[Front Cover]
Value Investing in Small Companies
for More Than 25 Years
THE
ROYCE
FUNDS
PENNSYLVANIA MUTUAL FUND
PMF II
ROYCE GIFTSHARES FUND
1998 Annual Report
www.roycefunds.com
[End Front Cover]
<PAGE>
The Royce Funds Road Map
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TWO DISTINCT MARKETS
For more than 25 years, Royce & Associates has utilized a disciplined value
approach to select small-cap companies. We believe that the small-cap universe
is comprised of two distinct markets, small- and micro-cap, and that each
requires a distinct investment strategy.
[Blue Line] SMALL-CAP
[Yellow Line] MICRO-CAP
CORE FUNDS
The small-cap universe (companies with market caps between $300 million and $1
billion) is no longer small, unknown or under-owned; therefore, we believe that
this higher level of efficiency requires greater portfolio concentration.
The micro-cap universe (companies with market caps less than $300 million)
provides more choices (approximately 6,500 companies), yet greater trading
difficulties; therefore, we believe that broad diversification is appropriate
given the liquidity constraints of this sector.
[Blue Line] ROYCE PREMIER FUND
Concentrated Small-Cap Portfolio
[Yellow Line] ROYCE MICRO-CAP FUND
Diversified Micro-Cap Portfolio
COMBINED FUNDS
These portfolios invest in both small- and micro-cap companies and represent our
flagship approach. Two of our combined portfolios, Pennsylvania Mutual Fund and
PMF II, employ a more diversified investment strategy and are designed for both
individuals and institutions. Royce GiftShares Fund, one of the few gifting and
estate-planning portfolios, uses a more concentrated approach.
[Blue Line] PENNSYLVANIA MUTUAL FUND
[Yellow Line] Diversified Small- and Micro-Cap Portfolio
[Blue Line] PMF II
[Yellow Line] Diversified Small- and Micro-Cap Portfolio
[Blue Line] ROYCE GIFTSHARES FUND
[Yellow Line] Concentrated Small- and Micro-Cap Portfolio
THEME FUNDS
These portfolios invest in securities primarily found in our Core Funds that
have special attributes. One has low-volatility characteristics (dividends), one
has the potential for higher returns and volatility (low-priced stocks) and one
takes specific sector (financial services) risk. Performance and volatility may
be substantially different for each of these portfolios.
[Blue Line] ROYCE TOTAL RETURN FUND
[Yellow Line] Dividend-Paying Securities
[Blue Line] ROYCE LOW-PRICED STOCK FUND
[Yellow Line] Stocks Priced Below $15
[Blue Line] ROYCE FINANCIAL SERVICES FUND
[Yellow Line] Financial Services Companies
<PAGE>
THE ROYCE FUNDS
- --------------------------------------------------------------------------------
Annual Report Reference Guide
================================================================================
<TABLE>
<S> <C>
Jump, Jive An' Wail: 1998's stock market provided more than its share of swinging moments. 2
- ---------------------------------------------------------------------------------------------------
It Don't Mean a Thing (If It Ain't Got That Swing): Recent changes to 5
small-cap stock definitions have little impact on our own small- and
micro-cap work.
- ---------------------------------------------------------------------------------------------------
Pennsylvania Mutual Fund* outperformed its small-cap benchmark index, the 10
Russell 2000, for the second half, the one-, three-, 15- and 20-year periods.
The Fund's average annual total return since Chuck Royce became its portfolio
manager (6/30/73) was 16.0%.
- ---------------------------------------------------------------------------------------------------
PMF II, managed by Buzz Zaino since April 1, 1998, outperformed the Russell 2000 12
for the fourth quarter, the second half, the one-year, two-year and since
inception (11/19/96) periods.
- ---------------------------------------------------------------------------------------------------
Royce GiftShares Fund*, our gifting and estate-planning portfolio, outperformed 14
the Russell 2000 for the fourth quarter, the second half, the one-year,
three-year and since inception (12/27/95) periods. The Fund's average annual
total return since inception was 23.6%.
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Updates and Notes: What's New on Our Website 16
(www.roycefunds.com) and a Y2K Update.
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Schedules of Investments and Other Financial Statements. 17
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Postscript: Furby-Mania. Inside Back Cover
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</TABLE>
For more than 25 years, our approach has focused on evaluating a company's worth
- -- what we believe a business 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 pay for a security must be substantially lower than
our appraisal of its worth.
[Graphic: looking through magnifying glass at The Royce Funds newpaper listing]
AVERAGE ANNUAL TOTAL RETURNS Through December 31, 1998
<TABLE>
<CAPTION>
SINCE
FUND (INCEPTION) 1-YEAR 3-YEAR 5-YEAR INCEPTION
- --------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Pennsylvania Mutual Fund* (6/30/73) 4.2% 13.7% 11.6% 16.0%
- --------------------------------------------------------------------------------------
PMF II (11/19/96) 4.9 n/a n/a 14.6
- --------------------------------------------------------------------------------------
Royce GiftShares Fund* (12/27/95) 19.5 23.7 n/a 23.6
- --------------------------------------------------------------------------------------
* Investment Class.
<PAGE>
Letter To Our Shareholders
- --------------------------------------------------------------------------------
[Begin Sidebar]
[PHOTO OF CHARLES M. ROYCE]
Charles M. Royce, President
I feel very strongly that the new market cycle will be shorter, with more
historically typical annualized returns. The last cycle began in 1990. By any
traditional measurement, that was a very long period. I think that the new cycle
will last no more than a couple of years and could well be a very low return
period.
[End Sidebar]
[Cartoon Graphic: dancers "Jiving" to a swing band at the "Wall Street Hop"]
-C- Blaustein '99
JUMP, JIVE AN' WAIL
Although the stock market took a brief but dramatic downturn during the third
quarter, it was not enough to keep its swinging participants off the dance
floor. In three out of four quarters in 1998, large-cap stocks provided
investors with jazzed-up returns. In contrast, small-cap securities grooved in
quarters one and four, but sang the blues in quarters two and three.
This year's stock market soiree also produced swing in abundance.
According to Tim Hayes of Ned Davis Research, the average daily swing of the Dow
Jones Industrial Average ("Dow") in 1998 from the low to the high was 2.6% on an
intra day basis or about 225 points a day. On an intra-year basis, the large-cap
S&P 500 was off 19.2% from its peak on July 17, 1998 to its trough on August 31,
1998, while the small-cap Russell 2000 was off 36.5% from its April 21, 1998
peak to its October 8 trough. Although both large- and small-cap securities
rallied in 1998's fourth quarter, the calendar-year performance disparity
between the two indices was the widest since the inception of the Russell 2000
Index in 1979.
THE JOINT IS JUMPIN'
Large-cap and technology stocks were at the top of the charts in 1998. Both the
Dow and S&P 500 reached record highs despite third quarter setbacks. The Dow
(+18.1%) generated its fourth consecutive year of double digit gains, and the
S&P 500 (+28.6%) posted an unprecedented fourth consecutive year of 20%+
returns.
If this were not amazing enough, consider the results of the Nasdaq
Composite, which was up 39.6% for the year. How much of a difference did
technology make? The tech-heavy Nasdaq 100 finished 1998 up 85.5% versus only
6.8% for the Nasdaq Industrials. Wow!
2 | The Royce Funds Annual Report 1998
<PAGE>
I GOT IT BAD (AND THAT AIN'T GOOD)
While large-cap enjoyed cheers and applause in 1998, small-cap endured cat
calls. However, even though the small-cap oriented Russell 2000 did hit some
sour notes -- the index was down 2.6% for the full year -- it was not entirely
off key, considering it was down 23.9% for the combined second and third
quarters. Just how tough was it for small-cap mutual fund investors? According
to fund rating service Morningstar, out of 2,802 domestic equity funds overall,
only 12 of the 397 small-cap objective funds with a three-year history garnered
four or five star ratings as of December 31, 1998. This means that out of the
910 funds that received four or five star ratings, only 1.3% were small-cap
portfolios.
Fortunately for those of us in the small-cap business, there were some
smooth sounds to soothe the second and third quarter blues as small-caps staged
a short but impressive rally at year-end. From its bottom on October 8 through
December 31, the Russell 2000 was up 36.3%, comfortably ahead of the S&P 500,
which was up 28.1%. A little more of this in 1999 would be music to our ears.
[Begin Callout]
[O]ut of the 910 funds that received four or five star [Morningstar] ratings,
only 1.3% [12 funds] were small-cap portfolios.
[End Callout]
EVERY PICTURE TELLS A STORY
While calendar-year periods are often used in performance comparisons, we find
that peak-to-peak periods, or full market cycles, are generally more revealing,
especially when discussing relative performance. Although small-cap
underperformance was evident throughout most of 1998, we believe that the
small-cap downturn began much earlier. Prior to the high established on April
21, the last major peak for the Russell 2000 occurred on May 22, 1996, led by
technology and a flood of IPO offerings. From that previous peak to the Russell
2000 trough on October 8, 1998, small-cap stocks were not on investors' hit
parade.
Many investors forget that small-caps were the market leaders for the
almost six-year period prior to the peak on May 22, 1996, which began with the
small-cap trough in October, 1990. Perhaps the recent period of prolonged
underperformance has made memories fuzzy.
These distinctly different periods demonstrate the ebb and flow
between large- and small-cap performance and how unrealistic it is to expect
small-cap companies to always lag or large-cap companies to permanently lead.
With this in mind, we thought that it would be interesting to examine the April
- - October small-cap decline in the context of previous downturns. Since the
Russell 2000's inception in 1979, there have been five major small-cap declines
of 20% or more, including 1998's. Each of the four previous declines was
followed by one- to two-year periods of substantial upside performance (70%+).
LATE '90s: Small Caps Languish
5/22/96 - 10/8/98
- ------------------------------
</TABLE>
<TABLE>
<S> <C>
Russell 2000 -12.0%
S&P 500 47.6%
</TABLE>
Early '90s: A completely different picture
10/31/90 - 5/22/96
- ------------------------------------------
<TABLE>
<S> <C>
Russell 2000 236.2%
S&P 500 162.1%
</TABLE>
The Royce Funds Annual Report 1998 | 3
<PAGE>
[Begin Sidebar]
There has certainly been a change in market leadership, one that so far has had
its greatest effect within large-cap. Global multinationals and financial
services have relinquished leadership to technology, which continues to be a
market-leading sector within both large- and small-cap. This is the beginning, I
think, of a substantial shift in overall market leadership, which signals the
beginning of a new market cycle.
[End Sidebar]
With the Russell 2000 up 36.3% from its October low, have potential
small-cap investors missed the boat? If history is any indication, we don't
think so. While the past is not a blueprint for the future, historical precedent
might suggest that the small-cap rally has both time and distance on its side.
RUSSELL 2000 PEAK-TO-TROUGH-TO-PEAK PERFORMANCE PERIODS
[bar chart]
<TABLE>
<CAPTION>
<S> <C>
Decline From Peak Subsequent Rise
-26.2% 115.5%
6/15/81-8/12/82 8/12/82-6/24/83
-24.1% 72.5%
6/24/83-7/25/84 7/25/84-7/3/86
-38.9% 76.8%
8/25/87-10/28/87 10/28/87-10/9/89
-32.5% 83.1%
10/9/89-10/31/90 10/31/90-2/12/92
-36.5% 36.3%
4/21/98-10/8/98 10/8/98-12/31/98
</TABLE>
[end bar chart]
Historical market trends are not necessarily indicative of future market
movements.
WE WALK THE LINE
Twice each year, we provide details and offer commentary on our Funds' recent
performance. This exercise, while important in many ways, always gives us pause.
As long-term investors, it feels odd to spend time commenting on short-term
performance. Yet the investment world is captivated by the short term, with far
too much attention devoted to who has this year's -- or even this quarter's --
best returns. In contrast, we believe that investors should be neither too
encouraged nor too dismayed by short-term relative results.
We are less concerned about near-term performance -- even when, as in
1998, we are pleased with the results -- because valuation and performance are
rarely in sync in the short run. In other words, we do not expect today's
undervalued stock to immediately reach what we think is its full value. Our
investment horizon for portfolio selection is three to five years;
Take The "A" Train
During a holiday season vacation, the intrepid advisor hopped on the New York
City subway and took the "A" train to the Columbus Circle stop. After joining in
on a jam session with the Duke Ellington Orchestra, he made his way to our
office and chatted with Chuck Royce about the relevance of the terms "growth"
and "value" in today's small-cap market.
With all the changes that have taken place in the small-cap world over the last
decade, do you think that the definitions of value and growth have changed as
well?
The definitions have not changed as much as their usefulness has. At
some level, we think that describing the way that we manage money exclusively as
"value" is incomplete. Although it's common practice within the investment
community to do so, we don't divide the equity world into growth and value
stocks. We spend our time thinking about how to limit risk without sacrificing
return. If we find a stock that we believe has terrific growth prospects, we
want to buy it with the least risk possible, i.e., at an attractive price -- we
don't worry about whether or not the stock is considered a value or a growth
stock.
4 | The Royce Funds Annual Report 1998
<PAGE>
in general we try to find stocks with the potential to at least double in value
during that time period. What happens in the short term is a function of market
direction and luck. We can control neither. While Pennsylvania Mutual Fund, PMF
II and Royce GiftShares Fund did provide a short-term performance advantage over
the Russell 2000, we are most pleased that the Funds have provided a long-term
performance edge. For a complete review and discussion of our results and our
risk profiles, please see pages 10-15.
[Begin Callout]
Our investment horizon for portfolio selction is three to five years; in general
we try to find stocks with the potential to at least double in value during that
time period.
[End Callout]
IT DON'T MEAN A THING
(IF IT AIN'T GOT THAT SWING)
Several years ago, Billboard magazine made changes in the criteria of its famous
chart system to more effectively track the changing music scene. In a similar
move, Morningstar, Inc. and Lipper Analytical, the fund industry's preeminent
ranking and analysis services, recently announced that they would be altering
their capitalization and style criteria to more accurately reflect the realities
of today's equity market. For instance, rather than use pre-established
market-cap cutoffs, with small-cap being defined as less than $1 billion,
Morningstar has now divided the equity universe based on the following
percentages: Large-cap will constitute the top 5% of the 5,000 largest U.S.
stocks in their database, mid-cap will be the next 15% of the 5,000 and
small-cap will comprise the remaining 80%. The net effect is a more liberal
definition of small-cap stocks and by
RUSSELL 2000'S EXPANDING MARKET CAPITALIZATION
<TABLE>
<CAPTION>
12/31/89 12/31/94 12/31/98
- -------------------------------------------------
<S> <C> <C> <C>
Weighted Average $190 $400 $880
- -------------------------------------------------
Median $70 $210 $430
- -------------------------------------------------
</TABLE>
Russell 2000 weighted average and median market capitalization in millions.
Source: Frank Russell Company
If value and growth have become less useful terms, what has been the effect on
the firm's selection process?
There really hasn't been an appreciable effect on our selection
process. We have always looked at our mission in life, so to speak, as wanting
to be very good small-cap investors who pay equal attention to risk and reward.
We've never been anti-growth, we just don't want to overpay for growth, so we
try to be conscious of all the risk elements when selecting securities. These
elements may include evaluating growth prospects relative to the stock price, as
well as trading strategy, ownership issues, business risk and liquidity risk.
Frankly, in most instances, we can't buy high-growth companies at
attractive prices, i.e., at "lower risk," because the world frequently tends to
overprice these securities. But it's important to remember that this has nothing
to do with how the outside world is classifying these stocks -- we are value
investors, but we don't confine ourselves to "value" stocks.
The Royce Funds Annual Report 1998 | 5
<PAGE>
[Begin Sidebar]
Relative valuations for small-cap stocks remain very strong in our view, even
after the recent run of solid performance in the fourth quarter. Although
valuation and performance do not correlate in the short term, we certainly
expect that over most full market cycles they should.
[End Sidebar]
extension small-cap funds -- as of December 31, 1998, the highest median market
cap among funds in the small-cap category was $1.2 billion.
The small-cap expansion has affected small-cap indices as well. The
Russell 2000, which measures the 2,000 smallest U.S. companies out of the
largest 3,000 U.S. companies (as tracked by the Russell 3000), has undergone
considerable capitalization drift during the decade. As of December 31, 1998,
the largest stock in the Russell 2000 had a market cap of $3.2 billion. The
median market cap for the index was $430 million and the weighted-average market
cap was $880 million, squarely in the upper end of the small-cap sector. It may
not be long until the weighted-average market cap exceeds $1 billion.
Regardless of how others are defining and redefining small-cap, there
has been no effect on our daily work. We concern ourselves primarily with the
same financial characteristics that have been central to our work for more than
25 years. However, the difference between the small- and micro-cap sectors is
critical to us because we believe that they behave differently and require
different investment strategies. In making our case, we are happy to risk
sounding like the fan who doggedly insists that major differences exist between
country and western music, or soul and rhythm and blues (this may be the only
risk we don't mind taking).
The more efficient upper tier of small-cap receives considerable
institutional attention and research coverage. This is why we use a concentrated
approach in this sector. We rely not only on our standard criteria -- looking
for companies with unusually strong returns on assets,
[Begin Callout]
[T]he difference between the small- and micro-cap sectors is critical to us
because we believe that they behave differently and require different investment
strategies.
[End Callout]
Under what business or market conditions would you buy the stock of a company
conventionally regarded as "small-cap growth"?
Although we are usually not interested in the high-priced, "super
growth" type of company, there are four conditions that bring traditional growth
companies into our price range. One would be companies with the flu, as opposed
to pneumonia, i.e., ones that have experienced a temporary earnings shortfall.
This often scares investors, which leads them to sell. The result is usually a
lower price, one that we are willing to pay if the company's underlying
financial condition remains stable. A second type would be companies whose
growth rates are shifting to more real-world levels, i.e., 10% - 15% cyclically
from 20% sequentially, and whose stock price has been penalized by the market.
Over the years, we've bought securities with these characteristics trading at
attractive prices. Another would be companies in high-growth industries whose
specific year-over-year results vary. The last case is the least common. Adverse
market conditions can simply drive prices down to the point where growth becomes
cheap. This generally occurs only in more serious market downturns, maybe once
or
6 | The Royce Funds Annual Report 1998
<PAGE>
cash flows and balance sheets, as well as solid growth prospects -- but on
non-quantitative research, such as competitive and strategic analysis.
With micro-cap stocks, institutional competition is the least of our
worries. Liquidity issues and trading constraints are of much greater concern to
us in this sector, where institutional interest is thin and research coverage is
often nonexistent. Due to the breadth and diversity of the micro-cap sector, the
research and security selection process is both time-consuming and
labor-intensive. We look at dozens to find a handful. Investing in micro-caps
more closely resembles the way we have chosen stocks historically, with close
attention to quantitative factors such as balance sheets and cash flows. It also
requires an understanding of what makes micro-cap companies distinctive. Unlike
upper-tier small-cap companies, which have corporate cultures similar to larger
companies, micro-cap companies are usually dominated by the personalities of
their CEOs, who are often the founders and majority owners of the business.
So even as the equity market continues the natural process of change and
expansion, we will stay with what has worked for us in the past, and what we
believe continues to work for us today. We have adjusted as the times have
demanded without sacrificing the essence of who we are -- uncompromising and
risk-conscious money managers.
[Begin Callout]
Investing in micro-caps more closely resembles the way we have chosen stocks
historically, with close attention to quantitive factors such as balance sheets
and cash flows.
[End Callout]
THE TIMES THEY ARE A-CHANGING
If nothing else, this summer's decline served as a reminder that cycles remain a
reality in the equity markets and that returns go up and down. This is true
whether we are talking about
twice in a decade. This past year's market downturn is the most recent instance,
but prior to that, we'd have to go back to 1990.
Do you think that more attractive valuations and risk factors still exist in the
less glamorous kind of company that traditionally draws attention from value
investors?
This may surprise people, but many of these companies -- those that
the industry would regard as "value" -- are not as attractively priced relative
to many small-cap stocks that might be considered growth. The reason is that
within small-cap, value has generally outperformed growth over the last
two-and-a-half years. These "value" stocks are therefore not quite the bargains
that they were a few years ago, which is another reason why we see less
usefulness in terms such as value and growth. Regardless of how the industry
classifies them, we have a strong preference for a company that has proven it
can weather storms, but whose stock price, for whatever reason, has been knocked
off balance.
The Royce Funds Annual Report 1998 | 7
<PAGE>
[Begin Sidebar]
What sometimes happens in a period preceding an upswing such as we experienced
recently is that small-caps become extraordinarily cheap across the board. The
market creates conditions that enable us to buy stocks that typically don't
trade at the kind of attractive discounts that we have been seeing. This
summer's downturn enabled us to purchase higher growth rates at a cheaper price
than we have been able to do in a very long time.
[End Sidebar]
[Cartoon (The Future for Small-Caps) with a Caption "Guarded Optimism"]
-C- Hank Blaustein 1999
individual stocks or stock markets. The dominant theme in 1998 was change, as
declining prices produced significant investment opportunities and a shift in
market leadership.
This summer's decline gave us a rare investment opportunity, as
virtually all small-cap securities were repriced regardless of an individual
company's circumstances. According to a Salomon Smith Barney report published in
July in The Wall Street Journal, the average stock with a market value of $250
million or less fell more than 40% from its 52-week high. The last time such a
substantial small-cap sector repricing occurred was 1990. If one believes (as we
do) that long-term outperformance is directly related to exploiting valuation
discrepancies, then this summer's downturn provided us with substantial future
performance potential.
In addition to creating numerous investment opportunities, the October
trough may have signaled the completion of the 1990's bull market. From October
31, 1990 through its trough on August 31, 1998, the S&P 500 compounded at an
18.8% average annual rate of return, well above its long-term norm of 10.5%
(Source: Ibbotson and Associates). Although it is difficult to say with any
certainty, we believe that the new cycle will be different, with chart toppers
coming from both large- and small-cap securities.
Signs of change were already present in the fourth quarter. Market
leadership shifted away from the trio of global multinationals, large financials
and technology, leaving technology as a solo act -- more exciting, but much less
stable. According to Goldman Sachs, the average internet stock -- a dominant
force inside the technology sector -- was up 225% in
[Begin Callout]
If one believes (as we do) that long-term outperformance is directly related to
exploiting valuation discrepancies, then this summer's downturn provided us with
substantial future performance potential.
[End Callout]
8 | The Royce Funds Annual Report 1998
<PAGE>
[Photo of: (l-r) Jack Fockler, Whitney George, Chuck Royce,
Charlie Dreifus, Buzz Zaino]
1998. Internet frenzy has recently consumed the market landscape. It seems a
fitting coda to this decade's bull market, an outsized, speculative phase to an
outsized market cycle. However, when this sector corrects, a subsequent
correction to the market as a whole seems likely, and a new cycle will be under
way for certain. It is in this new cycle that we believe our "guarded optimism"
for small-caps will be substantiated. We are also confident that in this
low-return environment, there will be great value in "value."
We appreciate your continued support and invite your questions and
comments.
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
Fans of all musical genres may be interested to know that...
"Jump, Jive An' Wail" is a swing standard originally made famous by Louis
Prima that jumped back on the charts in 1998 thanks to a new version by the
Brian Setzer Orchestra, with a little help from a popular TV commercial for
The Gap.
"The Joint Is Jumpin'" also enjoyed a second life when the music of Fats
Waller became the subject of the Broadway show Ain't Misbehavin' in the '80s.
"I Got It Bad (And That Ain't Good)," a swing classic, was one of the
centerpieces of the Duke Ellington Orchestra's repertoire through the '40s
and '50s.
"Every Picture Tells a Story" is the title track from Rod Stewart's
groundbreaking 1971 album, one of the first rock and roll records to
emphasize acoustic instruments.
"Take the 'A' Train," another in a long list of Duke Ellington classics, is
indeed one of the trains that stops just minutes from our midtown Manhattan
offices.
When it comes to small-cap stocks and a long-term investment horizon, like
country music legend Johnny Cash, "We Walk The Line."
"It Don't Mean A Thing (If It Ain't Got That Swing)," yet another Ellington
gem, is one of the best-known songs of the swing era, and says it all about
the music that once again has the country hopping.
"The Times They Are A-Changin," the title song from an early Bob Dylan
record, comes from what is probably the most famous protest album of all
time.
The Royce Funds Annual Report 1998 | 9
<PAGE>
PENNSYLVANIA MUTUAL FUND+
- --------------------------------------------------------------------------------
[Begin Sidebar]
What We Do
Pennsylvania Mutual Fund ("PMF"), our flagship fund, seeks long-term growth
of capital by investing primarily in a broadly diversified portfolio of small-
and micro-cap companies using a value approach.
How We Did
Pennsylvania Mutual Fund's broadly diversified portfolio of small- and micro-cap
stocks enjoyed a performance advantage over its benchmark index, the small-cap
oriented Russell 2000, for the second half and one-year period ended December
31, 1998. PMF also beat the Russell 2000 for the three-, 15-, and 20-year
periods. In addition, the Fund outperformed the index since the 1996 small-cap
market peak, with a cumulative return of 36.6% versus 19.9% for the Russell
2000. PMF's average annual total return since Chuck Royce became the portfolio
manager (6/30/73) was 16.0%.
In 1998's second half, PMF benefited from a slightly increased exposure to
technology companies, a market-leading sector within both small- and large-cap
stocks. The Fund's top five positions -- drawn from a variety of industry groups
- -- were significant contributors to its performance.
The Fund, whose total net assets at year-end were $607 million, is one of the
oldest small-cap funds available. PMF 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 years ended December 31, 1998. June 30, 1998 marked our
25th anniversary as the Fund's manager.
[End Sidebar]
<TABLE>
AVERAGE ANNUAL TOTAL RETURNS Through 12/31/98
<S> <C>
Fourth Quarter 1998* 12.5%
- --------------------------------------------------------------------------------
Jul-Dec 1998* -4.3
- --------------------------------------------------------------------------------
1-Year 4.2
- --------------------------------------------------------------------------------
3-Year 13.7
- --------------------------------------------------------------------------------
5-Year 11.6
- --------------------------------------------------------------------------------
10-Year 11.8
- --------------------------------------------------------------------------------
20-Year 15.5
- --------------------------------------------------------------------------------
Since Inception (6/30/73) 16.0
</TABLE>
*Not annualized.
<TABLE>
RISK/RETURN COMPARISON 20-Year Period Ended 12/31/98
<CAPTION>
Average Annual Standard
Total Return Deviation RUR
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
PMF 15.5% 15.2 1.02
- --------------------------------------------------------------------------------
Russell 2000 14.9% 19.1 0.78
- --------------------------------------------------------------------------------
Return per Unit of Risk (RUR) is the 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.
</TABLE>
Over the last 20 years, Pennsylvania Mutual Fund has outperformed the Russell
2000 on BOTH an absolute and a risk-adjusted basis.
[Begin Line Chart]
Recent Market performance Line Chart for Pennsylvania Mutual Fund
<TABLE>
<CAPTION>
Date Russell 2000
<S> <C>
12/31/95 0.00%
1/31/96 -0.11%
2/28/96 3.01%
3/31/96 5.11%
4/30/96 10.73%
5/31/96 15.09%
6/30/96 10.36%
7/31/96 0.73%
8/31/96 6.58%
9/30/96 10.75%
10/31/96 9.04%
11/30/96 13.54%
12/31/96 16.51%
1/31/97 18.84%
2/28/97 15.95%
3/31/97 10.48%
4/30/97 10.79%
5/31/97 23.12%
6/30/97 28.40%
7/31/97 34.37%
8/31/97 37.45%
9/30/97 47.51%
10/31/97 41.04%
11/30/97 40.12%
12/31/97 42.57%
1/31/98 40.32%
2/28/98 50.69%
3/31/98 56.90%
4/30/98 57.76%
5/31/98 49.26%
6/30/98 49.57%
7/31/98 37.45%
8/31/98 10.73%
9/30/98 19.40%
10/31/98 24.27%
11/30/98 30.78%
12/31/98 38.88%
</TABLE>
<TABLE>
RECENT MARKET PERFORMANCE
<CAPTION>
PEAK 5/22/96
- ---------------------
5/22/96 - 12/31/98
- ---------------------
<S> <C>
PMF 36.6%
- ---------------------
Russell 2000 19.9%
- ---------------------
</TABLE>
<TABLE>
<CAPTION>
PEAK 4/21/98
- ---------------------
<S> <C>
4/21/98- 12/31/98
- ---------------------
PMF -6.9%
- ---------------------
Russell 2000 -13.4%
- ---------------------
</TABLE>
[End Line Chart]
Pennsylvania Mutual Fund has provided solid absolute and relative performance
since the small-cap peak in May 1996.
[Begin Line Chart]
PENNSYLVANIA MUTUAL FUND vs. RUSSELL 2000 Value of $10,000 Invested on 12/31/78
Growth of a $10,000 Investment Chart For Pennsylvania Mutual Fund
<TABLE>
<CAPTION>
Penn Russell
Date Mutual 2000
<S> <C> <C>
12/31/78 10,000 10,000
3/31/79 11,670 11,688
6/30/79 12,228 12,473
9/30/79 13,586 13,857
12/31/79 13,547 14,309
3/31/80 10,969 12,475
6/30/80 13,107 14,995
9/30/80 16,161 18,391
12/31/80 17,030 19,830
3/31/81 18,088 21,473
6/30/81 19,877 22,270
9/30/81 15,152 18,366
12/31/81 17,143 20,232
3/31/82 15,672 18,346
6/30/82 15,932 18,082
9/30/82 17,799 19,988
12/31/82 22,879 25,279
3/31/83 27,238 29,689
6/30/83 31,656 35,713
9/30/83 31,263 33,963
12/31/83 32,148 32,643
3/31/84 31,036 30,452
6/30/84 30,763 29,536
9/30/84 32,722 31,160
12/31/84 33,157 30,257
3/31/85 36,715 34,466
6/30/85 37,905 35,687
9/30/85 37,791 34,133
12/31/85 42,035 39,650
3/31/86 46,516 45,265
6/30/86 49,135 47,460
9/30/86 45,671 41,646
12/31/86 46,735 41,905
3/31/87 53,530 52,094
6/30/87 54,221 51,724
9/30/87 56,775 53,890
12/31/87 47,378 38,229
3/31/88 54,220 45,521
6/30/88 57,771 48,521
9/30/88 58,551 48,065
12/31/88 59,020 47,748
3/31/89 63,163 51,424
6/30/89 66,845 54,700
9/30/89 69,699 58,392
12/31/89 68,870 55,502
3/31/90 68,264 54,275
6/30/90 70,476 56,370
9/30/90 58,812 42,537
12/31/90 60,923 44,676
3/31/91 73,254 57,963
6/30/91 73,994 57,064
9/30/91 76,946 61,715
12/31/91 80,317 65,251
3/31/92 86,373 70,145
6/30/92 84,170 65,361
9/30/92 86,156 67,231
12/31/92 93,316 77,261
3/31/93 98,094 80,561
6/30/93 97,044 82,317
9/30/93 100,897 89,511
12/31/93 103,813 91,865
3/31/94 102,692 89,422
6/30/94 100,443 85,943
9/30/94 104,189 91,908
12/31/94 103,064 90,198
3/31/95 107,238 94,356
6/30/95 114,198 103,198
9/30/95 122,260 113,394
12/31/95 122,358 115,854
3/31/96 124,903 121,774
6/30/96 129,350 127,863
9/30/96 129,350 128,298
12/31/96 138,081 134,969
3/31/97 138,661 127,978
6/30/97 156,146 148,736
9/30/97 175,961 170,868
12/31/97 172,544 165,144
3/31/98 189,092 181,741
6/30/98 187,768 173,271
9/30/98 159,747 138,375
12/31/98 179,731 160,944
</TABLE>
[Blue Line] PMF
[Yellow Line] Russell 2000
[End Line Chart]
Includes reinvestment of distributions.
10 | The Royce Funds Annual Report 1998
<PAGE>
PERFORMANCE AND PORTFOLIO REVIEW
- --------------------------------------------------------------------------------
[Begin Bar Chart]
DOWN MARKET PERFORMANCE COMPARISON
All Down Periods of 7.5% or Greater Over the Last 15 Years, in Percentages (%)
<TABLE>
<CAPTION>
PMF Russell 2000
<S> <C> <C>
7/3/86 - -8.6 -14.6
9/16/86
8/25/87 - -23.2 -38.9
10/28/87
10/9/89 - -20.9 -32.3
10/30/90
2/12/92 - -2.6 -12.0
7/8/92
3/18/94 - -7.6 -12.3
12/9/94
5/22/96 - -6.5 -15.4
7/24/96
1/22/97 - -2.5 -9.0
4/25/97
10/13/97 - -7.5 -11.3
1/12/98
4/21/98 - -25.1 -36.5
10/8/98
</TABLE>
[End Bar Chart]
Pennsylvania Mutual Fund outperformed the Russell 2000
during all nine major downturns over the last 15 years.
<TABLE>
Portfolio Diagnostics
<S> <C>
Median Market Cap. $364 million
- ------------------------------------------------------
Weighted Average P/E Ratio 15.8x
- ------------------------------------------------------
Weighted Average P/B Ratio 1.7x
- ------------------------------------------------------
Weighted Average Yield 1.4%
- ------------------------------------------------------
Net Assets $607 million
- ------------------------------------------------------
Turnover Rate 29%
- ------------------------------------------------------
Symbol (Investment Class) PENNX
(Consultant Class) RYPCX
</TABLE>
<TABLE>
Top 10 Positions % of Net Assets
<S> <C>
National Computer Systems 1.7%
- ------------------------------------------------------
Velcro Industries 1.6
- ------------------------------------------------------
Arthur J. Gallagher & Co. 1.3
- ------------------------------------------------------
New England Business Service 1.3
- ------------------------------------------------------
Medical Assurance 1.3
- ------------------------------------------------------
Curtiss-Wright Corporation 1.2
- ------------------------------------------------------
The Commerce Group 1.1
- ------------------------------------------------------
Chiron Corporation 1.1
- ------------------------------------------------------
Simpson Manufacturing 1.1
- ------------------------------------------------------
Dionex Corporation 1.1
</TABLE>
<TABLE>
PORTFOLIO SECTOR BREAKDOWN With Examples % of Net Assets
<S> <C>
Industrial Products Building Systems and Components, Construction Materials, Specialty Chemicals and Materials 20.1%
Industrial Services Transportation and Logistics, Printing, Engineering and Construction 16.0
Technology Components and Systems, Software/Services, Semiconductors and Equipment 12.3
Consumer Products Home Furnishings/Appliances, Apparel and Shoes, Publishing 12.2
Financial Intermediaries Insurance, Banking, Securities Brokers 11.6
Financial Services Insurance Brokers, Investment Management, Information and Processing 8.6
Natural Resources Oil and Gas, Energy Services, Real Estate 4.8
Consumer Services Retail Stores, Restaurants/Lodging, Leisure/Entertainment 3.7
Health Surgical Products and Devices, Drugs and Biotech, Health Services 2.7
Utilities 0.5
Miscellaneous 5.0
Treasuries, Cash & Cash Equivalents 2.5
</TABLE>
+ 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.
[Begin Sidebar]
<TABLE>
GOOD IDEAS THAT WORKED
1998 Realized and Unrealized Gain
<S> <C>
National Computer Systems $6,526,448
- ------------------------------------------------------
Velcro Industries 3,994,313
- ------------------------------------------------------
LandAmerica Financial Group 3,326,215
- ------------------------------------------------------
Plenum Publishing Corporation 3,000,565
- ------------------------------------------------------
Oshkosh Truck Corporation Cl. B 2,979,882
- ------------------------------------------------------
Combined Gain $19,827,423
- ------------------------------------------------------
</TABLE>
<TABLE>
GOOD IDEAS AT THE TIME
1998 Realized and Unrealized Loss
<S> <C>
Denbury Resources $5,718,959
- ------------------------------------------------------
Tom Brown 3,187,009
- ------------------------------------------------------
DIMON Incorporated 2,904,761
- ------------------------------------------------------
Highlands Insurance Group 2,752,750
- ------------------------------------------------------
Gibson Greetings 2,079,777
- ------------------------------------------------------
Combined Loss $16,643,256
- ------------------------------------------------------
</TABLE>
National Computer Systems -- Dominant in the educational testing business for
many years, this company has emerged as a true leader in technology solutions
for both educational and large corporate customers. A long-term core holding in
the Fund, the combination of solid results and market recognition improved not
only the company's business, but also its valuations.
Velcro Industries -- This long-term core holding in the Fund continued to
deliver solid financial results that were finally recognized in the market -- a
classic example of investment patience paying off. While most people know the
product, not many knew the company. Fortunately, investors discovered the
connection last year, placing a more appropriate valuation on this company's
fundamentals.
Denbury Resources -- The senior managers of this small energy company have
significant experience at successfully building energy enterprises. Having
suffered from the general collapse in energy prices, we believe that the
talented management team will help this stock to turn around when energy prices
recover.
Tom Brown -- An exploration company primarily in the natural gas business, this
stock suffered from the decline in energy prices. We increased our position
throughout the year, believing that, because the energy business is a cyclical
one in which prices move both ways and our need for natural gas is not going to
diminish, energy prices will eventually recover.
[End Sidebar]
THE ROYCE FUNDS ANNUAL REPORT 1998 | 11
<PAGE>
PMF II
- --------------------------------------------------------------------------------
[Begin Sidebar]
WHAT WE DO
PMF II seeks long-term growth of capital by investing primarily in a diversified
portfolio of small- and micro-cap companies using a value approach. Buzz Zaino
became the Fund's primary portfolio manager effective April 1, 1998.
HOW WE DID
PMF II outperformed its benchmark index, the small-cap oriented Russell 2000,
for the fourth quarter, the second half and the one-year period ended December
31, 1998. The Fund also beat the Russell 2000 for the two-year and since
inception (11/19/96) periods, with average annual total returns of 12.6% and
14.6%, respectively, versus 9.2% and 11.1% for the index.
Making the greatest positive impact on the Fund's performance were portfolio
holdings in the market-leading technology sector, where many stocks became
bargain-priced in this fall's market decline, before rebounding sharply in the
fourth quarter. This increased exposure to technology reflects not only the
investment style of Mr. Zaino, but also the attractive values brought about by
this year's market downturn.
PMF II has not been run as a sibling to Pennsylvania Mutual Fund since Buzz
Zaino assumed portfolio management responsibility. Although it is not formally
restricted in terms of market capitalization, the Fund will generally focus on
small- and micro-cap stocks. Mr. Zaino uses an opportunistic approach focusing
on turnarounds and undervalued companies. Total net assets at year-end were $34
million. In November, the Fund marked its second year of performance history.
[End Sidebar]
<TABLE>
Average Annual Total Returns Through 12/31/98
<S> <C>
Fourth Quarter 1998* 22.0%
- --------------------------------------------------------------------------------
Jul-Dec 1998* -2.5
- --------------------------------------------------------------------------------
1-Year 4.9
- --------------------------------------------------------------------------------
2-Year 12.6
- --------------------------------------------------------------------------------
Since Inception (11/19/96) 14.6
</TABLE>
*Not annualized.
[Begin Line Chart]
Recent Market performance Line Chart for PMF II
<TABLE>
<CAPTION>
Date Russell 2000
<S> <C>
12/31/96 0.00%
1/31/97 2.00%
2/28/97 -0.48%
3/31/97 -5.18%
4/30/97 -4.91%
5/31/97 5.67%
6/30/97 10.21%
7/31/97 15.33%
8/31/97 17.97%
9/30/97 26.61%
10/31/97 21.04%
11/30/97 20.26%
12/31/97 22.37%
1/31/98 20.44%
2/28/98 29.34%
3/31/98 34.67%
4/30/98 35.41%
5/31/98 28.11%
6/30/98 28.38%
7/31/98 17.99%
8/31/98 -4.92%
9/30/98 2.52%
10/31/98 6.70%
11/30/98 12.30%
12/31/98 19.25%
</TABLE>
<TABLE>
RECENT MARKET PERFORMANCE
<CAPTION>
PEAK 1/22/97
- -----------------------
1/22/97 - 12/31/98
- -----------------------
<S> <C>
PMF II 27.0%
- -----------------------
Russell 2000 16.6%
- -----------------------
</TABLE>
<TABLE>
<CAPTION>
PEAK 4/21/98
- -----------------------
4/21/98 - 12/31/98
- -----------------------
<S> <C>
PMF II -8.0%
- -----------------------
Russell 2000 -13.4%
- -----------------------
</TABLE>
[End Line Chart]
PMF II has provided a performance edge from the January 1997
and the April 1998 small-cap peaks.
[Begin Line Chart]
PMF II VS. RUSSELL 2000 Value of $10,000 invested on 11/19/96
Growth of a $10,000 Investment Chart For PMF II
Russell
Date PMF II 2000
11/19/96 10,000 10,000
11/30/96 10,260 10,209
12/31/96 10,520 10,476
1/31/97 10,460 10,686
2/28/97 10,580 10,426
3/31/97 10,420 9,934
4/30/97 10,460 9,962
5/31/97 11,000 11,071
6/30/97 11,620 11,546
7/31/97 12,000 12,083
8/31/97 12,440 12,359
9/30/97 13,339 13,264
10/31/97 13,139 12,681
11/30/97 13,019 12,599
12/31/97 12,711 12,820
1/31/98 12,517 12,617
2/28/98 13,333 13,550
3/31/98 14,128 14,109
4/30/98 14,428 14,186
5/31/98 14,063 13,422
6/30/98 13,677 13,450
7/31/98 12,689 12,361
8/31/98 10,692 9,961
9/30/98 10,929 10,741
10/31/98 11,787 11,179
11/30/98 12,990 11,765
12/31/98 13,335 12,493
[Blue Line] PMF II
[Yellow Line] Russell 2000
[End Line Chart]
Includes reinvestment of distributions.
12 | THE ROYCE FUNDS ANNUAL REPORT 1998
<PAGE>
PERFORMANCE AND PORTFOLIO REVIEW
- --------------------------------------------------------------------------------
[bar chart]
<TABLE>
DOWN MARKET PERFORMANCE COMPARISON
All Down Periods of 7.5% or Greater, in Percentages (%)
<CAPTION>
PMF II Russell 2000
<S> <C> <C>
1/22/97 -
4/25/97 -1.1 -9.0
10/13/97 -
1/12/98 -10.1 -11.3
4/21/98 -
10/8/98 -33.9 -36.5
</TABLE>
[end bar chart]
PMF II outperformed the Russell 2000 during all three down market periods since
its inception.
<TABLE>
Portfolio Diagnostics
<S> <C>
Median Market Cap. $183 million
- ---------------------------------------------------------
Weighted Average P/E Ratio 14.8x
- ---------------------------------------------------------
Weighted Average P/B Ratio 1.2x
- ---------------------------------------------------------
Weighted Average Yield 0.6%
- ---------------------------------------------------------
Net Assets $34 million
- ---------------------------------------------------------
Turnover Rate 120%
- ---------------------------------------------------------
Symbol RYPNX
</TABLE>
<TABLE>
<CAPTION>
Top 10 Positions % of Net Assets
<S> <C>
American Bank Note
Holographics 1.6%
- ---------------------------------------------------------
HMT Technology Corporation 1.5
- ---------------------------------------------------------
Smurfit Stone Container 1.4
- ---------------------------------------------------------
Benchmark Electronics 1.3
- ---------------------------------------------------------
Toro 1.2
- ---------------------------------------------------------
Tektronix 1.2
- ---------------------------------------------------------
Fritz Companies 1.2
- ---------------------------------------------------------
Phoenix Technologies 1.2
- ---------------------------------------------------------
True North Communications 1.2
- ---------------------------------------------------------
Midwest Grain Products 1.2
</TABLE>
<TABLE>
PORTFOLIO SECTOR BREAKDOWN With Examples % of Net Assets
<S> <C>
Technology Components and Systems, Software/Services, Semiconductors and Equipment 36.3%
Industrial Products Building Systems and Components, Construction Materials, Specialty Chemicals and Materials 26.0
Industrial Services Transportation and Logistics, Printing, Engineering and Construction 10.3
Consumer Services Retail Stores, Restaurants/Lodging, Leisure/Entertainment 10.2
Consumer Products Home Furnishings/Appliances, Apparel and Shoes, Publishing 6.4
Health Surgical Products and Devices, Drugs and Biotech, Health Services 4.0
Natural Resources Oil and Gas, Energy Services, Real Estate 3.2
Financial Intermediaries Insurance, Banking, Securities Brokers 1.1
Bonds 0.5
Treasuries, Net Cash & Cash Equivalents 2.0
</TABLE>
<TABLE>
GOOD IDEAS THAT WORKED
1998 Realized and Unrealized Gain
<S> <C>
- --------------------------------------------------------
Emulex Corporation $433,405
- --------------------------------------------------------
American Bank Note Holographics 385,220
- --------------------------------------------------------
National Computer Systems 287,068
- --------------------------------------------------------
Insituform Technologies Cl. A 276,199
- --------------------------------------------------------
LandAmerica Financial Group 269,546
- --------------------------------------------------------
Combined Gain $1,651,438
- --------------------------------------------------------
</TABLE>
<TABLE>
GOOD IDEAS AT THE TIME
1998 Realized and Unrealized Loss
<S> <C>
- --------------------------------------------------------
Golden Books Family Entertainment $256,020
- --------------------------------------------------------
Ziff-Davis 212,639
- --------------------------------------------------------
Tom Brown 197,055
- --------------------------------------------------------
Patina Oil & Gas Corporation 194,806
- --------------------------------------------------------
Arkansas Best Corporation 194,129
- --------------------------------------------------------
Combined Loss $1,054,649
- --------------------------------------------------------
</TABLE>
Emulex Corporation -- One of the principal developers of Fibre Channel gigabit
connectivity, a technology that allows users to communicate faster through a
high-speed connection between the personal computer and the disk drive. Although
in development for several years, the market recognized Fibre Channel as the new
generation of technology in the last six months of 1998.
National Computer Systems -- Dominant in the educational testing business for
many years, new management has expanded its market, helping this company to
emerge as a true leader in technology solutions for both educational and large
corporate customers. A combination of solid results and market recognition
improved not only the company's business, but also its valuations.
Golden Books Family Entertainment -- After making considerable investments to
improve this company's operations, new management has been unable to turn the
business around and continues to struggle with higher expenses and declining
revenues. We sold this stock on its way down, took our losses and moved on.
Tom Brown -- An exploration company primarily in the natural gas business, this
stock suffered from the decline of energy prices. We believe that, because the
energy business is a cyclical one in which prices move both ways and that our
need for natural gas is not going to diminish, energy prices will eventually
recover.
[End Sidebar]
THE ROYCE FUNDS ANNUAL REPORT 1998 | 13
<PAGE>
ROYCE GIFTSHARES FUND+
- --------------------------------------------------------------------------------
[Begin Sidebar]
WHAT WE DO
Royce GiftShares Fund ("RGF"), a special-purpose fund, seeks long-term growth of
capital by investing primarily in a limited number of small- and micro-cap
stocks using a value approach. 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, for the quarter, the second half, the one-year, three-year and
since inception (12/27/95) periods ended December 31, 1998. The Fund also
enjoyed a substantial performance advantage over the Russell 2000 since the 1996
small-cap market peak, with a cumulative return of 65.0% versus 19.9% for the
index. RGF's average annual total return since inception was 23.6%.
Making the greatest positive impact on the Fund's performance were portfolio
holdings in the market-leading technology sector, where many stocks became
bargain-priced in this fall's market decline, before rebounding sharply later in
the fourth quarter. This increased exposure to technology is not indicative of a
change in our investment style, but instead reflects both the growing role
technology plays in the economy (which includes a vastly expanding universe of
small-cap technology companies) and the attractive values brought about by this
year's market downturn. We remain committed to absolute valuation in our
selection process.
RGF has an overall four-star (****) rating from Morningstar out of 2,802
domestic equity funds with a three-year history ended December 31, 1998. The
Fund is also one of Morningstar's lowest risk funds as measured by the
Morningstar risk ratio, RGF is one of the few mutual funds specifically designed
for gifting and estate-planning purposes and total net assets at year-end were
$9.7 million. The Fund, which combines the advantages of a trust with the
benefits of a mutual fund, marked its third year of performance history in
December.
[End Sidebar]
<TABLE>
AVERAGE ANNUAL TOTAL RETURNS Through 12/31/98
<S> <C> <C>
Fourth Quarter 1998* 28.4%
- --------------------------------------------------------------------------------
Jul-Dec 1998* 5.6
- --------------------------------------------------------------------------------
1-Year 19.5
- --------------------------------------------------------------------------------
3-Year 23.7
- --------------------------------------------------------------------------------
Since Inception (12/27/95) 23.6
</TABLE>
*Not annualized.
<TABLE>
RISK/RETURN COMPARISON Inception (12/27/95) Through 12/31/98
<CAPTION>
Average Annual Standard
Total Return Deviation RUR*
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Royce GiftShares Fund 23.6% 15.1 1.56
- --------------------------------------------------------------------------------
Russell 2000 11.8% 19.9 0.59
- --------------------------------------------------------------------------------
</TABLE>
*Return per Unit of Risk (RUR) is the average annual total return divided by the
annualized standard deviation over a designated time period. Please read the
prospectus for a more complete discussion of risk.
Since its inception, Royce GiftShares Fund has outperformed the Russell 2000 on
BOTH an absolute and a risk-adjusted basis.
RECENT MARKET PERFORMANCE
[Begin Line Chart]
Recent Market performance Line Chart for Royce GiftShares
Fund
<TABLE>
<CAPTION>
Date Russell 2000
<S> <C>
12/31/95 0.00%
1/31/96 -0.11%
2/28/96 3.01%
3/31/96 5.11%
4/30/96 10.73%
5/31/96 15.09%
6/30/96 10.36%
7/31/96 0.73%
8/31/96 6.58%
9/30/96 10.75%
10/31/96 9.04%
11/30/96 13.54%
12/31/96 16.51%
1/31/97 18.84%
2/28/97 15.95%
3/31/97 10.48%
4/30/97 10.79%
5/31/97 23.12%
6/30/97 28.40%
7/31/97 34.37%
8/31/97 37.45%
9/30/97 47.51%
10/31/97 41.04%
11/30/97 40.12%
12/31/97 42.57%
1/31/98 40.32%
2/28/98 50.69%
3/31/98 56.90%
4/30/98 57.76%
5/31/98 49.26%
6/30/98 49.57%
7/31/98 37.45%
8/31/98 10.73%
9/30/98 19.40%
10/31/98 24.27%
11/30/98 30.78%
12/31/98 38.88%
</TABLE>
PEAK 5/22/96
<TABLE>
<CAPTION>
- -----------------------
<S> <C>
5/22/96 - 12/31/98
- -----------------------
RGF 65.0%
- -----------------------
Russell 2000 19.9%
- -----------------------
</TABLE>
<TABLE>
PEAK 4/21/98
- -----------------------
<S> <C>
4/21/98 - 12/31/98
- -----------------------
RGF 2.1%
- -----------------------
Russell 2000 -13.4%
- -----------------------
</TABLE>
Royce GiftShares Fund has provided strong absolute and relative performance
since the small-cap peak in May 1996.
ROYCE GIFTSHARES FUND vs. RUSSELL 2000 Value of $10,000 Invested on 12/27/95
[Begin Line Chart]
Growth of a $10,000 Investment Chart For Royce GiftShares Fund
<TABLE>
<CAPTION>
Royce Russell
Date GiftShares 2000
<S> <C> <C>
12/27/95 10,000 10,000
12/31/95 10,020 10,064
3/31/96 10,600 10,578
6/30/96 11,500 11,107
9/30/96 11,600 11,145
12/31/96 12,580 11,724
3/31/97 12,645 11,117
6/30/97 14,113 12,920
9/30/97 15,623 14,843
12/31/97 15,855 14,346
3/31/98 18,035 15,787
6/30/98 17,943 15,052
9/30/98 14,753 12,020
12/31/98 18,944 13,981
</TABLE>
[Blue Line] RGF
[Yellow Line] Russell 2000
[End Line Chart]
Includes reinvestment of distributions.
14 | THE ROYCE FUNDS ANNUAL REPORT 1998
<PAGE>
PERFORMANCE AND PORTFOLIO REVIEW
- --------------------------------------------------------------------------------
[bar chart]
DOWN MARKET PERFORMANCE COMPARISON
All Down Periods of 7.5% or Greater, in Percentages (%)
<TABLE>
<CAPTION>
RGF Russell 2000
<S> <C> <C>
5/22/96 -
7/24/96 -3.5 -15.4
1/22/97 -
4/25/97 -0.5 -9.0
10/13/97 -
1/12/98 -3.8 -11.3
4/21/98 -
10/8/98 -30.7 -36.5
</TABLE>
[end bar chart]
Royce GiftShares Fund has outperformed the Russell 2000 during all four down
market periods since its inception.
<TABLE>
PORTFOLIO DIAGNOSTICS
<S> <C>
Median Market Cap. $302 million
- ----------------------------------------------
Weighted Average P/E Ratio 15.9x
- ----------------------------------------------
Weighted Average P/B Ratio 1.8x
- ----------------------------------------------
Weighted Average Yield 0.8%
- ----------------------------------------------
Net Assets $9.7 million
- ----------------------------------------------
Turnover Rate 153%
- ----------------------------------------------
Symbol (Investment Class) RGFAX
(Consultant Class) RGFCX
- ----------------------------------------------
</TABLE>
<TABLE>
TOP 10 POSITIONS % of Net Assets
<S> <C>
800-JR CIGAR 3.2%
- ----------------------------------------------
Zenith National Insurance 2.4
- ----------------------------------------------
Dallas Semiconductor Corporation 2.4
- ----------------------------------------------
Charming Shoppes 2.3
- ----------------------------------------------
Richardson Electronics 2.3
- ----------------------------------------------
Kronos Incorporated 2.3
- ----------------------------------------------
REMEC 2.2
- ----------------------------------------------
MacNeal-Schwendler Corporation 2.2
- ----------------------------------------------
Chiron Corporation 2.2
- ----------------------------------------------
Sunglass Hut International 2.2
</TABLE>
<TABLE>
<CAPTION>
PORTFOLIO SECTOR BREAKDOWN With Examples % of Net Assets
<S> <C>
Technology Components and Systems, Software/Services, Semiconductors and Equipment 30.1%
Consumer Products Home Furnishings/Appliances, Apparel and Shoes, Publishing 16.7
Health Surgical Products and Devices, Drugs and Biotech, Health Services 8.5
Industrial Products Building Systems and Components, Construction Materials, Specialty Chemicals and Materials 7.8
Financial Intermediaries Insurance, Banking, Securities Brokers 6.6
Industrial Services Transportation and Logistics, Printing, Engineering and Construction 6.2
Natural Resources Oil and Gas, Energy Services, Real Estate 6.0
Consumer Services Retail Stores, Restaurants/Lodging, Leisure/Entertainment 5.6
Financial Services Insurance Brokers, Investment Management, Information and Processing 1.8
Miscellaneous 4.5
Treasuries, Cash & Cash Equivalents 6.2
</TABLE>
+ 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.
[Begin Side Bar]
<TABLE>
GOOD IDEAS THAT WORKED
1998 Realized and Unrealized Gain
<S> <C>
REMEC $205,692
- --------------------------------------------
Sunglass Hut International 170,615
- --------------------------------------------
EarthWeb 154,038
- --------------------------------------------
800-JR CIGAR 146,097
- --------------------------------------------
Analog Devices 134,421
- --------------------------------------------
Combined Gain $810,863
- --------------------------------------------
</TABLE>
<TABLE>
GOOD IDEAS AT THE TIME
1998 Realized and Unrealized Loss
<S> <C>
Denbury Resources $118,470
- --------------------------------------------
Perceptron 91,045
- --------------------------------------------
Pittston BAX Group 80,351
- --------------------------------------------
Willbros Group 79,193
- --------------------------------------------
Standard Commercial Corporation 77,988
- --------------------------------------------
Combined Loss $447,047
- --------------------------------------------
</TABLE>
REMEC -- This small microwave component manufacturer suffered from declining
orders as a result of problems in Southeast Asia, and as a result, we were able
to buy this stock at a very attractive price. They have a solid business with
the military and it now appears as if their commercial business is recovering,
which has caused a dramatic reversal in share price performance.
Sunglass Hut International -- Overexpansion in 1996 - 1997 caused considerable
turmoil for the company's results in 1998. We bought in the midst of the
turmoil, investing in the company's franchise value and its long-term potential.
There are early signs that the corporate turnaround strategy is progressing
well, as evidenced by the recent share price performance.
Denbury Resources -- The senior managers of this small energy company have
significant experience at successfully building energy enterprises. Having
suffered from the general collapse in energy prices, we believe that the
talented management team will help this stock to turn around when energy prices
recover.
Perceptron -- This leading manufacturer of three-dimensional image units for
automobile-inspections robots continued to suffer from difficult product
transition cycles. That drove this stock from a high of $30 all the way down to
$6.
[End Side Bar]
THE ROYCE FUNDS ANNUAL REPORT 1998 | 15
<PAGE>
UPDATES AND NOTES TO PERFORMANCE AND RISK INFORMATION
- --------------------------------------------------------------------------------
[Graphic of Computer and Keyboard with THE ROYCE FUNDS on screen]
NEW @ www.roycefunds.com
New this quarter on our website is the addition of Fund prices for our
open- and closed-end funds. Fund prices are updated daily on the site and can be
found in the Performance/Diagnostics/Prices section. Our What's New column
continues to be popular. What's New is updated each week on Monday and features
fund updates, market commentary and Chuck Royce's latest thoughts.
Y2K UPDATE
Royce & Associates recently filed its report on Year 2000 (Y2K) readiness
(Form ADV-Y2K), as required by the U.S. Securities and Exchange Commission. Form
ADV-Y2K -- which is available on our website in Up-to-the-Minute's Recent
Developments section -- asks for specific Y2K information, such as the existence
and progress of Y2K compliance plans and contingency plans, systems that may be
affected by Y2K and the Y2K readiness of third parties upon which Royce and its
clients may be relying to perform mission critical services. Royce and the Funds
are working to ensure that our systems and those of our service providers are
Y2K compliant, and we do not anticipate that any Y2K problems will have a
material impact on Royce's ability to provide services to the Funds at current
levels.
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).
There can be no assurance that securities mentioned in this report will be
included in any Royce-managed portfolio in the future.
Morningstar proprietary ratings reflect historical risk-adjusted performance
as of 12/31/98 and are subject to change monthly. The rating is calculated
from a fund's three-, five- and 10-year average annual total returns with
appropriate fee adjustments and a risk factor that reflects performance
relative to three-month Treasury bill returns. Royce GiftShares Fund received
four stars for the three-year period ended 12/31/98 in the domestic equity
investment category out of 2,802 funds. Ten percent of the funds in an
investment category receive five stars and 22.5% receive four stars.
Morningstar proprietary risk ratio measures a fund's downside volatility
relative to all equity funds, which have an average score of 1.00. The average
score for the 397 funds in the small-cap objective category with a three-year
history was 1.47 for the three years ended 12/31/98. 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, Pennsylvania Mutual Fund and Royce
GiftShares Fund for this period were 0.78, 0.47, 0.77 and 0.68, 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, Nasdaq Composite, Nasdaq 100, Nasdaq
Industrials, S&P 500 and Dow Jones Industrial Average are unmanaged indices of
domestic common stocks. The Royce Funds and Royce GiftShares Fund are service
marks of The Royce Funds.
16 | THE ROYCE FUNDS ANNUAL REPORT 1998
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
PENNSYLVANIA MUTUAL FUND DECEMBER 31, 1998
- --------------------------------------------------------------------------------
COMMON STOCKS -- 97.5%
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Consumer Products -- 12.2%
Apparel and Shoes - 3.1%
Garan Incorporated 89,500 $ 2,517,188
K-Swiss Cl. A 86,500 2,324,687
Oshkosh B'Gosh Cl. A 237,000 4,784,438
St. John Knits 137,600 3,577,600
Weyco Group 196,600 4,988,725
Wolverine World Wide 46,400 614,800
------------
18,807,438
------------
Collectibles - 0.9%
Enesco Group 240,800 5,598,600
------------
Food/Beverage/Tobacco - 0.7%
800-JR CIGAR* 177,000 4,115,250
------------
Home Furnishings/Appliances - 2.6%
Bassett Furniture Industries 171,575 4,139,247
Burnham Corporation Cl. A 51,526 1,957,988
Burnham Corporation Cl. B 4,442 168,796
Conso International
Corporation* 58,600 344,275
La-Z-Boy Incorporated 176,700 3,147,469
Lifetime Hoan Corporation 368,199 3,589,940
The Rival Company 187,600 2,520,875
------------
15,868,590
------------
Publishing - 1.1%
Gibson Greetings* 187,700 2,228,938
The Topps Company* 845,800 4,229,000
------------
6,457,938
------------
Sports and Recreation - 1.4%
Aldila* 207,100 517,750
Johnson Worldwide
Associates Cl. A* 116,870 1,081,047
**Oakley* 225,200 2,125,325
Sturm, Ruger & Company 381,700 4,556,544
------------
8,280,666
------------
Other Consumer Products - 2.4%
**Koala Corporation* 16,500 286,687
Lazare Kaplan International* 84,100 588,700
Matthews International
Corporation Cl. A 138,200 4,353,300
Velcro Industries 64,800 9,655,200
------------
14,883,887
------------
74,012,369
============
Consumer Services -- 3.7%
Restaurants/Lodging - 1.0%
Applebee's International 144,600 2,982,375
Buffets* 252,400 3,013,025
------------
5,995,400
------------
SHARES VALUE
------ -----
Retail Stores - 2.7%
Catherines Stores Corporation* 286,400 $ 3,114,600
Charming Shoppes* 964,800 4,160,700
Mikasa 202,200 2,578,050
Sunglass Hut International* 402,700 2,818,900
Talbots 118,200 3,708,525
------------
16,380,775
------------
22,376,175
============
Financial Intermediaries -- 11.6%
Banking - 1.7%
Baker Boyer Bancorp 31,300 1,502,400
Community Banks 62,550 1,571,569
F & M Bancorporation 13,800 828,000
Farmers & Merchants Bank of
Long Beach* 1,266 3,582,780
Hanmi Bank* 25,089 332,429
Oriental Financial Group 84,833 2,656,333
------------
10,473,511
------------
Insurance - 9.8%
Alleghany Corporation* 5,303 996,301
Baldwin & Lyons Cl. B 125,678 3,110,530
Capitol Transamerica Corporation 144,745 2,704,922
Chicago Title Corporation 60,009 2,816,672
The Commerce Group 196,342 6,957,870
Fremont General Corporation 106,340 2,631,915
Highlands Insurance Group* 170,800 2,231,075
Leucadia National Corporation 11,928 375,732
Medical Assurance 230,910 7,634,455
NYMAGIC 72,800 1,510,600
Orion Capital Corporation 59,686 2,376,249
PMA Capital Corporation Cl. A 231,350 4,525,784
PXRE Corporation 207,441 5,198,990
RLI 34,781 1,156,468
Trenwick Group 163,800 5,343,975
Wesco Financial Corporation 13,560 4,810,410
Zenith National Insurance 231,000 5,341,875
------------
59,723,823
------------
Securities Brokers - 0.1%
Legg Mason 9,500 299,844
------------
70,497,178
============
Financial Services -- 8.6%
Information and Processing - 1.8%
Duff & Phelps Credit Rating 99,299 5,442,826
Fair Isaac and Company 59,100 2,729,681
Investors Financial Services
Corporation 42,804 2,552,189
------------
10,724,696
------------
</TABLE>
THE ROYCE FUNDS ANNUAL REPORT 1998 | 17
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
PENNSYLVANIA MUTUAL FUND DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Financial Services (continued)
Insurance Brokers - 3.8%
E.W. Blanch Holdings 131,300 $ 6,228,544
Crawford & Company Cl. A 386,875 5,174,453
Arthur J. Gallagher & Co. 182,500 8,052,812
Hilb, Rogal & Hamilton Company 183,300 3,643,088
-----------
23,098,897
-----------
Investment Management - 3.0%
Affiliated Managers Group* 119,500 3,570,062
Eaton Vance 215,000 4,488,125
The John Nuveen Company Cl. A 67,800 2,517,075
NVEST L.P. 56,000 1,557,500
Phoenix Investment Partners 226,600 1,911,938
The Pioneer Group 213,700 4,220,575
-----------
18,265,275
-----------
52,088,868
===========
Health -- 2.7%
Commercial Service - 0.3%
PAREXEL International
Corporation* 89,500 2,237,500
-----------
Drugs and Biotech - 1.1%
Chiron Corporation* 263,000 6,887,312
-----------
Health Services - 0.1%
**Jenny Craig* 127,300 763,800
-----------
Personal Care - 0.1%
Jean-Philippe Fragrances* 28,400 173,950
-----------
Surgical Products and Devices - 1.1%
Diagnostic Products Corporation 2,700 84,038
Haemonetics Corporation* 283,400 6,447,350
Nitinol Medical Technologies* 13,100 49,125
-----------
6,580,513
-----------
16,643,075
===========
Industrial Products -- 20.1%
Building Systems and Components - 6.4%
American Buildings Company* 21,600 529,200
Falcon Products 189,600 2,275,200
International Aluminum
Corporation 140,500 4,153,531
Juno Lighting 212,000 4,955,500
Kimball International Cl. B 178,000 3,382,000
Liberty Homes Cl. A 93,350 991,844
Liberty Homes Cl. B 21,950 263,400
Preformed Line Products
Company 189,786 5,314,008
Simpson Manufacturing* 180,900 6,772,444
Skyline Corporation 169,200 5,499,000
Thor Industries 183,100 4,669,050
-----------
38,805,177
-----------
SHARES VALUE
------ -----
Construction Materials - 3.5%
Ash Grove Cement Company 50,018 $ 4,576,647
Ash Grove Cement Company Cl. B 5,000 457,500
CalMat 162,000 5,001,750
Florida Rock Industries 209,900 6,506,900
Puerto Rican Cement Company 135,600 4,737,525
-----------
21,280,322
-----------
Industrial Components - 0.2%
Woodhead Industries 104,650 1,360,450
-----------
Machinery - 2.8%
Lincoln Electric Holdings 252,380 5,615,455
Lund International Holdings* 105,700 898,450
Nordson Corporation 48,900 2,512,237
Oshkosh Truck Corporation Cl. B 184,900 6,124,813
Tecumseh Products Company Cl. A 33,800 1,575,925
-----------
16,726,880
-----------
Paper and Packaging - 1.3%
CLARCOR 63,175 1,263,500
P. H. Glatfelter Company 119,600 1,480,050
Liqui-Box Corporation 60,800 3,161,600
PalEx* 286,300 2,165,144
-----------
8,070,294
-----------
Pumps, Valves and Bearings - 1.4%
Kaydon Corporation 118,900 4,763,431
NN Ball and Roller 320,900 1,885,287
Robroy Industries Cl. A 94,535 1,323,490
Roper Industries 30,000 611,250
-----------
8,583,458
-----------
Specialty Chemicals and Materials - 2.1%
Aceto Corporation 24,546 325,234
CFC International* 58,000 464,000
Chemfab Corporation* 23,500 486,156
LeaRonal 93,557 3,169,243
Lilly Industries Cl. A 241,561 4,816,122
MacDermid 86,231 3,373,788
-----------
12,634,543
-----------
Textiles - 1.4%
Fab Industries 184,232 3,960,988
Thomaston Mills Cl. A 900 2,869
Unifi 217,500 4,254,844
-----------
8,218,701
-----------
Other Industrial Products - 1.0%
BHA Group Holdings 169,857 2,356,766
Myers Industries 135,132 3,876,599
-----------
6,233,365
-----------
121,913,190
===========
</TABLE>
18 | THE ROYCE FUNDS ANNUAL REPORT 1998
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
PENNSYLVANIA MUTUAL FUND DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Industrial Services -- 16.0%
Advertising/Publishing - 1.0%
Grey Advertising 10,231 $ 3,724,084
Ziff-Davis* 160,000 2,530,000
-----------
6,254,084
-----------
Commercial Services - 1.5%
ABM Industries Incorporated 96,600 3,344,775
BHI Corporation* 103,500 3,182,625
CDI* 20,000 403,750
Cornell Corrections* 102,700 1,951,300
-----------
8,882,450
-----------
Engineering and Construction - 2.2%
Insituform Technologies Cl. A* 109,500 1,587,750
Morrison Knudsen Corporation* 258,300 2,518,425
Sevenson Environmental Services 234,400 1,992,400
Stone & Webster 124,000 4,123,000
Willbros Group* 504,900 2,808,506
-----------
13,030,081
-----------
Food/Tobacco Processors - 2.1%
DIMON Incorporated 235,600 1,752,275
Farmer Bros. 18,475 3,953,650
Midwest Grain Products* 369,950 5,040,569
Standard Commercial
Corporation 263,020 2,252,109
-----------
12,998,603
-----------
Industrial Distribution - 1.0%
TBC Corporation* 118,277 842,724
**Vallen Corporation* 269,400 5,388,000
-----------
6,230,724
-----------
Printing - 3.7%
Bowne & Co. 209,800 3,750,175
Ennis Business Forms 232,400 2,309,475
Merrill Corporation 203,600 3,932,025
New England Business Service 200,100 7,828,913
The Standard Register Company 139,010 4,300,622
-----------
22,121,210
-----------
Transportation and Logistics - 4.5%
Air Express International
Corporation 162,130 3,526,327
AirNet Systems* 139,000 1,998,125
Arnold Industries 351,048 5,660,649
Circle International Group 281,874 5,778,417
Frozen Food Express Industries 418,867 3,298,578
Kenan Transport Company 76,300 2,556,050
The Pittston BAX Group 282,700 3,145,037
**Ryanair Holdings ADR*+ 43,000 1,623,250
-----------
27,586,433
-----------
97,103,585
===========
SHARES VALUE
------ -----
<S> <C> <C>
Natural Resources -- 4.8%
Energy Services - 0.9%
Carbo Ceramics 154,300 $ 2,700,250
Helmerich & Payne 136,300 2,640,813
-----------
5,341,063
-----------
Oil and Gas - 3.3%
Barrett Resources* 176,700 4,240,800
Tom Brown* 447,700 4,490,991
Denbury Resources* 1,038,772 4,220,011
**Devon Energy Corporation 119,000 3,651,812
Tidewater 10,000 231,875
Titan Exploration* 488,900 3,208,406
-----------
20,043,895
-----------
Real Estate - 0.6%
Alico 7,800 140,400
Consolidated-Tomoka Land 49,400 697,775
**FRP Properties* 97,500 2,632,500
Resurgence Properties* 66,700 3,335
-----------
3,474,010
-----------
28,858,968
===========
Technology -- 12.3%
Aerospace/Defense - 2.2%
Curtiss-Wright Corporation 185,400 7,068,375
Special Metals Corporation* 307,600 2,749,175
Woodward Governor Company 159,272 3,523,893
-----------
13,341,443
-----------
Components and Systems - 3.4%
CEM Corporation* 50,000 490,625
Dionex Corporation* 183,776 6,730,796
Hach Company 54,361 652,332
Hach Company Cl. A 56,361 577,700
Modern Controls 83,400 479,550
Newport Corporation 141,200 2,382,750
PCD* 91,100 1,184,300
Penn Engineering and
Manufacturing 210,750 4,715,531
Penn Engineering and
Manufacturing Cl. A 47,050 929,237
VideoServer* 138,100 2,537,588
-----------
20,680,409
-----------
Distribution - 1.2%
Marshall Industries* 199,600 4,890,200
Richardson Electronics 270,262 2,601,272
-----------
7,491,472
-----------
Semiconductors and Equipment - 3.0%
Analog Devices* 145,200 4,555,650
Dallas Semiconductor
Corporation 74,500 3,035,875
</TABLE>
THE ROYCE FUNDS ANNUAL REPORT 1998 | 19
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
PENNSYLVANIA MUTUAL FUND DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Technology (continued)
Semiconductors and Equipment (continued)
Electroglas* 215,300 $ 2,529,775
Exar Corporation* 236,300 3,810,338
Helix Technology Corporation 73,000 949,000
Kulicke and Soffa Industries* 35,000 621,250
Unitrode Corporation* 155,000 2,712,500
Veeco Instruments* 7,100 377,187
------------
18,591,575
------------
Software/Services - 2.4%
Cognex Corporation* 152,700 3,054,000
Comdisco 82,200 1,387,125
National Computer Systems 272,906 10,097,522
Tyler Corporation* 25,000 153,125
------------
14,691,772
------------
Telecommunications - 0.1%
Level 3 Communications* 2,800 120,750
------------
74,917,421
============
Utilities - 0.5%
Southern Union Company* 125,446 3,057,746
============
Miscellaneous -- 5.0% 30,095,048
============
TOTAL COMMON STOCKS
(Cost $387,625,830) 591,563,623
============
</TABLE>
<TABLE>
<CAPTION>
VALUE
-----
<S> <C>
REPURCHASE AGREEMENT -- 2.0%
State Street Bank and Trust Company, 4.25%
dated 12/31/98, due 1/04/99, maturity value
$12,105,714 (collateralized by U.S. Treasury
Notes, 7.50% due 2/15/05, valued at
$12,346,425)
(Cost $12,100,000) $ 12,100,000
============
TOTAL INVESTMENTS -- 99.5%
(Cost $399,725,830) 603,663,623
CASH AND OTHER ASSETS
LESS LIABILITIES -- 0.5% 3,235,164
------------
NET ASSETS -- 100.0% $606,898,787
============
</TABLE>
- --------------------------------------------------------------------------------
* Non-income producing.
+ American Depository Receipt.
** A portion of these securities were on loan at December 31, 1998. Total market
value of all securities on loan at December 31, 1998 was $5,131,814, for
which the Fund had received $5,417,022 as collateral.
INCOME TAX INFORMATION: The cost of total investments for Federal income tax
purposes was $400,583,128. At December 31, 1998, net unrealized appreciation for
all securities was $203,080,495, consisting of aggregate gross unrealized
appreciation of $231,875,241 and aggregate gross unrealized depreciation of
$28,794,746. The Fund designated $66,630,920 as a capital gain dividend for the
purpose of the dividend paid deduction.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
20 | THE ROYCE FUNDS ANNUAL REPORT 1998
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
PMF II DECEMBER 31, 1998
- --------------------------------------------------------------------------------
COMMON STOCKS -- 97.5%
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Consumer Products -- 6.4%
Apparel and Shoes - 1.3%
Brown Group 10,000 $ 175,625
Genesco* 15,000 85,312
Leslie Fay Company* 25,000 167,188
----------
428,125
----------
Collectibles - 0.3%
Enesco Group 5,000 116,250
----------
Home Furnishings/Appliances - 1.2%
Toro 15,000 427,500
----------
Publishing - 2.2%
Houghton Mifflin Company 7,700 363,825
Polaroid Corporation 12,500 233,594
The Topps Company* 27,900 139,500
----------
736,919
----------
Sports and Recreation - 1.0%
Callaway Golf Company 16,500 169,125
Johnson Worldwide
Associates Cl. A* 18,800 173,900
----------
343,025
----------
Other Consumer Products - 0.4%
A.T. Cross Company Cl. A 27,700 148,887
----------
2,200,706
==========
Consumer Services -- 10.2%
Direct Marketing - 0.4%
Spiegel Cl. A* 25,200 144,900
----------
Leisure/Entertainment - 3.3%
AMC Entertainment* 12,600 265,387
Hollywood Park* 37,500 311,719
King World Productions* 12,000 353,250
Spelling Entertainment Group* 28,400 213,000
----------
1,143,356
----------
Restaurants/Lodging - 1.9%
Cooker Restaurant Corporation 42,800 256,800
Piccadilly Cafeterias 17,900 187,950
Rock Bottom Restaurants* 34,500 187,594
----------
632,344
----------
Retail Stores - 4.6%
The Bombay Company* 60,500 336,531
Charming Shoppes* 41,500 178,969
The Elder-Beerman Stores* 20,000 231,250
The Good Guys* 55,200 355,350
InterTAN* 33,200 192,975
Little Switzerland* 50,000 115,625
Tops Appliance City* 58,700 165,094
----------
1,575,794
----------
3,496,394
==========
SHARES VALUE
------ -----
Financial Intermediaries -- 1.1%
Insurance - 1.1%
Old Guard Group 15,000 $ 215,625
PMA Capital
Corporation Cl. A 8,000 156,500
----------
372,125
==========
Health -- 4.0%
Commercial Service - 0.7%
Ultrak* 31,200 230,100
----------
Health Services - 0.7%
Jenny Craig* 38,400 230,400
----------
Personal Care - 1.8%
Balanced Care Corporation 39,300 314,400
Weider Nutrition International 50,300 320,662
----------
635,062
----------
Surgical Products and Devices - 0.8%
Spacelabs Medical* 12,100 278,300
----------
1,373,862
==========
Industrial Products -- 26.0%
Building Systems and Components - 2.3%
American Buildings Company* 13,500 330,750
Drew Industries Incorporated* 15,000 174,375
Pameco Corporation* 25,000 289,063
----------
794,188
----------
Construction Materials - 3.8%
Florida Rock Industries 10,000 310,000
L. B. Foster Company Cl. A* 38,700 256,387
The Lamson & Sessions Co.* 43,700 223,963
Northwest Pipe Company* 17,000 274,125
Oregon Steel Mills 20,000 237,500
----------
1,301,975
----------
Industrial Components - 2.8%
Chyron Corporation* 97,900 183,563
Gundle/SLT Environmental* 24,600 98,400
Tektronix 14,000 420,875
Woodhead Industries 20,000 260,000
----------
962,838
----------
Machinery - 2.1%
CMI Corporation Cl. A 45,500 361,156
DeVlieg-Bullard* 70,400 44,000
Hurco Companies* 25,000 131,250
Lund International Holdings* 20,900 177,650
----------
714,056
----------
</TABLE>
THE ROYCE FUNDS ANNUAL REPORT 1998 | 21
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
PMF II DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Industrial Products (continued)
Paper and Packaging - 3.5%
Applied Extrusion Technologies* 26,200 $ 209,600
Gaylord Container
Corporation Cl. A* 56,700 347,288
Peak International Limited* 20,100 168,337
Smurfit Stone Container* 30,000 474,375
----------
1,199,600
----------
Pumps, Valves and Bearings - 0.5%
NN Ball and Roller 24,900 146,288
----------
Specialty Chemicals and Materials - 3.5%
Calgon Carbon Corporation 40,000 300,000
Lawter International 25,800 299,925
Lilly Industries Cl. A 17,200 342,925
Olin 9,300 263,306
----------
1,206,156
----------
Textiles - 1.4%
Cone Mills Corporation* 42,200 237,375
Dixie Group 30,200 245,375
----------
482,750
----------
Other Industrial Products - 6.1%
American Bank Note
Holographics* 31,500 551,250
Fansteel* 42,400 243,800
Griffon Corporation* 26,000 276,250
Imation* 22,800 399,000
Maxwell Technologies* 5,700 229,425
Medar* 49,600 55,800
Scotsman Industries 17,400 357,787
----------
2,113,312
----------
8,921,163
==========
Industrial Services -- 10.3%
Advertising/Publishing - 1.2%
True North Communications 15,000 403,125
----------
Engineering and Construction - 2.2%
Insituform Technologies Cl. A* 25,000 362,500
Modtech* 15,300 233,325
Roy F. Weston Cl. A* 53,500 147,125
----------
742,950
----------
Food/Tobacco Processors - 1.2%
Midwest Grain Products* 29,300 399,212
----------
Industrial Distribution - 0.9%
Del Global Technologies* 14,000 161,000
Vallen Corporation* 7,800 156,000
----------
317,000
----------
Printing - 1.3%
Bowne & Co. 19,100 341,413
Ennis Business Forms 10,000 99,375
----------
440,788
----------
SHARES VALUE
------ -----
Transportation and Logistics - 3.5%
Arkansas Best Corporation* 30,000 $ 175,312
Arnold Industries 9,500 153,188
Fritz Companies* 38,200 413,037
OMI* 63,400 206,050
Sea Containers Cl. A 9,100 272,431
----------
1,220,018
----------
3,523,093
==========
Natural Resources -- 3.2%
Metals and Mining - 1.0%
Century Aluminum Company 15,800 149,112
Inco Limited 18,500 195,406
----------
344,518
----------
Oil and Gas - 2.1%
Tom Brown* 22,800 228,713
Patina Oil & Gas Corporation 71,700 210,619
Snyder Oil Corporation 23,400 311,512
----------
750,844
----------
Real Estate - 0.1%
Resurgence Properties* 45,000 2,250
----------
1,097,612
==========
Technology -- 36.3%
Aerospace/Defense - 2.4%
Cubic Corporation 20,000 375,000
DRS Technologies* 34,800 380,625
Hawker Pacific Aerospace* 7,800 27,300
Wyman-Gordon* 5,000 51,250
----------
834,175
----------
Components and Systems - 7.5%
Box Hill Systems* 48,500 260,688
Ciprico* 25,000 168,750
Data General Corporation* 15,000 246,562
Exabyte Corporation* 36,300 199,650
HMT Technology Corporation* 40,000 512,500
Innovex 15,000 205,781
Penn Engineering and
Manufacturing 14,700 328,913
Read-Rite Corporation* 15,000 221,719
STB Systems* 30,700 205,306
Smartflex Systems* 30,000 217,500
----------
2,567,369
----------
Distribution - 3.7%
Bell Industries* 25,000 284,375
Bell Microproducts* 25,500 235,875
Kent Electronics Corporation* 16,400 209,100
Pioneer-Standard Electronics 30,200 283,125
Richardson Electronics 25,000 240,625
----------
1,253,100
----------
</TABLE>
22 | THE ROYCE FUNDS ANNUAL REPORT 1998
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
PMF II DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Technology (continued)
Semiconductors and Equipment - 8.2%
California Micro Devices
Corporation* 44,800 $ 112,000
Cirrus Logic* 30,600 300,263
Exar Corporation* 17,100 275,737
FSI International* 31,000 321,625
International Rectifier
Corporation* 33,700 328,575
Photon Dynamics* 54,100 277,263
S3 Incorporated* 30,500 224,461
Sigma Designs* 48,700 140,013
Silicon Valley Group* 25,000 318,750
VLSI Technology* 16,500 180,469
Vishay Intertechnology* 22,600 327,700
-----------
2,806,856
-----------
Software/Services - 7.7%
Benchmark Electronics* 12,000 439,500
Computer Network
Technology Corporation* 9,800 122,500
Enterprise Software* 13,230 66,150
Evans & Sutherland
Computer Corporation* 15,400 271,425
MacNeal-Schwendler
Corporation* 28,000 196,000
Merix Corporation* 61,400 368,400
Phoenix Technologies* 47,400 408,825
System Software Associates* 56,500 397,266
Technology Solutions Company* 34,300 367,653
-----------
2,637,719
-----------
Telecommunications - 6.8%
Allen Telecom* 52,400 350,425
Boca Research* 36,900 115,313
C-COR Electronics* 24,000 330,000
California Microwave* 30,000 281,250
CommScope* 15,200 255,550
Comtech Telecommunications* 20,000 175,000
General DataComm Industries* 45,800 105,912
Spectrian Corporation* 14,800 190,550
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
SymmetriCom* 53,500 $ 357,781
Watkins-Johnson Company 8,000 163,000
------------
2,324,781
------------
12,424,000
============
TOTAL COMMON STOCKS
(Cost $31,663,570) 33,408,955
============
</TABLE>
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT
---------
<S> <C> <C>
CORPORATE BONDS -- 0.5%
California Microwave 5.25%
Conv. Sub. Deb. due 12/15/03 $ 50,000 31,437
Chock Full O'Nuts 8.00%
Conv. Sub. Deb. due 9/15/06 44,000 44,000
VLSI Technology 8.25%
Conv. Sub. Note due 10/01/05 100,000 94,250
-----------
TOTAL CORPORATE BONDS
(Cost $172,915) 169,687
===========
REPURCHASE AGREEMENT -- 2.3%
State Street Bank and Trust Company,
4.25% dated 12/31/98, due 1/04/99,
maturity value $800,378 (collateralized
by U.S. Treasury Notes, 6.375% due
4/30/99, valued at $818,050)
(Cost $800,000) 800,000
=======
TOTAL INVESTMENTS -- 100.3%
(Cost $32,636,485) 34,378,642
LIABILITIES LESS CASH AND
OTHER ASSETS -- (0.3)% (100,957)
-----------
NET ASSETS -- 100.0% $34,277,685
===========
</TABLE>
- --------------------------------------------------------------------------------
* Non-income producing.
INCOME TAX INFORMATION: The cost of total investments for Federal income tax
purposes was $32,925,308. At December 31, 1998, net unrealized appreciation for
all securities was $1,453,334, consisting of aggregate gross unrealized
appreciation of $4,517,417 and aggregate gross unrealized depreciation of
$3,064,083. The Fund designated $388,984 as a capital gain dividend for the
purpose of the dividend paid deduction.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS
THE ROYCE FUNDS ANNUAL REPORT 1998 | 23
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
ROYCE GIFTSHARES FUND DECEMBER 31, 1998
- --------------------------------------------------------------------------------
COMMON STOCKS -- 93.8%
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Consumer Products -- 16.7%
Apparel and Shoes - 4.4%
The North Face* 15,000 $ 195,000
Oshkosh B'Gosh Cl. A 3,000 60,563
Superior Uniform Group 12,000 174,000
----------
429,563
----------
Collectibles - 1.0%
Enesco Group 4,200 97,650
----------
Food/Beverage/Tobacco - 3.3%
800-JR CIGAR* 13,500 313,875
----------
Home Furnishings/Appliances - 1.8%
Bassett Furniture Industries 2,500 60,312
Conso International
Corporation* 20,000 117,500
----------
177,812
----------
Publishing - 1.6%
The Topps Company* 31,500 157,500
----------
Sports and Recreation - 1.5%
Oakley* 15,000 141,563
----------
Other Consumer Products - 3.1%
Lazare Kaplan International* 17,800 124,600
Velcro Industries 1,200 178,800
----------
303,400
----------
1,621,363
==========
Consumer Services -- 5.6%
Retail Stores - 5.6%
Charming Shoppes* 52,800 227,700
Sunglass Hut International* 29,800 208,600
Urban Outfitters* 6,000 101,250
----------
537,550
==========
Financial Intermediaries -- 6.6%
Insurance - 6.6%
The Commerce Group 3,000 106,312
Medical Assurance* 4,318 142,764
Orion Capital Corporation 4,000 159,250
Zenith National Insurance 10,000 231,250
----------
639,576
==========
Financial Services -- 1.8%
Insurance Brokers - 0.9%
Arthur J. Gallagher & Co. 2,000 88,250
----------
Investment Management - 0.9%
Affiliated Managers Group* 3,000 89,625
----------
177,875
==========
SHARES VALUE
------ -----
Health -- 8.5%
Commercial Service - 1.2%
Young Innovations* 8,500 $ 111,563
----------
Drugs and Biotech - 5.8%
BioReliance Corporation* 15,000 120,000
Chiron Corporation* 8,000 209,500
International Isotopes* 6,500 104,000
NeXstar Pharmaceuticals* 13,500 124,875
----------
558,375
----------
Surgical Products and Devices - 1.5%
Haemonetics Corporation* 6,600 150,150
----------
820,088
==========
Industrial Products -- 7.8%
Building Systems and Components - 1.0%
Falcon Products 8,200 98,400
----------
Machinery - 2.4%
Lincoln Electric Holdings 5,900 131,275
Lund International Holdings* 11,600 98,600
----------
229,875
----------
Pumps, Valves and Bearings - 1.8%
Roper Industries 8,500 173,187
----------
Specialty Chemicals and Materials - 0.5%
Lilly Industries Cl. A 2,600 51,838
----------
Other Industrial Products - 2.1%
BHA Group Holdings 14,443 200,397
----------
753,697
==========
Industrial Services -- 6.2%
Advertising/Publishing - 1.1%
True North Communications 4,000 107,500
----------
Commercial Services - 1.9%
BHI Corporation* 6,000 184,500
----------
Food/Tobacco Processors - 0.5%
Midwest Grain Products* 3,300 44,962
----------
Transportation and Logistics - 2.7%
Air Express International
Corporation 4,800 104,400
Circle International Group 7,900 161,950
----------
266,350
----------
603,312
==========
</TABLE>
24 | THE ROYCE FUNDS ANNUAL REPORT 1998
<PAGE>
SCHEDULES OF INVESTMENTS
- -------------------------------------------------------------------------------
ROYCE GIFTSHARES FUND DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Natural Resources -- 6.0%
Oil and Gas - 6.0%
Barrett Resources* 6,300 $ 151,200
Tom Brown* 9,200 92,287
Denbury Resources* 50,000 203,125
Titan Exploration* 20,100 131,906
----------
578,518
==========
Technology -- 30.1%
Components and Systems - 6.7%
Industrial Scientific Corporation 4,700 109,275
Modern Controls 13,300 76,475
National Instruments* 5,600 191,100
Newport Corporation 6,000 101,250
PCD* 13,500 175,500
----------
653,600
----------
Distribution - 5.2%
Marshall Industries* 7,400 181,300
Pioneer-Standard Electronics 10,000 93,750
Richardson Electronics 23,300 224,263
----------
499,313
----------
Semiconductors and Equipment - 5.4%
Analog Devices* 4,500 141,187
Dallas Semiconductor
Corporation 5,600 228,200
Electroglas* 8,000 94,000
Exar Corporation* 3,700 59,663
----------
523,050
----------
SHARES VALUE
------ -----
<S> <C> <C>
Software/Services - 10.6%
ARDENT Software* 6,600 $ 151,800
JDA Software Group* 16,500 159,844
Kronos Incorporated* 5,000 221,562
MacNeal-Schwendler
Corporation* 30,000 210,000
National Computer Systems 5,000 185,000
Segue Software* 4,800 97,200
----------
1,025,406
----------
Telecommunications - 2.2%
REMEC* 12,100 217,800
----------
2,919,169
==========
Miscellaneous -- 4.5% 439,129
==========
TOTAL COMMON STOCKS
(Cost $8,061,639) 9,090,277
==========
REPURCHASE AGREEMENT -- 5.1%
State Street Bank and Trust Company,
4.25% dated 12/31/98, due 1/04/99,
maturity value $500,236 (collateralized
by U.S. Treasury Notes, 7.875% due
8/15/01, valued at $514,988)
(Cost $500,000) 500,000
==========
TOTAL INVESTMENTS -- 98.9%
(Cost $8,561,639) 9,590,277
CASH AND OTHER ASSETS LESS
LIABILITIES -- 1.1% 103,915
----------
NET ASSETS -- 100.0% $9,694,192
==========
</TABLE>
- --------------------------------------------------------------------------------
* Non-income producing.
INCOME TAX INFORMATION: The cost of total investments for Federal income tax
purposes was $8,561,639. At December 31, 1998, net unrealized appreciation for
all securities was $1,028,638, consisting of aggregate gross unrealized
appreciation of $1,392,842 and aggregate gross unrealized depreciation of
$364,204.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
THE ROYCE FUNDS ANNUAL REPORT 1998| 25
<PAGE>
STATEMENTS OF ASSETS AND LIABILITIES DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Pennsylvania Royce
Mutual Fund PMF II GiftShares Fund
----------- ------ ---------------
<S> <C> <C> <C>
ASSETS:
Investments at value (identified cost $387,625,830, $31,836,485 and
$8,061,639, respectively) $ 591,563,623 $ 33,578,642 $ 9,090,277
Repurchase agreements (at cost and value) 12,100,000 800,000 500,000
Cash 4,508 62,755 9,851
Collateral from brokers on securities loaned 5,417,022 -- --
Receivable for investments sold 4,300,158 545,213 --
Receivable for dividends and interest 729,862 19,269 4,952
Receivable for capital shares sold 438,675 51,305 198,575
Prepaid expenses and other assets 31,003 15,550 8,002
- ------------------------------------------------------------------------------------------------------------------------
Total Assets 614,584,851 35,072,734 9,811,657
- ------------------------------------------------------------------------------------------------------------------------
LIABILITIES:
Payable for collateral on securities loaned 5,417,022 -- --
Payable for investments purchased 1,137,746 745,536 90,689
Payable for capital shares redeemed 487,879 5,927 5,356
Payable for investment advisory fees 389,348 14,320 2,513
Accrued expenses 254,069 29,266 18,907
- ------------------------------------------------------------------------------------------------------------------------
Total Liabilities 7,686,064 795,049 117,465
- ------------------------------------------------------------------------------------------------------------------------
Net Assets $ 606,898,787 $ 34,277,685 $ 9,694,192
========================================================================================================================
ANALYSIS OF NET ASSETS:
Undistributed net investment income $ 50,325 $ -- $ --
Accumulated net realized gain on investments 2,040,187 1,203,167 552,028
Net unrealized appreciation on investments 203,937,793 1,742,157 1,028,638
Capital shares 82,623 5,692 1,178
Additional paid-in capital 400,787,859 31,326,669 8,112,348
- ------------------------------------------------------------------------------------------------------------------------
Net Assets $ 606,898,787 $ 34,277,685 $ 9,694,192
Investment Class $ 466,857,376 $ 34,277,685 $ 8,418,203
Consultant Class $ 140,041,411 $ 1,275,989
========================================================================================================================
SHARES OUTSTANDING:
(unlimited number of $.001 par value shares authorized for each Fund)
Investment Class 63,551,836 5,691,513 1,021,168
Consultant Class 19,071,480 156,741
========================================================================================================================
NET ASSET VALUES:
(Net Assets [divided by] Shares Outstanding)
Investment Class (offering and redemption price* per share) $ 7.35 $ 6.02 $ 8.24
Consultant Class (offering and redemption price** per share) $ 7.34 $ 8.14
========================================================================================================================
</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, if any.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
26 | THE ROYCE FUNDS ANNUAL REPORT 1998
<PAGE>
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
===================================
Pennsylvania Mutual Fund
-----------------------------------
Year ended Year ended
December 31, December 31,
1998 1997
===================================
<S> <C> <C>
INVESTMENT OPERATIONS:
Net investment income (loss) $ 2,847,051 $ 4,409,053
Net realized gain on investments 67,731,907 57,122,461
Net change in unrealized appreciation on investments (43,310,982) 59,891,240
- ------------------------------------------------------------------------------------------
Net increase in net assets from investment operations 27,267,976 121,422,754
- ------------------------------------------------------------------------------------------
DISTRIBUTIONS:
Net investment income
Investment Class (2,894,969) (3,514,299)
Consultant Class -- (658,502)
Net realized gain on investments
Investment Class (41,174,076) (57,918,964)
Consultant Class (12,374,251) (17,311,988)
- ------------------------------------------------------------------------------------------
Total distributions (56,443,296) (79,403,753)
- ------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS:
Value of shares sold
Investment Class 131,448,215 60,713,483
Consultant Class 4,633,372 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 41,415,445 55,324,790
Consultant Class 11,840,244 17,180,389
Value of shares redeemed
Investment Class (192,077,698) (108,160,769)
Consultant Class (20,768,837) (10,190,290)
- ------------------------------------------------------------------------------------------
Net increase (decrease) in net assets from
capital share transactions (23,509,259) 160,696,415
- ------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN NET ASSETS (52,684,579) 202,715,416
NET ASSETS:
Beginning of year 659,583,366 456,867,950
- ------------------------------------------------------------------------------------------
End of year (a) $ 606,898,787 $ 659,583,366
==========================================================================================
CAPITAL SHARE TRANSACTIONS (in shares):
Shares sold
Investment Class 16,866,770 7,452,126
Consultant Class 579,570 156,892
Shares issued in connection with the
merger of Royce Value Fund
Consultant Class -- 18,295,100
Shares issued for reinvestment of distributions
Investment Class 5,899,787 7,101,539
Consultant Class 1,686,598 2,205,442
Shares redeemed
Investment Class (24,138,522) (13,880,141)
Consultant Class (2,651,359) (1,200,763)
- ------------------------------------------------------------------------------------------
Net increase (decrease) in shares outstanding (1,757,156) 20,130,195
- ------------------------------------------------------------------------------------------
<CAPTION>
=================================================================
PMF II Royce GiftShares Fund
-------------------------------- ------------------------------
Year ended Year ended Year ended Year ended
December 31, December 31, December 31, December 31,
1998 1997 1998 1997
=================================================================
<S> <C> <C> <C> <C>
INVESTMENT OPERATIONS:
Net investment income (loss) $ (44,314) $ 245,395 $ (28,802) $ (6,040)
Net realized gain on investments 1,597,782 1,811,059 585,011 192,176
Net change in unrealized appreciation on investments (373,765) 1,644,420 730,213 221,469
- ------------------------------------------------------------------------------------------------------------------------
Net increase in net assets from investment operations 1,179,703 3,700,874 1,286,422 407,605
- ------------------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS:
Net investment income
Investment Class -- (271,235) -- --
Consultant Class -- --
Net realized gain on investments
Investment Class (933,562) (1,220,556) (13,608) (184,608)
Consultant Class (2,159) (3,935)
- ------------------------------------------------------------------------------------------------------------------------
Total distributions (933,562) (1,491,791) (15,767) (188,543)
- ------------------------------------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS:
Value of shares sold
Investment Class 15,585,247 3,475,010 3,728,172 2,172,160
Consultant Class 1,021,791 105,710
Value of shares issued in connection with the
merger of Royce Value Fund
Consultant Class
Distributions reinvested
Investment Class 891,292 1,388,651 13,603 184,794
Consultant Class 2,136 3,935
Value of shares redeemed
Investment Class (4,688,495) (2,686,425) (57,930) (27,676)
Consultant Class (5,398) (411)
- ------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in net assets from
capital share transactions 11,788,044 2,177,236 4,702,374 2,438,512
- ------------------------------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN NET ASSETS 12,034,185 4,386,319 5,973,029 2,657,574
NET ASSETS:
Beginning of year 22,243,500 17,857,181 3,721,163 1,063,589
- ------------------------------------------------------------------------------------------------------------------------
End of year (a) $ 34,277,685 $ 22,243,500 $ 9,694,192 $ 3,721,163
========================================================================================================================
CAPITAL SHARE TRANSACTIONS (in shares):
Shares sold
Investment Class 2,584,105 603,433 503,437 317,894
Consultant Class 141,588 15,046
Shares issued in connection with the
merger of Royce Value Fund
Consultant Class
Shares issued for reinvestment of distributions
Investment Class 156,949 232,216 1,753 27,216
Consultant Class 278 581
Shares redeemed
Investment Class (808,098) (470,991) (7,319) (4,318)
Consultant Class (692) (60)
- ------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in shares outstanding 1,932,956 364,658 639,045 356,359
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Includes undistributed net investment income of $50,325 in 1998 and
$266,266 in 1997 for Pennsylvania Mutual Fund.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
THE ROYCE FUNDS ANNUAL REPORT 1998 | 27
<PAGE>
STATEMENTS OF OPERATIONS YEAR ENDED DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Pennsylvania Royce
Mutual Fund PMF II GiftShares Fund
------------ ------ ---------------
INVESTMENT INCOME:
Income:
<S> <C> <C> <C>
Dividends $ 8,652,343 $ 214,859 $ 52,374
Interest 1,686,684 79,002 18,641
- -------------------------------------------------------------------------------------------------------------------
Total Income 10,339,027 293,861 71,015
- -------------------------------------------------------------------------------------------------------------------
Expenses:
Investment advisory fees 4,939,625 270,520 62,411
Distribution fees -- Investment Class -- -- 13,895
Distribution fees -- Consultant Class 1,477,405 -- 6,831
Administrative and office facilities 305,919 11,321 2,196
Shareholder reports -- Investment Class 296,521 18,098 12,002
Shareholder reports -- Consultant Class 74,817 -- 2,886
Shareholder servicing -- Investment Class 294,807 16,884 9,709
Shareholder servicing -- Consultant Class 65,282 -- 9,079
Custodian 143,592 57,686 14,110
Trustees' fees 84,165 3,298 737
Audit 68,429 15,635 13,035
Legal 23,783 1,019 308
Registration -- Investment Class 22,244 14,669 12,704
Registration -- Consultant Class 12,427 -- 3,393
Organizational expenses -- Investment Class -- 5,050 4,035
Other expenses 52,311 3,469 868
- -------------------------------------------------------------------------------------------------------------------
Total Expenses 7,861,327 417,649 168,199
Fees Waived by Investment Adviser and Distributor (369,351) (79,474) (58,108)
Expenses Reimbursed by Investment Adviser -- Consultant Class -- -- (10,274)
- -------------------------------------------------------------------------------------------------------------------
Net Expenses 7,491,976 338,175 99,817
- -------------------------------------------------------------------------------------------------------------------
Net Investment Income (Loss) 2,847,051 (44,314) (28,802)
- -------------------------------------------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Net realized gain on investments 67,731,907 1,597,782 585,011
Net change in unrealized appreciation on investments (43,310,982) (373,765) 730,213
- -------------------------------------------------------------------------------------------------------------------
Net realized and unrealized gain on investments 24,420,925 1,224,017 1,315,224
- -------------------------------------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS FROM INVESTMENT OPERATIONS $ 27,267,976 $1,179,703 $1,286,422
===================================================================================================================
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
28 | THE ROYCE FUNDS ANNUAL REPORT 1998
<PAGE>
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 NET NET REALIZED
ASSET VALUE, INVESTMENT AND UNREALIZED
BEGINNING INCOME GAIN (LOSS)
OF PERIOD (LOSS) ON INVESTMENTS
- -----------------------------------------------------
<S> <C> <C> <C> <C>
PENNSYLVANIA MUTUAL FUND -- INVESTMENT CLASS (a)
1998 $7.82 $ 0.05 $0.24
1997 7.11 0.07 1.70
1996 7.71 0.11 0.84
1995 7.41 0.11 1.27
1994 8.31 0.12 (0.18)
PENNSYLVANIA MUTUAL FUND -- CONSULTANT CLASS (b)
1998 $7.81 $(0.01) $0.24
1997 7.90 0.02 0.93
PMF II (c)
1998 $5.92 $(0.01) $0.29
1997 5.26 0.07 1.03
1996 5.00 -- 0.26
ROYCE GIFTSHARES FUND -- INVESTMENT CLASS (d)
1998 $6.91 $(0.02) $1.37
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 $(0.06) $1.34
1997 7.21 (0.01) 0.11
- -------------------------------------------------
<CAPTION>
DISTRIBUTIONS DISTRIBUTIONS
FROM NET FROM NET NET ASSET NET ASSETS,
INVESTMENT REALIZED GAIN VALUE, END TOTAL END OF PERIOD
INCOME ON INVESTMENTS OF PERIOD RETURN (IN THOUSANDS)
- -----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PENNSYLVANIA MUTUAL FUND -- INVESTMENT CLASS (a)
$(0.05) $(0.71) $7.35 4.2% $466,857
(0.06) (1.00) 7.82 25.0% 507,635
(0.11) (1.44) 7.11 12.8% 456,868
(0.11) (0.97) 7.71 18.7% 630,119
(0.11) (0.73) 7.41 (0.7)% 771,417
PENNSYLVANIA MUTUAL FUND -- CONSULTANT CLASS (b)
$ -- $(0.70) $7.34 3.4% $140,042
(0.04) (1.00) 7.81 12.0% 151,948
PMF II (c)
$ -- $0.18) $6.02 4.9% $ 34,278
(0.08) (0.36) 5.92 20.8% 22,244
-- -- 5.26 5.2% 17,857
ROYCE GIFTSHARES FUND -- INVESTMENT CLASS (d)
$ -- $(0.02) $8.24 19.5% $ 8,418
-- (0.43) 6.91 26.0% 3,614
-- (0.45) 5.83 25.6% 1,064
-- -- 5.01 0.2% 502
ROYCE GIFTSHARES FUND -- CONSULTANT CLASS (e)
$ -- $(0.02) $8.14 18.5% $ 1,276
-- (0.43) 6.88 1.5% 107
- ------------------------------------------------------------------------------------
<CAPTION>
RATIO OF RATIO OF NET
EXPENSES INVESTMENT PORTFOLIO
TO AVERAGE INCOME (LOSS) TO TURNOVER
NET ASSETS AVERAGE NET ASSETS RATE
- ------------------------------------------------------
<S> <C> <C> <C>
PENNSYLVANIA MUTUAL FUND -- INVESTMENT CLASS (a)
1.01% 0.62% 29%
1.05% 0.88% 18%
0.99% 1.05% 29%
0.98% 1.18% 10%
0.98% 1.33% 17%
PENNSYLVANIA MUTUAL FUND -- CONSULTANT CLASS (b)
1.74% (0.11)% 29%
1.65%* 0.29%* 18%
PMF II (c)
1.25% (0.16)% 120%
0.99% 1.23% 77%
0.97%* 0.83%* 1%
ROYCE GIFTSHARES FUND -- INVESTMENT CLASS (d)
1.49% (0.35)% 153%
1.49% (0.32)% 64%
1.49% (0.05)% 93%
0.70%* 0.00%* 0%
ROYCE GIFTSHARES FUND -- CONSULTANT CLASS (e)
2.49% (1.39)% 153%
2.49%* (1.35)%* 64%
- ------------------------------------------------------
</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 December 31, 1998 and 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 December 31, 1998, 1997 and 1996, the expense ratios
before the waivers would have been 1.54%, 1.56% and 1.97%, respectively. The
Fund commenced operations on November 19, 1996.
(d) Expense ratios are shown after fee waivers and expense reimbursements by the
investment adviser and distributor. For the periods ended December 31, 1998,
1997, 1996 and 1995, the expense ratios before the waivers and
reimbursements would have been 2.45%, 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 December 31, 1998 and 1997, the
expense ratios before the waivers and reimbursements would have been 4.70%
and 30.28%, respectively. The Class commenced operations on September 26,
1997. Total returns do not deduct contingent deferred sales charge.
* Annualized.
THE ROYCE FUNDS ANNUAL REPORT 1998 | 29
<PAGE>
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
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 distribution, shareholder servicing, registration
and shareholder reports fees and 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 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 are determined on the basis of identified cost for book and tax
purposes.
Expenses:
The Fund incurs direct and indirect expenses. Expenses directly
attributable to a Fund are charged to the Fund's operations, while expenses
applicable to one or more series of the Trust 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 that 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 undistributed at fiscal year end is distributed in the
following year.
Repurchase agreements:
The Funds enter into repurchase agreements with respect to portfolio
securities solely with State Street Bank and Trust Company ("SSB&T"), the
custodian of the Funds' assets. Each Fund restricts repurchase agreements to
maturities of no more than seven days. Securities pledged as collateral for
repurchase agreements, 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 maintained at a value at least equal to 100% of
the current market value of the loaned securities.
30| THE ROYCE FUNDS ANNUAL REPORT 1998
<PAGE>
NOTES TO FINANCIAL STATEMENTS (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 Pennsylvania Mutual Fund at the annual rate of
1.0% of the first $50 million of the Fund's average net assets, 0.875% of the
next $50 million of such net assets and 0.75% of additional amounts of average
net assets, and for PMF II and Royce GiftShares Fund at the annual rate of 1.0%
of average net assets. The Investment Adviser had voluntarily committed to
waive its fees and reimburse for certain expenses to the extent necessary to
maintain the ratio of expenses to average net assets at or below 1.25%, 1.49%
and 2.49% of average net assets for PMF II, Royce GiftShares Fund-Investment
Class and Royce GiftShares Fund-Consultant Class, respectively, for the year
ended December 31, 1998. For the year ended December 31, 1998, Pennsylvania
Mutual Fund, PMF II and Royce GiftShares Fund recorded advisory fees of
$4,939,625, $191,046 (net of voluntary waivers of $79,474) and $18,198 (net of
voluntary waivers of $44,213), respectively.
Royce Fund Services, Inc. ("RFS"), the distributor of the Trust's shares, is
an affiliate of Royce. The distribution agreement provides for maximum fees at
the annual rate of 1.0% of each Fund's Consultant Class average net assets and
0.25% of Royce GiftShares Fund - Investment Class' average net assets. For the
year ended December 31, 1998, RFS received 12b-1 distribution fees of
$1,108,054 (net of voluntary waivers of $369,351) and $6,831 from the
Consultant Classes of Pennsylvania Mutual Fund and Royce GiftShares Fund,
respectively. RFS voluntarily waived the distribution fees of $13,895 from the
Investment Class of Royce GiftShares Fund.
Purchases and Sales of Investment Securities:
For the year ended December 31, 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 $177,110,349 $41,848,845 $13,690,974
====================================================================================
Sales $234,377,605 $30,505,013 $ 8,644,020
====================================================================================
</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.
THE ROYCE FUNDS ANNUAL REPORT 1998 | 31
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
- --------------------------------------------------------------------------------
To the Board of Trustees of The Royce Fund and the Shareholders of Pennsylvania
Mutual Fund, PMF II and Royce GiftShares Fund:
In our opinion, the accompanying statements of assets and liabilities,
including the schedules of investments, and the related statements of
operations and of changes in net assets and the financial highlights present
fairly, in all material respects, the financial positions of Pennsylvania
Mutual Fund, PMF II, and Royce GiftShares Fund (the "Funds") at December 31,
1998, and the results of their operations, the changes in their net assets and
the financial highlights for the periods indicated, in conformity with
generally accepted accounting principles. These financial statements and
financial highlights (hereafter referred to as "financial statements") are the
responsibility of the Funds' management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these financial statements in accordance with generally accepted
auditing standards which require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits, which included confirmation of investments owned at December 31,
1998 by correspondence with the custodian and brokers, provide a reasonable
basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Boston, Massachusetts
February 10, 1999
32 | THE ROYCE FUNDS ANNUAL REPORT 1998
<PAGE>
[Inside Back Cover]
[Graphics of a sphere and jumping jacks superimposed on page]
POSTSCRIPT
- --------------------------------------------------------------------------------
"FURBY-MANIA"
A member of our senior investment staff told us this tale of holiday shopping
mania.
Like all dutiful Dads, I do my best to help my wife out with Christmas
shopping. Of course, having an office a block away from FAO Schwartz doesn't
hurt. This year we faced the same problem that every parent of young children
faces every Christmas. The names may change, but the dilemma is as old as St.
Nick himself. I can sum it up in one word -- Furby.
At first my wife and I, delusional, I guess, with terror at being unable to
locate one of these odd furry fellows, tried to convince our child that
something else -- a teddy bear or jigsaw puzzle -- might be a little easier on
Santa. With the curious combination of awe and greed that afflicts every
youngster at this time of year, our little darling sweetly replied,"Santa will
bring me a Furby because Santa can do anything."
We made a few more lame attempts to stem the tide. "If you don't stop
pestering your mother and me," I announced around the 18th, "you'll wind up with
coal in your stocking," a statement that produced a torrent of tears and a
demand from my wife that I limit my conversations with the children to the
injustices of trading spreads on micro-cap stocks until after Christmas. I was
also put on solo Furby procurement duty.
First I tried using one of those online bidding sites. Nothing in my years
of trading stocks on Wall Street prepared me for the brutality and ruthlessness
of desperate parents vying for Furbies. I realized as I bid $200 for a toy with
as much intrinsic value as a pair of sweat socks that I had forgotten everything
I had learned about value investing, but I didn't care -- I had to get a Furby
or risk sleeping in the reindeer stable. But I couldn't do it. My instincts as a
value investor were too strong, and a housewife from Des Moines bid the last
remaining one away from me for $220.
It was almost lunch time on the 23rd. No Furby. Suddenly, the phone rang.
It was an old college friend, "Fast" Eddie. Eddie is a buyer for FAO Schwartz.
"Listen, I could be fired for even thinking about telling you this, but a
shipment of Furbies is coming in today at 3:00, on the floor by 3:30. Remember,
you never spoke to me!" Before I could even muster a "And how are you, Eddie,"
he hung up. Talk about insider information!
At 3:15 I was out the door and headed down West 58th Street toward the toy Mecca
of midtown Manhattan, casually elbowing tourists foolish enough to get in my
way. Just as I got through the door, I saw Eddie ducking into a stairwell and
out of sight. I recognized a young portfolio manager of a very aggressive growth
fund running toward the back of the store, scattering children in his wake. I
followed, knowing how these growth guys are always after the next big thing.
Were we too late? Through a maze of shouting kids and pushy parents, all I could
see was a Furby display and some empty shelves. My watch said 3:28! Suddenly, I
heard a scream and the sound of something falling. Apparently, my young
portfolio manager friend was reaching for the last Furby when he was hit with an
avalanche of discounted Tickle-Me-Elmos and Sing-and-Snore Ernies, the Furbies
of 1996 and 1997, now being hawked for a fraction of their original price as
part of a display called "Precious Memories of Christmas Past." I could just
make out his outstretched hand and the very top of his head, the rest of him
buried under a sea of red Elmo fur. As I bent down to see if he was all right, a
kindly old woman gently scooped the last Furby from the floor. "Buy, buy, I
don't care how high it goes, I need that stock," murmured my friend, obviously
dizzy from so many furry blows to the head.
Fortunately, he was fine, just a little shaken up. I returned to the office
disappointed, but grateful that my brush with Furby-mania had taught me an
important lesson about why we don't buy stocks the way consumers buy Furbies. If
anything, we stick to Barbies, footballs and board games, the predictable but
steady items that may never be this (or any) year's "gotta have it," but never
really go out of style, either.
Lost in my reflections, I barely noticed that my telephone message light
was on. It was from Eddie. "Sorry I didn't get to you at the store," his message
said, "but I was able to put one aside for you. Come by my office after work,
and it's all yours."
I guess it's a good thing Eddie chose toys over stocks.
[Begin Sidebar]
Furby-mania had taught me an important lesson about why we don't buy stocks the
way consumers buy Furbies. If anything, we stick to Barbies, footballs and board
games, the predictable but steady items that may never be this (or any) year's
"gotta have it," but never really go out of style, either.
[End Sidebar]
<PAGE>
[Back Cover]
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 $2.8
billion in total assets under management, Royce & Associates remains an
independent firm committed to the same principles that have served us well for
more than 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 participating in the small-cap market's total returns with
below-average volatility.
REALISTIC EXPECTATIONS AND CONSISTENT DISCIPLINE
Royce Premier Fund, Royce Total Return Fund, Pennsylvania Mutual Fund and Royce
GiftShares 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 officers, employees and their affiliates
currently have approximately $35 million invested in The Royce Funds.
THE ROYCE FUNDS
1414 AVENUE OF THE AMERICAS, NEW YORK NY 10019
GENERAL INFORMATION
Additional Report Copies
and Prospectus Inquiries
(800) 221-4268
SHAREHOLDER SERVICES
(800) 841-1180
AUTOMATED TELEPHONE SERVICES
(800) 78-ROYCE (787-6923)
ADVISOR SERVICES
For Fund Materials, Performance Updates,
Transactions or Account Inquiries
(800) 33-ROYCE (337-6923)
BROKER/DEALER SERVICES
For Fund Materials and Performance Updates
(800) 59-ROYCE (597-6923)
www.roycefunds.com
[email protected]
This report must be accompanied or preceded by a current
prospectus of each of the Funds.
Please read the prospectus carefully before investing or sending money.
[End Back Cover]
