devices - 2.2%
Haemonetics Corporation* 24,500 392,000
Spacelabs Medical* 15,900 266,325
------------
658,325
------------
1,301,768
============
Industrial Products -- 18.1%
Aerospace/Defense - 2.7%
Curtiss-Wright Corporation 12,400 485,925
Wyman-Gordon* 16,100 320,994
------------
806,919
------------
Building Systems and Components - 2.1%
American Buildings Company* 10,000 297,500
Skyline Corporation 10,000 326,250
------------
623,750
------------
</TABLE>
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 23
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
PMF II JUNE 30, 1998 (unaudited)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Industrial Products (continued)
Construction Materials - 4.4%
CalMat 12,600 $ 277,200
Drew Industries Incorporated* 18,200 271,862
Florida Rock Industries 8,200 239,338
L. B. Foster Company Cl. A* 2,700 14,006
Northwest Pipe Company* 10,000 235,000
Puerto Rican Cement Company 6,400 302,400
------------
1,339,806
------------
Industrial Components - 0.8%
The Lamson & Sessions Co.* 37,800 233,887
------------
Machinery - 3.6%
CMI Corporation Cl. A 40,000 285,000
DeVlieg-Bullard* 54,300 122,175
Fansteel* 17,100 149,625
Global Industrial Technologies* 18,500 265,938
Hurco Companies* 35,100 254,475
------------
1,077,213
------------
Pumps, Valves and Bearings - 0.5%
NN Ball and Roller 13,500 161,156
------------
Specialty Chemicals and Materials - 2.3%
Lilly Industries Cl. A 16,800 363,300
NL Industries 16,500 330,000
------------
693,300
------------
Textiles - 0.9%
Cone Mills Corporation* 32,400 279,450
------------
Other Industrial Products - 0.8%
Griffon Corporation* 12,300 157,594
Medar* 43,900 93,288
------------
250,882
------------
5,466,363
============
Industrial Services -- 15.0%
Advertising - 0.6%
Ziff-Davis 12,000 166,500
------------
Commercial Services - 1.0%
The Olsten Corporation 11,800 132,012
Roy F. Weston Cl. A* 42,600 165,075
------------
297,087
------------
Engineering and Construction - 3.6%
Insituform Technologies Cl. A* 30,300 419,466
Morrison Knudsen Corporation* 20,000 281,250
Sevenson Environmental Services 23,640 197,985
Stone & Webster 5,000 198,125
------------
1,096,826
------------
Food/Tobacco Processors - 1.2%
Midwest Grain Products* 25,000 362,500
------------
Industrial Distribution - 0.5%
Vallen Corporation* 7,800 155,025
------------
Printing - 1.7%
Ennis Business Forms 24,900 289,463
The Standard Register Company 6,300 222,862
------------
512,325
------------
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Transportation and Logistics - 6.4%
Arkansas Best Corporation* 30,800 $ 288,750
Arnold Industries 25,000 368,750
Fritz Companies* 20,000 267,500
Frozen Food Express Industries 30,000 296,250
Sea Containers Cl. A 18,200 696,150
------------
1,917,400
------------
4,507,663
============
Natural Resources -- 3.8%
Oil and Gas - 3.7%
Tom Brown* 20,300 381,894
Denbury Resources* 15,000 195,938
Patina Oil & Gas Corporation 31,500 220,500
Snyder Oil Corporation 15,800 315,012
------------
1,113,344
------------
Real Estate - 0.1%
Resurgence Properties* 45,000 33,750
------------
1,147,094
============
Technology -- 18.0%
Distribution - 4.8%
Emulex Corporation* 22,400 133,000
Indenet* 99,200 291,400
Pioneer-Standard Electronics 27,600 265,650
Richardson Electronics 40,000 540,000
VLSI Technology* 12,700 213,122
------------
1,443,172
------------
Hardware - 8.9%
Aydin Corporation* 10,000 87,500
Boca Research* 29,800 134,100
California Micro Devices
Corporation* 33,600 157,500
Cirrus Logic* 35,000 389,375
Cubic Corporation 13,300 317,538
DRS Technologies* 7,000 83,125
Elsag Bailey Process
Automation* 15,000 360,937
Exabyte Corporation* 25,500 212,766
FSI International* 2,900 28,094
HMT Technology Corporation* 25,400 212,725
Lam Research Corporation* 9,400 179,775
Penn Engineering and
Manufacturing 13,700 342,500
Photon Dynamics* 24,600 86,100
S3 Incorporated* 4,200 21,525
Sigma Designs* 26,500 79,500
------------
2,693,060
------------
</TABLE>
24 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
PMF II JUNE 30, 1998 (unaudited)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Technology (continued)
Software/Services - 2.3%
Intersolv* 12,400 $ 199,175
MacNeal-Schwendler
Corporation* 22,700 222,744
National Computer Systems 11,400 273,600
-----------
695,519
-----------
Telecommunications - 2.0%
C-COR Electronics* 17,200 326,800
SymmetriCom* 28,600 171,600
Telco Systems* 6,700 95,056
-----------
593,456
-----------
5,425,207
===========
TOTAL COMMON STOCKS
(Cost $25,476,929) 27,108,285
===========
</TABLE>
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT
------
<S> <C> <C>
CORPORATE BOND -- 0.3%
VLSI Technology 8.25% Conv.
Sub. Note due 10/01/05
(Cost $99,250) $100,000 97,750
===========
</TABLE>
<TABLE>
<CAPTION>
VALUE
-----
<S> <C>
REPURCHASE AGREEMENT -- 9.9%
State Street Bank and Trust Company,
5.15% dated 6/30/98, due 7/01/98,
maturity value $3,000,429
(collateralized by U.S. Treasury
Bonds, 10.625% due 8/15/15,
valued at $3,061,071)
(Cost $ 3,000,000) $ 3,000,000
===========
TOTAL INVESTMENTS -- 100.1%
(Cost $28,576,179) 30,206,035
LIABILITIES LESS CASH AND
OTHER ASSETS -- (0.1)% (42,164)
-----------
NET ASSETS -- 100.0% $30,163,871
===========
</TABLE>
- --------------------------------------------------------------------------------
* Non-income producing.
+ American Depository Receipt.
INCOME TAX INFORMATION: The cost of total investments for federal income tax
purposes was $28,576,179. At June 30, 1998, net unrealized appreciation for all
securities was $1,629,856, consisting of aggregate gross unrealized
appreciation of $3,408,554 and aggregate gross unrealized depreciation of
$1,778,698.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 25
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
ROYCE GIFTSHARES FUND JUNE 30, 1998 (unaudited)
- --------------------------------------------------------------------------------
COMMON STOCKS -- 91.0%
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Consumer Products -- 13.2%
Apparel and Shoes - 1.0%
Oshkosh B'Gosh Cl. A 1,500 $ 66,750
----------
Collectibles - 5.1%
Enesco Group 10,900 335,175
----------
Home Furnishings/Appliances - 0.7%
Bassett Furniture Industries 1,000 28,188
Lifetime Hoan Corporation 1,650 16,500
----------
44,688
----------
Publishing - 2.5%
Gibson Greetings* 5,200 130,000
The Topps Company* 11,500 35,578
----------
165,578
----------
Sports and Recreation - 3.9%
Johnson Worldwide
Associates Cl. A* 1,500 18,937
Lund International Holdings* 11,600 131,950
RockShox* 25,000 100,000
----------
250,887
----------
863,078
==========
Consumer Services -- 4.6%
Restaurants/Lodging - 1.7%
Applebee's International 5,000 111,875
----------
Retail - 2.9%
Catherines Stores Corporation* 3,900 38,269
Charming Shoppes* 32,000 152,000
----------
190,269
----------
302,144
==========
Financial Intermediaries -- 10.5%
Insurance - 10.5%
Capitol Transamerica Corporation 5,800 119,263
The Commerce Group 3,000 116,250
LandAmerica Financial Group 2,000 114,500
Leucadia National Corporation 1,000 33,062
Medical Assurance* 1,680 46,620
Nobel Insurance Limited 2,000 27,000
Pennsylvania Manufacturers
Corporation Cl. A 4,900 112,700
Zenith National Insurance 4,000 112,750
----------
682,145
==========
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Financial Services -- 3.6%
Insurance Brokers - 3.3%
Arthur J. Gallagher & Co. 2,000 $ 89,500
Willis Corroon Group ADR+ 10,000 125,625
----------
215,125
----------
Investment Management - 0.3%
Phoenix Investment Partners 2,000 17,375
----------
232,500
==========
Health -- 2.0%
Commercial Service - 0.8%
Young Innovations* 3,500 53,812
----------
Drugs and Biotech - 1.2%
BioReliance Corporation 5,000 75,313
----------
129,125
==========
Industrial Products -- 15.6%
Aerospace/Defense - 1.4%
Woodward Governor Company 3,000 92,625
----------
Construction Materials - 2.7%
CalMat 4,000 88,000
Florida Rock Industries 3,000 87,562
----------
175,562
----------
Machinery - 5.4%
Lincoln Electric Holding Co. 15,900 351,787
----------
Paper and Packaging - 2.2%
PalEx* 15,000 142,500
----------
Specialty Chemicals and Materials - 0.8%
Lilly Industries Cl. A 2,600 56,225
----------
Textiles - 0.7%
Unifi 1,300 44,525
----------
Other Industrial Products - 2.4%
BHA Group Holdings 3,443 56,809
Modern Controls 13,300 99,750
----------
156,559
----------
1,019,783
==========
Industrial Services -- 14.8%
Advertising - 1.8%
True North Communications 4,000 117,000
----------
Commercial Services - 1.8%
BHI Corporation* 3,000 118,500
----------
Engineering and Construction - 2.2%
Insituform Technologies Cl. A* 8,000 110,750
Sevenson Environmental Services 4,280 35,845
----------
146,595
----------
</TABLE>
26 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
ROYCE GIFTSHARES FUND JUNE 30, 1998 (unaudited)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Industrial Services (continued)
Food/Tobacco Processors - 2.1%
Midwest Grain Products* 3,300 $ 47,850
Standard Commercial
Corporation* 8,020 88,220
----------
136,070
----------
Printing - 1.5%
New England Business Service 3,000 96,750
----------
Transportation and Logistics - 5.4%
Arnold Industries 2,000 29,500
Frozen Food Express Industries 5,500 54,312
Kenan Transport Company 5,000 171,875
Pittston BAX Group 6,000 93,375
----------
349,062
----------
963,977
==========
Natural Resources -- 5.1%
Oil and Gas - 5.1%
Tom Brown* 9,400 176,838
Denbury Resources* 12,000 156,750
----------
333,588
==========
Technology -- 17.2%
Distribution - 5.8%
Perceptron* 7,000 84,000
Pioneer-Standard Electronics 10,000 96,250
Richardson Electronics 14,600 197,100
----------
377,350
----------
Hardware - 3.4%
Electroglas* 8,000 104,500
Exar Corporation* 3,700 77,700
Penn Engineering and
Manufacturing 1,500 37,500
----------
219,700
----------
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Software/Services - 8.0%
Kronos Incorporated* 5,000 $ 181,250
MacNeal-Schwendler
Corporation* 10,000 98,125
National Computer Systems 5,000 120,000
Sybase* 17,700 123,347
----------
522,722
----------
1,119,772
==========
Miscellaneous -- 4.4% 289,364
==========
TOTAL COMMON STOCKS
(Cost $5,566,134) 5,935,476
==========
REPURCHASE AGREEMENT -- 15.3%
State Street Bank and Trust Company,
5.15% dated 6/30/98, due 7/01/98,
maturity value $1,000,143
(collateralized by U.S. Treasury
Notes, 6.125% due 12/31/01,
valued at $1,021,331)
(Cost $1,000,000) 1,000,000
==========
TOTAL INVESTMENTS -- 106.3%
(Cost $6,566,134) 6,935,476
LIABILITIES LESS CASH AND
OTHER ASSETS -- (6.3)% (413,222)
----------
NET ASSETS -- 100.0% $6,522,254
==========
</TABLE>
- --------------------------------------------------------------------------------
* Non-income producing.
+ American Depository Receipt.
INCOME TAX INFORMATION: The cost of total investments for federal income tax
purposes was $6,566,134. At June 30, 1998, net unrealized appreciation for all
securities was $369,342, consisting of aggregate gross unrealized appreciation
of $675,261 and aggregate gross unrealized depreciation of $305,919.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 27
<PAGE>
STATEMENTS OF ASSETS AND LIABILITIES JUNE 30, 1998 (unaudited)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Pennsylvania Royce
Mutual Fund PMF II GiftShares Fund
----------- ------ ---------------
<S> <C> <C> <C>
ASSETS:
Investments at value (identified cost $385,966,630, $25,576,179 and
$5,566,134, respectively) $639,739,666 $27,206,035 $5,935,476
Repurchase agreements (at cost and value) 24,600,000 3,000,000 1,000,000
Cash 5,705 23,046 4,257
Collateral from brokers on securities loaned 7,677,700 -- --
Receivable for investments sold 885,480 176,900 --
Receivable for capital shares sold 2,538,029 120,517 13,775
Receivable for dividends and interest 714,165 20,669 7,418
Prepaid expenses and other assets 38,408 18,239 9,996
- ------------------------------------------------------------------------------------------------------------------------
Total Assets 676,199,153 30,565,406 6,970,922
- ------------------------------------------------------------------------------------------------------------------------
LIABILITIES:
Payable for collateral on securities loaned 7,677,700 -- --
Payable for investments purchased 1,485,280 354,724 435,569
Payable for capital shares redeemed 105,518 12,802 --
Payable for investment advisory fees 423,898 12,400 513
Accrued expenses 189,114 21,609 12,586
- ------------------------------------------------------------------------------------------------------------------------
Total Liabilities 9,881,510 401,535 448,668
- ------------------------------------------------------------------------------------------------------------------------
Net Assets $666,317,643 $30,163,871 $6,522,254
========================================================================================================================
ANALYSIS OF NET ASSETS:
Undistributed net investment income $ 1,736,073 $ 2,266 $ 1,022
Accumulated net realized gain on investments 50,652,635 2,515,443 568,494
Net unrealized appreciation on investments 253,773,036 1,629,856 369,342
Capital shares 78,412 4,734 834
Additional paid-in capital 360,077,487 26,011,572 5,582,562
- ------------------------------------------------------------------------------------------------------------------------
Net Assets $666,317,643 $30,163,871 $6,522,254
Investment Class $509,136,047 $30,163,871 $5,847,711
Consultant Class $157,181,596 $ 674,543
========================================================================================================================
SHARES OUTSTANDING:
(unlimited number of $.001 par value shares authorized for each Fund)
Investment Class 59,847,654 4,734,404 747,335
Consultant Class 18,564,091 86,839
========================================================================================================================
NET ASSET VALUES (Net Assets [divided by] Shares Outstanding):
Investment Class (offering and redemption price* per share) $8.51 $6.37 $7.82
Consultant Class (offering price** per share) $8.47 $7.77
========================================================================================================================
</TABLE>
* Shares redeemed within one year of purchase are subject to a 1% redemption
fee, payable to the Fund.
** Redemption price per share is equal to NAV, less applicable deferred sales
charge.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
28 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
====================================
Pennsylvania Mutual Fund
------------------------------------
Six months ended Year ended
June 30, 1998 December 31,
(unaudited) 1997
====================================
<S> <C> <C>
INVESTMENT OPERATIONS:
Net investment income (loss) $ 1,469,807 $ 4,409,053
Net realized gain on investments 49,353,674 57,122,461
Net change in unrealized appreciation on investments 6,524,261 59,891,240
- --------------------------------------------------------------------------------------------
Net increase in net assets from investment operations 57,347,742 121,422,754
- --------------------------------------------------------------------------------------------
DIVIDENDS AND DISTRIBUTIONS:
Net investment income
Investment Class -- (3,514,299)
Consultant Class -- (658,502)
Net realized gain on investments
Investment Class -- (57,918,964)
Consultant Class -- (17,311,988)
- --------------------------------------------------------------------------------------------
Total dividends and distributions -- (79,403,753)
- --------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS:
Net proceeds from shares sold
Investment Class 55,690,494 60,713,483
Consultant Class 2,471,317 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
Consultant Class -- 17,180,389
Cost of shares redeemed
Investment Class (98,912,080) (108,160,769)
Consultant Class (9,863,196) (10,190,290)
- --------------------------------------------------------------------------------------------
Net increase (decrease) in net assets from
capital share transactions (50,613,465) 160,696,415
- --------------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS 6,734,277 202,715,416
NET ASSETS:
Beginning of period 659,583,366 456,867,950
- --------------------------------------------------------------------------------------------
End of period (a) $ 666,317,643 $ 659,583,366
============================================================================================
CAPITAL SHARE TRANSACTIONS:
Shares sold
Investment Class 6,657,239 7,452,126
Consultant Class 295,415 156,892
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
Consultant Class -- 2,205,442
Shares redeemed
Investment Class (11,733,386) (13,880,141)
Consultant Class (1,187,995) (1,200,763)
- --------------------------------------------------------------------------------------------
Net increase (decrease) in shares outstanding (5,968,727) 20,130,195
- --------------------------------------------------------------------------------------------
<CAPTION>
===================================================================
PMF II Royce GiftShares Fund
---------------------------------- --------------------------------
Six months ended Year ended Six months ended Year ended
June 30, 1998 December 31, June 30, 1998 December 31,
(unaudited) 1997 (unaudited) 1997
===================================================================
<S> <C> <C> <C> <C>
INVESTMENT OPERATIONS:
Net investment income (loss) $ 2,266 $ 245,395 $ 1,022 $ (6,040)
Net realized gain on investments 1,937,232 1,811,059 556,908 192,176
Net change in unrealized appreciation on investments (486,066) 1,644,420 70,917 221,469
- --------------------------------------------------------------------------------------------------------------------------
Net increase in net assets from investment operations 1,453,432 3,700,874 628,847 407,605
- --------------------------------------------------------------------------------------------------------------------------
DIVIDENDS AND DISTRIBUTIONS:
Net investment income
Investment Class -- (271,235) -- --
Consultant Class -- --
Net realized gain on investments
Investment Class -- (1,220,556) -- (184,608)
Consultant Class -- (3,935)
- --------------------------------------------------------------------------------------------------------------------------
Total dividends and distributions -- (1,491,791) -- (188,543)
- --------------------------------------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS:
Net proceeds from shares sold
Investment Class 7,992,679 3,475,010 1,679,997 2,172,160
Consultant Class 505,361 105,710
Value of shares issued in connection with the
merger of Royce Value Fund
Consultant Class
Distributions reinvested
Investment Class -- 1,388,651 -- 184,794
Consultant Class -- 3,935
Cost of shares redeemed
Investment Class (1,525,740) (2,686,425) (13,114) (27,676)
Consultant Class -- (411)
- --------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in net assets from
capital share transactions 6,466,939 2,177,236 2,172,244 2,438,512
- --------------------------------------------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS 7,920,371 4,386,319 2,801,091 2,657,574
NET ASSETS:
Beginning of period 22,243,500 17,857,181 3,721,163 1,063,589
- --------------------------------------------------------------------------------------------------------------------------
End of period (a) $ 30,163,871 $ 22,243,500 $6,522,254 $3,721,163
==========================================================================================================================
CAPITAL SHARE TRANSACTIONS:
Shares sold
Investment Class 1,220,150 603,433 225,672 317,894
Consultant Class 71,272 15,046
Shares issued in connection with the
merger of Royce Value Fund
Consultant Class
Shares issued for reinvestment of
dividends and distributions
Investment Class -- 232,216 -- 27,216
Consultant Class -- 581
Shares redeemed
Investment Class (244,303) (470,991) (1,634) (4,318)
Consultant Class -- (60)
- --------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in shares outstanding 975,847 364,658 295,310 356,359
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Includes undistributed net investment income of $1,736,073, $2,266 and
$1,022 in 1998 and $266,266, $0 and $0 in 1997 for Pennsylvania Mutual
Fund, PMF II and Royce GiftShares Fund, respectively.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 29
<PAGE>
STATEMENTS OF OPERATIONS SIX MONTHS ENDED JUNE 30, 1998 (unaudited)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Pennsylvania Royce
Mutual Fund PMF II GiftShares Fund
------------ ------ ---------------
INVESTMENT INCOME:
Income:
<S> <C> <C> <C>
Dividends $ 4,434,268 $ 126,741 $ 24,998
Interest 977,756 37,369 18,581
- -----------------------------------------------------------------------------------------------------
Total Income 5,412,024 164,110 43,579
- -----------------------------------------------------------------------------------------------------
Expenses:
Investment advisory fees 2,609,348 129,455 27,024
Distribution fees 779,783 -- 8,479
Shareholder servicing fees 179,445 8,477 10,487
Administrative and office facilities expenses 168,432 5,803 996
Postage expenses 109,341 8,223 6,207
Custodian fees 73,141 19,316 6,097
Audit fees 37,229 6,135 6,535
Trustees' fees 35,778 1,323 299
Registration fees 19,019 6,712 8,087
Legal fees 13,596 626 225
Other expenses 112,050 7,299 4,512
- -----------------------------------------------------------------------------------------------------
Total Expenses 4,137,162 193,369 78,948
Fees Waived by Investment Adviser and Distributor (194,945) (31,525) (29,515)
Expenses Reimbursed by Investment Adviser -- -- (6,876)
- -----------------------------------------------------------------------------------------------------
Net Expenses 3,942,217 161,844 42,557
- -----------------------------------------------------------------------------------------------------
Net Investment Income 1,469,807 2,266 1,022
- -----------------------------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN ON INVESTMENTS:
Net realized gain on investments 49,353,674 1,937,232 556,908
Net change in unrealized appreciation on investments 6,524,261 (486,066) 70,917
- -----------------------------------------------------------------------------------------------------
Net realized and unrealized gain on investments 55,877,935 1,451,166 627,825
- -----------------------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS FROM INVESTMENT OPERATIONS $57,347,742 $1,453,432 $ 628,847
=====================================================================================================
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
This table is presented to show selected data for a share outstanding throughout
each period, and to assist shareholders in evaluating a Fund's performance for
the periods presented.
<TABLE>
<CAPTION>
NET ASSET VALUE, NET INVESTMENT NET REALIZED AND DIVIDENDS FROM
BEGINNING INCOME UNREALIZED GAIN (LOSS) NET INVESTMENT
OF PERIOD (LOSS) ON INVESTMENTS INCOME
---------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PENNSYLVANIA MUTUAL FUND -- INVESTMENT CLASS (a)
++ 1998 $7.82 $0.03 $0.66 $ --
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)
++ 1998 $7.81 ($0.01) $0.67 $ --
1997 7.90 0.02 0.93 (0.04)
PMF II (c)
++ 1998 $5.92 $ -- $0.45 $ --
1997 5.26 0.07 1.03 (0.08)
1996 5.00 -- 0.26 --
ROYCE GIFTSHARES FUND -- INVESTMENT CLASS (d)
++ 1998 $6.91 $ -- $0.91 $ --
1997 5.83 (0.01) 1.52 --
1996 5.01 -- 1.27 --
1995 5.00 -- 0.01 --
ROYCE GIFTSHARES FUND -- CONSULTANT CLASS (e)
++ 1998 $6.88 ($0.02) $0.91 $ --
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)
++ $ -- $8.51 8.8% $ 509,136 1.00%* 0.61%* 11% $0.0653
(1.00) 7.82 25.0% 507,635 1.05% 0.88% 18% 0.0629
(1.44) 7.11 12.8% 456,868 0.99% 1.05% 29% 0.0588
(0.97) 7.71 18.7% 630,119 0.98% 1.18% 10% --
(0.73) 7.41 (0.7)% 771,417 0.98% 1.33% 17% --
(0.48) 8.31 11.3% 1,022,161 0.98% 1.23% 24% --
PENNSYLVANIA MUTUAL FUND -- CONSULTANT CLASS (b)
++ $ -- $8.47 8.5% $ 157,182 1.74%* (0.13)%* 11% $0.0653
(1.00) 7.81 12.0% 151,948 1.65%* 0.29%* 18% 0.0629
PMF II (c)
++ $ -- $6.37 7.6% $ 30,164 1.25%* 0.02%* 46% $0.0575
(0.36) 5.92 20.8% 22,244 0.99% 1.23% 77% 0.0564
-- 5.26 5.2% 17,857 0.97%* 0.83%* 1% 0.0586
ROYCE GIFTSHARES FUND -- INVESTMENT CLASS (d)
++ $ -- $7.82 13.2% $ 5,848 1.49%* 0.11%* 53% $0.0640
(0.43) 6.91 26.0% 3,614 1.49% (0.32)% 64% 0.0558
(0.45) 5.83 25.6% 1,064 1.49% (0.05)% 93% 0.0566
-- 5.01 0.2% 502 0.70%* 0.00%* 0% --
ROYCE GIFTSHARES FUND -- CONSULTANT CLASS (e)
++ $ -- $7.77 12.9% $ 675 2.49%* (0.76)%* 53% $0.0640
(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 ratios are shown after fee waivers by the distributor. For the
periods ended June 30, 1998 and December 31, 1997, the expense ratios
before the waivers would have been 1.99% and 2.00%, respectively. The Class
commenced operations on June 18, 1997.
(c) Expense ratios are shown after fee waivers by the investment adviser. For
the periods ended June 30, 1998, December 31, 1997 and 1996, the expense
ratios before the waivers would have been 1.49%, 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 June 30,
1998, December 31, 1997, 1996 and 1995, the expense ratios before the
waivers and reimbursements would have been 2.60%, 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 periods ended June 30, 1998 and December
31, 1997, the expense ratios before the waivers and reimbursements would
have been 6.34% and 30.28%, respectively. The Class commenced operations on
September 26, 1997. Total returns do not deduct contingent deferred sales
charges.
* Annualized.
+ Beginning in 1996, funds are required to disclose average commission rates
paid per share for purchases and sales of investments.
++ Six months ended June 30, 1998 (unaudited).
30 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
NOTES TO FINANCIAL STATEMENTS (unaudited)
- --------------------------------------------------------------------------------
Summary of Significant Accounting Policies:
Pennsylvania Mutual Fund, PMF II and Royce GiftShares Fund (the "Fund" or
"Funds") are three series of The Royce Fund (the "Trust"), a diversified
open-end management investment company organized as a Delaware business trust.
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.
Classes of shares have equal rights as to earnings and assets, except
that each class may bear different net distribution and shareholder servicing
fees, certain other expenses and expense reimbursements. Investment income,
realized and unrealized capital gains or losses on investments and expenses
other than those attributable to a specific class are allocated to each class
of shares based on its relative net assets.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of income and expenses during the
reporting period. Actual results could differ from those estimates.
Valuation of investments:
Securities listed on an exchange or on the Nasdaq National Market System
are valued on the basis of the last reported sale prior to the time the
valuation is made or, if no sale is reported for such day, at their bid price
for exchange-listed securities and at the average of their bid and asked
prices for Nasdaq securities. Quotations are taken from the market where the
security is primarily traded. Other over-the-counter securities for which
market quotations are readily available are valued at their bid price.
Securities for which market quotations are not readily available are valued at
their fair value under procedures established and supervised by the Board of
Trustees. Bonds and other fixed income securities may be valued by reference
to other securities with comparable ratings, interest rates and maturities,
using established independent pricing services.
Investment transactions and related investment income:
Investment transactions are accounted for on the trade date. Dividend
income is recorded on the ex-dividend date and any non-cash dividend income is
recorded at the fair market value of the securities received. Interest income
is recorded on the accrual basis. Realized gains and losses from investment
transactions and unrealized appreciation and depreciation are determined on
the basis of identified cost for book and tax purposes.
Expenses:
The Funds incur direct and indirect expenses. Expenses directly
attributable to a Fund are charged to the Fund's operations, while expenses
applicable to one or more Royce Funds are allocated in an equitable manner.
Allocated personnel costs of employees of The Royce Funds are included in
administrative and office facilities expenses.
Taxes:
As qualified regulated investment companies under Subchapter M of the
Internal Revenue Code, the Funds are not subject to income taxes to the extent
that each Fund distributes substantially all of its taxable income for its
fiscal year. The Schedules of Investments include information regarding income
taxes under the caption "Income Tax Information".
Distributions:
Any dividend and capital gain distributions are recorded on the
ex-dividend date and paid annually in December. These distributions are
determined in accordance with income tax regulations which may differ from
generally accepted accounting principles. Permanent book and tax basis
differences relating to shareholder distributions will result in
reclassifications within the capital accounts. Undistributed net investment
income may include temporary book and tax basis differences which will reverse
in a subsequent period. Any taxable income or gain remaining at fiscal year
end is distributable in the following year.
Repurchase agreements:
The Funds enter into repurchase agreements with respect to portfolio
securities solely with State Street Bank and Trust Company ("SSB&T"), the
custodian of the Funds' assets. Each Fund restricts repurchase agreements to
maturities of no more than seven days. Securities pledged as collateral for
repurchase agreements, which are held by SSB&T until maturity of the
repurchase agreements, are marked-to-market daily and maintained at a value at
least equal to the principal amount of the repurchase agreement (including
accrued interest). Repurchase agreements could involve certain risks in the
event of default or insolvency of SSB&T, including possible delays or
restrictions upon the ability of each Fund to dispose of its underlying
securities.
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 by
the custodian. The collateral is equal to at least 100% of the current market
value of the loaned securities.
THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998 | 31
<PAGE>
NOTES TO FINANCIAL STATEMENTS (unaudited) (continued)
- --------------------------------------------------------------------------------
Investment Adviser and Distributor:
Under the Trust's investment advisory agreements with Royce & Associates,
Inc. ("Royce"), Royce is entitled to receive management fees which are
computed daily and payable monthly. For the six months ended June 30, 1998,
Pennsylvania Mutual Fund, PMF II and Royce GiftShares Fund recorded advisory
fees of $2,609,348, $97,930 (net of voluntary waivers of $31,525) and $3,690
(net of voluntary waivers of $23,334), respectively. 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.
Royce Fund Services, Inc. ("RFS"), the distributor of the Trust's shares,
is an affiliate of Royce. For the six months ended June 30, 1998, RFS received
12b-1 distribution fees of $584,838 (net of voluntary waivers of $194,945) and
$2,298 from the Consultant Classes of Pennsylvania Mutual Fund and Royce
GiftShares Fund, respectively. RFS voluntarily waived the distribution fees of
$6,181 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 0.25% per annum of Royce GiftShares
Fund -- Investment Class' average net assets.
Purchases and Sales of Investment Securities:
For the six months ended June 30, 1998, the cost of purchases and the
proceeds from sales of investment securities, other than short-term
securities, were as follows:
<TABLE>
<CAPTION>
====================================================================================
Pennsylvania Mutual Fund PMF II Royce GiftShares Fund
-------------------------- -------------- ----------------------
<S> <C> <C> <C>
Purchases $ 67,780,625 $15,754,714 $4,923,627
- ------------------------------------------------------------------------------
Sales $108,328,848 $11,010,638 $2,344,075
====================================================================================
</TABLE>
Transactions in Affiliated Companies:
An "Affiliated Company", as defined in the Investment Company Act of
1940, is a company in which a Fund owns at least 5% of the company's
outstanding voting securities. Pennsylvania Mutual Fund effected the following
transactions in shares of such companies for the six months ended June 30,
1998.
<TABLE>
<CAPTION>
================================================================================
Purchases Sales
Affiliated ----------------- ----------------- Realized Dividend
Company Shares Cost Shares Cost Gain/Loss Income
- -------------- -------- ------ -------- ------ ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
Preformed
Line Products
Company -- -- -- -- -- $52,191
Sevenson
Environmental
Services -- -- -- -- -- $20,622
================================================================================
</TABLE>
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, qualified 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.
32 | THE ROYCE FUNDS SEMI-ANNUAL REPORT 1998
<PAGE>
POSTSCRIPT
- --------------------------------------------------------------------------------
[graphic: montage: Wall Street street sign, stock certificates, Stock Market
building front, people working the stock market floor]
[page background image: man shooting a basketball]
HANG TIME
By now, the sight has grown familiar to all of us. A man with a basketball
launches himself off the hardwood into the air from what looks like an absurdly
early spot at the very top -- the very tip -- of the key. Moving gracefully and
effortlessly skyward, he displays an uncanny ability to evade any defender in
his path. The bodies of opponents gyrate at awkward angles, bobbing up and down
in a futile effort to stop him -- they do not even slow him down. As he cruises
toward the basket, there typically remains one hardy soul who will attempt to
forestall the inevitable. Yet this defender is also left confounded and
frustrated. Taking evasive action, the man shifts the ball from his left hand to
his right, now back again to his left, as the last defender plummets earthward,
landing on the court, able only to gaze upward and watch enviously as the man
dunks the ball with an elegance that a dunk is not supposed to possess. Michael
Jordan has done it again.
Jordan's aerial exploits have become the stuff of legend because of moments
such as this. With what looks like a casual disregard for the laws of gravity,
he has risen to be not only the greatest athlete of his time and the greatest
basketball player in the history of the game, but arguably the most famous human
being on the face of the earth. Basketball writers looking for a way to do
justice to his airness' high-flying feats have contributed a new phrase to our
collective lexicon, used to describe anything that lingers longer in the air
than physics or common sense would seem to allow -- Hang Time.
In our view, the stock market of the past four years is best characterized
as Jordanesque in the ability of a different sort of rampaging bull to remain at
lofty levels longer than any rational explanation would seem capable of
justifying. The prognosticators who have explained exactly why the Dow had
reached a peak at (take your pick) 7000, 8000 or 9000 have subsequently felt
like the multitude of sports writers who have prematurely predicted Jordan's
retirement. This explains why we like to avoid prognostication and instead save
our energy for the real game -- striving to build wealth for our shareholders.
The fundamentals of our small-cap value style -- finding attractively priced
companies with solid financials -- are the equivalent of good shot selection and
tough defense.
The market's remarkable hang time, like Jordan's, while enabling it to fly
to unparalleled heights for unequaled lengths of time, also makes it the
exception that proves the rule. Most would agree that Jordan is one of a kind,
and we feel much the same way about the recent run of the market. We should all
enjoy the good times while we can, without losing sight of the fact that, sooner
or later, all good things come to an end. Someday, and the day is not far off,
Michael will be more concerned about a tee time than a tip-off, having returned
the game to mere mortals. We believe that the market, too, will return to more
historical levels of performance and volatility, and when it does, we will be
where we have always been, playing the game with a solid fundamental approach.
[sidebar]
The market's remarkable hang time, like Jordan's, while enabling it to fly to
unparalleled heights for unequaled lengths of time, also makes it the exception
that proves the rule. Most would agree that Jordan is one of a kind, and we feel
much the same way about the recent run of the market.
[end sidebar]
<PAGE>
THE
ROYCE
FUNDS
ONE OF THE INDUSTRY'S MOST EXPERIENCED AND
HIGHLY-RESPECTED SMALL COMPANY VALUE MANAGERS
Charles M. Royce, who has been our primary portfolio manager since 1973, enjoys
one of the longest tenures of any active mutual fund manager. Today, with $3
billion in total assets under management, Royce & Associates, Inc. remains an
independent firm committed to the same principles that have served us well for
25 years.
MULTIPLE FUNDS, COMMON FOCUS
Over the years, we have chosen to concentrate on small company value investing.
Chuck Royce and his team provide investors with a range of funds that take full
advantage of the large and diverse small-cap sector. Our goal is to offer both
individual and institutional investors the best available small-cap value
portfolios by providing above-average full market cycle total returns with
below-average risk.
REALISTIC EXPECTATIONS AND CONSISTENT DISCIPLINE
Royce Premier Fund, Royce Total Return Fund and Pennsylvania Mutual Fund have
been among the "lowest risk" small-cap equity funds available. We cultivated our
approach by paying close attention to risk and by always maintaining the same
discipline, regardless of market movements and trends.
CO-OWNERSHIP OF FUNDS
As part of this commitment, it is important that our employees and shareholders
share a common financial goal; our principals, employees and their affiliates
currently have more than $40 million invested in The Royce Funds.
VALUE INVESTING IN SMALL COMPANIES FOR 25 YEARS
<TABLE>
<S> <C>
THE ROYCE FUNDS ADVISOR SERVICES
1414 Avenue of the Americas For Fund Materials, Performance Updates,
New York, NY 10019 Transactions or Account Inquiries
(800) 33-ROYCE (337-6923)
GENERAL INFORMATION
Additional Report Copies AUTOMATED TELEPHONE SERVICES
and Prospectus Inquiries (800) 78-ROYCE (787-6923)
(800) 221-4268
E-mail: [email protected]
SHAREHOLDER SERVICES Web address: www.roycefunds.com
(800) 841-1180
</TABLE>
This report must be accompanied or preceded by a current prospectus for one or
more of the Funds. Please read the prospectus carefully before investing or
sending money.
