[front cover]
Value Investing in Small Companies
for More Than 25 Years
THE
ROYCE
FUNDS
Royce Premier Fund
Royce Micro-Cap Fund
1998 Annual Report
www.roycefunds.com
<PAGE>
The Royce Funds Road Map
- --------------------------------------------------------------------------------
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 bar] SMALL-CAP
[Yellow bar] MICRO-CAP
<TABLE>
<S> <C>
Core Funds
The small-cap universe (companies with [Blue bar] ROYCE PREMIER FUND
market caps between $300 million and $1 Concentrated Small-Cap
billion) is no longer small, unknown or Portfolio
under-owned; therefore, we believe that
this higher level of efficiency requires
greater portfolio concentration.
The micro-cap universe (companies with [Yellow bar] ROYCE MICRO-CAP FUND
market caps less than $300 million) Diversified Micro-Cap
provides more choices (approximately Portfolio
6,500 companies), yet greater trading
difficulties; therefore, we believe that
broad diversification is appropriate
given the liquidity constraints of this
sector.
- -----------------------------------------------------------------------------------------------
Combined Funds
These portfolios invest in both small- [Blue bar] PENNSYLVANIA MUTUAL FUND
and micro-cap companies and represent [Yellow bar] Diversified Small- and
our flagship approach. Two of our Micro-Cap Portfolio
combined portfolios, Pennsylvania Mutual
Fund and PMF II, employ a more
diversified investment strategy and are [Blue bar] PMF II
designed for both individuals and [Yellow bar] Diversified Small- and
institutions. Royce GiftShares Fund, one Micro-Cap Portfolio
of the few gifting and estate-planning
portfolios, uses a more concentrated [Blue bar] ROYCE GIFTSHARES FUND
approach. [Yellow bar] Concentrated Small- and
Micro-Cap Portfolio
- -----------------------------------------------------------------------------------------------
Theme Funds
These portfolios invest in securities [Blue bar] ROYCE TOTAL RETURN FUND
primarily found in our Core Funds that [Yellow bar] Dividend-Paying Securities
have special attributes. One has
low-volatility characteristics
(dividends), one has the potential for [Blue bar] ROYCE LOW-PRICED STOCK FUND
higher returns and volatility [Yellow bar] Stocks Priced Below $15
(low-priced stocks) and one takes
specific sector (financial services)
risk. Performance and volatility may be [Blue bar] ROYCE FINANCIAL SERVICES FUND
substantially different for each of [Yellow bar] Financial Services Companies
these portfolios.
</TABLE>
<PAGE>
The Royce Funds
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Annual Report Reference Guide
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
Jump, Jive An' Wail: 1998's stock market provided 2
more than its share of swinging moments.
- ------------------------------------------------------------------------------------------------
It Don't Mean a Thing (If It Ain't Got That Swing): 5
Recent changes to small-cap stock definitions have
little impact on our own small- and micro-cap work.
- ------------------------------------------------------------------------------------------------
Royce Premier Fund's concentrated approach outperformed 10
its benchmark index, the small-cap oriented Russell 2000,
for the second half, the one-, three-, five-year and since inception
(12/31/91) periods.
- ------------------------------------------------------------------------------------------------
Royce Micro-Cap Fund* outperformed the Russell 2000 12
for the three-year and since inception (12/31/91) periods,
in spite of a difficult year for both micro-cap securities and for the Fund.
- ------------------------------------------------------------------------------------------------
Updates and Notes: What's New on Our Website 14
(www.roycefunds.com) and a Y2K Update.
- ------------------------------------------------------------------------------------------------
Schedules of Investments and Other Financial Statements. 15
- ------------------------------------------------------------------------------------------------
Postscript: Furby-Mania. Inside Back Cover
- ------------------------------------------------------------------------------------------------
</TABLE>
[graphic: looking through magnifying glass at The Royce Funds listing in
newspaper]
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.
- --------------------------------------------------------------------------------
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>
Royce Premier Fund (12/31/91) 6.7% 14.3% 12.7% 14.0%
- ------------------------------------------------------------------------------
Royce Micro-Cap Fund* (12/31/91) -3.3% 11.7% 11.4% 15.5%
</TABLE>
* Investment Class.
- --------------------------------------------------------------------------------
<PAGE>
Letter To Our Shareholders
[sidebar]
[photo: 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"]
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 398 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.
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%+).
[pull quote]
[O]ut of the 910 funds that received
four or five star [Morningstar] ratings,
only 1.3% [12 funds] were small-cap
portfolios.
[end pull quote]
<TABLE>
<CAPTION>
- ------------------------------------------
LATE '90s: SMALL CAPS LANGUISH
- ------------------------------------------
5/22/96 - 10/8/98
<S> <C>
Russell 2000 -12.0%
- ------------------------------------------
S&P 500 47.6%
- ------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ------------------------------------------
Early '90s: A COMPLETELY DIFFERENT PICTURE
- ------------------------------------------
10/31/90 - 5/22/96
<S> <C>
Russell 2000 236.2%
- ------------------------------------------
S&P 500 162.1%
- ------------------------------------------
</TABLE>
The Royce Funds Annual Report 1998 | 3
<PAGE>
[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]
RUSSELL 2000 PEAK-TO-TROUGH-TO-PEAK PERFORMANCE PERIODS
[bar chart]
<TABLE>
<CAPTION>
Decline From Peak Subsequent Rise
--------------------- -------------------------
<S> <C> <C> <C>
6/15/81- -26.2% 8/12/82- 115.5%
8/12/82 6/24/83
6/24/83- -24.1% 7/25/84- 72.5%
7/25/84 7/3/86
8/25/87- -38.9% 10/28/87- 76.8%
10/28/87 10/9/89
10/9/89- -32.5% 10/31/90- 83.1%
10/31/90 2/12/92
4/21/98- -36.5% 10/8/98- 36.3%
10/8/98 12/31/98
</TABLE>
Historical market trends are not necessarily indicative of future market
movements.
[end bar chart]
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.
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
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>
years; 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 Royce Premier Fund did
provide a short-term performance advantage over the Russell 2000, we are most
pleased that both Royce Premier Fund and Royce Micro-Cap Fund have provided a
long-term performance edge. For a complete review and discussion of our results
and our risk profiles, please see pages 10-13.
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
[pull quote]
Our investment horizon for portfolio
selection 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 pull quote]
- ----------------------------------------------
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>
[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,
[pull quote]
[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 pull quote]
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.
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
[pull quote]
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 pull quote]
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>
[cartoon graphic: 2 optimistic guys walking down the street with sign "The
Future for Small-Caps." They are flanked by three cautious-looking guards.
Caption: "Guarded Optimism"]
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
[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]
[pull quote]
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 pull quote]
8 | The Royce Funds Annual Report 1998
<PAGE>
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,
<TABLE>
<S> <C> <C>
/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
</TABLE>
[photo: Jack Fockler, Whitney George, Chuck Royce, Charlie Dreifus, Buzz Zaino]
(l-r) Jack Fockler, Whitney George, Chuck Royce,
Charlie Dreifus, Buzz Zaino
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>
Royce Premier Fund
- --------------------------------------------------------------------------------
[sidebar]
What We Do
Royce Premier Fund ("RPR") uses a value approach to invest primarily in a
limited number of small-company stocks with market capitalizations between $300
million and $1 billion. Royce generally looks to invest in companies that it
believes have excellent business strengths and/or prospects for growth, high
internal rates of return and low leverage, which are trading significantly below
our estimate of their worth.
How We Did
Royce Premier Fund's concentrated approach outperformed its benchmark index, the
small-cap oriented Russell 2000, for both the fourth quarter and the second
half. The Fund also beat the Russell 2000 for the one-, three-, five-year and
since inception (12/31/91) periods ended December 31, 1998. In addition, RPR
provided a strong performance advantage over the Russell 2000 from the 1996
small-cap peak, with a total return of 36.3% versus 19.9% for its benchmark.
In 1998's second half, the Fund benefited from an increased exposure to
technology stocks, a market-leading sector within both large- and small-cap in
1998. This increased exposure to technology is not indicative of a change in our
investment style, but instead reflects the growing role technology plays in the
economy, which includes a vastly expanding universe of small-cap technology
companies. We remain committed to absolute valuation measures in our selection
process.
RPR remains one of Morningstar's "lowest risk" small-cap funds as measured by
Morningstar risk ratio for the three years ended December 31, 1998. Total net
assets at year-end were $569 million, and the average annual total return since
inception was 14.0%. 1998 marked the Fund's seventh year of performance history.
[end sidebar]
<TABLE>
- ------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS Through 12/31/98
- ------------------------------------------------
<S> <C>
Fourth Quarter 1998* 15.1%
- ------------------------------------------------
July-Dec 1998* -1.6
- ------------------------------------------------
1-Year 6.7
- ------------------------------------------------
3-Year 14.3
- ------------------------------------------------
5-Year 12.7
- ------------------------------------------------
Since Inception (12/31/91) 14.0
- ------------------------------------------------
</TABLE>
*Not annualized.
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------
RISK/RETURN COMPARISON Inception (12/31/91) Through 12/31/98
- -----------------------------------------------------------------------------
Average Annual Standard
Total Return Deviation RUR
- -----------------------------------------------------------------------------
<S> <C> <C> <C>
Royce Premier 14.0% 9.4 1.49
- -----------------------------------------------------------------------------
Russell 2000 13.8% 15.5 0.89
- -----------------------------------------------------------------------------
</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 Premier Fund has outperformed the Russell 2000 on
BOTH an absolute and a risk-adjusted basis.
RECENT MARKET PERFORMANCE
[line chart]
<TABLE>
- --------------------
5/22/96 - 12/31/98
- --------------------
<S> <C>
RPR 36.3%
- --------------------
Russell 2000 19.9%
- --------------------
</TABLE>
<TABLE>
- --------------------
4/21/98 - 12/31/98
- --------------------
<S> <C>
RPR -4.8%
- --------------------
Russell 2000 -13.4%
- --------------------
</TABLE>
<TABLE>
<CAPTION>
Date Russell 2000
---- ------------
<S> <C>
12/31/1995 0.00%
1/31/1996 -0.11%
2/28/1996 3.01%
3/31/1996 5.11%
4/30/1996 10.73%
5/31/1996 15.09%
6/30/1996 10.36%
7/31/1996 0.73%
8/31/1996 6.58%
9/30/1996 10.75%
10/31/1996 9.04%
11/30/1996 13.54%
12/31/1996 16.51%
1/31/1997 18.84%
2/28/1997 15.95%
3/31/1997 10.48%
4/30/1997 10.79%
5/31/1997 23.12%
6/30/1997 28.40%
7/31/1997 34.37%
8/31/1997 37.45%
9/30/1997 47.51%
10/31/1997 41.04%
11/30/1997 40.12%
12/31/1997 42.57%
1/31/1998 40.32%
2/28/1998 50.69%
3/31/1998 56.90%
4/30/1998 57.76%
5/31/1998 49.26%
6/30/1998 49.57%
7/31/1998 37.45%
8/31/1998 10.73%
9/30/1998 19.40%
10/31/1998 24.27%
11/30/1998 30.78%
12/31/1998 38.88%
</TABLE>
[end line chart]
Royce Premier Fund has provided solid absolute and relative performance since
the small-cap peak in May 1996.
[line chart]
ROYCE PREMIER FUND vs. RUSSELL 2000 Value of $10,000 Invested on 12/31/91
Royce Premier Fund Russell 2000
Includes reinvestment of distributions.
<TABLE>
<CAPTION>
Royce Russell
Date Premier 2000
---- ------- ----
<S> <C> <C>
12/31/91 10,000 10,000
03/31/92 10,160 10,750
06/30/92 10,140 10,017
09/30/92 10,440 10,303
12/31/92 11,580 11,841
03/31/93 12,125 12,346
06/30/93 12,608 12,615
09/30/93 12,923 13,718
12/31/93 13,784 14,079
03/31/94 13,891 13,704
06/30/94 13,741 13,171
09/30/94 14,258 14,085
12/31/94 14,236 13,823
03/31/95 14,851 14,460
06/30/95 16,103 15,815
09/30/95 16,807 17,378
12/31/95 16,774 17,755
03/31/96 17,339 18,662
06/30/96 18,022 19,595
09/30/96 18,469 19,662
12/31/96 19,813 20,684
03/31/97 20,041 19,613
06/30/97 22,705 22,794
09/30/97 24,837 26,186
12/31/97 23,460 25,309
03/31/98 25,725 27,852
06/30/98 25,454 26,553
09/30/98 21,760 21,199
12/31/98 25,038 24,656
</TABLE>
[end line chart]
10 | 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>
Royce Premier Fund Russell 2000
<S> <C> <C>
2/12/92 - 0.0 -12.0
7/8/92
3/18/94 - -4.2 -12.3
12/9/94
5/22/96 - -6.4 -15.4
7/24/96
1/22/97 - 0.3 -9.0
4/25/97
10/13/97 - -11.0 -11.3
1/12/98
4/21/98 - -26.9 -36.5
10/8/98
</TABLE>
[end bar chart]
Royce Premier Fund has outperformed the Russell 2000 during all six major
downturns since its inception.
<TABLE>
- ------------------------------------
PORTFOLIO DIAGNOSTICS
- ------------------------------------
<S> <C>
Median Market Cap. $534 million
- ------------------------------------
Weighted Average P/E Ratio 16.6x
- ------------------------------------
Weighted Average P/B Ratio 1.9x
- ------------------------------------
Weighted Average Yield 1.3%
- ------------------------------------
Net Assets $569 million
- ------------------------------------
Turnover Rate 46%
- ------------------------------------
Symbol RYPRX
- ------------------------------------
</TABLE>
<TABLE>
- ---------------------------------
TOP 10 POSITIONS % of Net Assets
- ---------------------------------
<S> <C>
National Computer Systems 4.4%
- ---------------------------------
Affiliated Managers Group 3.4
- ---------------------------------
New England Business Service 3.1
- ---------------------------------
Zenith National Insurance 2.8
- ---------------------------------
Marshall Industries 2.7
- ---------------------------------
Haemonetics Corporation 2.7
- ---------------------------------
Florida Rock Industries 2.7
- ---------------------------------
E.W. Blanch Holdings 2.6
- ---------------------------------
Arthur J. Gallagher & Co. 2.6
- ---------------------------------
Unifi 2.5
- ---------------------------------
</TABLE>
[pull quote]
The top 35 positions
represented 86% of
the equity portfolio
as of 12/31/98.
[end pull quote]
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------
PORTFOLIO SECTOR BREAKDOWN With Examples % of Net Assets
- ----------------------------------------------------------------------------------------------------------------------
<S> <C>
Industrial Products Building Systems and Components, Construction Materials, Specialty Chemicals and Materials 19.2%
- ----------------------------------------------------------------------------------------------------------------------
Technology Components and Systems, Software/Services, Semiconductors and Equipment 17.7
- ----------------------------------------------------------------------------------------------------------------------
Financial Services Insurance Brokers, Investment Management, Information and Processing 12.2
- ----------------------------------------------------------------------------------------------------------------------
Financial Intermediaries Insurance, Banking, Securities Brokers 12.1
- ----------------------------------------------------------------------------------------------------------------------
Industrial Services Transportation and Logistics, Printing, Engineering and Construction 10.6
- ----------------------------------------------------------------------------------------------------------------------
Consumer Products Home Furnishings/Appliances, Apparel and Shoes, Publishing 7.0
- ----------------------------------------------------------------------------------------------------------------------
Health Surgical Products and Devices, Drugs and Biotech, Health Services 5.2
- ----------------------------------------------------------------------------------------------------------------------
Natural Resources Oil and Gas, Energy Services, Real Estate 3.9
- ----------------------------------------------------------------------------------------------------------------------
Consumer Services Retail Stores, Restaurants/Lodging, Leisure/Entertainment 3.3
- ----------------------------------------------------------------------------------------------------------------------
Treasuries, Cash & Cash Equivalents 8.8
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
- ------------------------------------------
GOOD IDEAS THAT WORKED
1998 Realized and Unrealized Gain
- ------------------------------------------
<S> <C>
National Computer Systems $13,894,729
- ------------------------------------------
Affiliated Managers Group 8,015,029
- ------------------------------------------
Haemonetics Corporation 5,841,050
- ------------------------------------------
Chiron Corporation 4,881,229
- ------------------------------------------
Avnet 4,627,051
==========================================
Combined Gain $37,259,088
==========================================
</TABLE>
<TABLE>
- ------------------------------------------
GOOD IDEAS AT THE TIME
1998 Realized and Unrealized Loss
- ------------------------------------------
<S> <C>
Tom Brown $8,252,909
- ------------------------------------------
Gibson Greetings 7,169,063
- ------------------------------------------
Denbury Resources 7,077,741
- ------------------------------------------
Willbros Group 5,843,567
- ------------------------------------------
Unifi 5,834,335
==========================================
Combined Loss $34,177,615
==========================================
</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.
Affiliated Managers Group - This investment management company's stock declined
precipitously in the late summer when investors abandoned it with unusual force
over concerns about the overall market and its effect on investment managers.
Knowing the business and understanding Affiliated Managers Group's unique
business model afforded us the confidence to acquire large portions of the stock
at prices that even we couldn't believe.
Tom Brown - An exploration company primarily in the natural gas business, this
investment 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, gas prices will eventually recover.
Gibson Greetings - A multiple of new products and new ventures in 1998 were not
enough to overcome a difficult competitive landscape in the greeting-card
industry, while near-term earnings disappointments caused the stock to trade at
a fraction of its book value. Although a losing proposition so far, we remain
encouraged by the company's strong balance sheet, large cash position and highly
motivated and very creative management team.
The Royce Funds Annual Report 1998 | 11
<PAGE>
Royce Micro-Cap Fund+
- --------------------------------------------------------------------------------
[sidebar]
What We Do
Royce Micro-Cap Fund ("RMC") uses a value approach to invest primarily in a
broadly diversified portfolio of companies with market capitalizations of less
than $300 million. We believe that the more volatile micro-cap sector, while
often higher in risk, offers greater potential for higher returns than any other
sector of the domestic equity marketplace.
How We Did
Royce Micro-Cap Fund's results reflect the performance difficulties of its
investment universe. 1998 was an especially turbulent year for micro-cap stocks,
marked by increased volatility and underperformance relative to the equity
market as a whole. Investors' preference for larger, more liquid stocks kept
micro-cap companies out of the investment spotlight, with the exception of
technology, a market-leading sector within both large- and small-cap. The Fund
underperformed its benchmark index, the small-cap oriented Russell 2000, for the
second half and the full year. However, the fund outperformed the Russell 2000
for the three-year and since inception (12/31/91) periods and since the 1996
small-cap peak. RMC's average annual total return since inception was 15.5%.
Royce Micro-Cap Fund is one of only a dozen micro-cap funds available with seven
years of performance history. Total net assets at year-end were $166 million.
Although RMC did not perform as we would have liked in 1998, we remain excited
about the long-term investment opportunities in micro-cap stocks.
Royce Micro-Cap Fund is now featured in the mutual funds section of
MicroCap1000.com (www.MicroCap1000.com), a website dedicated to the micro-cap
universe.
[end sidebar]
<TABLE>
- ---------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS Through 12/31/98
- ---------------------------------------------
<S> <C>
Fourth Quarter 1998* 14.6%
- ---------------------------------------------
Jul-Dec 1998* -9.1
- ---------------------------------------------
1-Year -3.3
- ---------------------------------------------
3-Year 11.7
- ---------------------------------------------
5-Year 11.4
- ---------------------------------------------
Since Inception (12/31/91) 15.5
- ---------------------------------------------
</TABLE>
*Not annualized.
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------
RISK/RETURN COMPARISON Inception (12/31/91) Through 12/31/98
- ---------------------------------------------------------------------------
Average Annual Standard
Total Return Deviation RUR
- ---------------------------------------------------------------------------
<S> <C> <C> <C>
Royce Micro-Cap 15.5% 12.3 1.26
- ---------------------------------------------------------------------------
Russell 2000 13.8% 15.5 0.89
- ---------------------------------------------------------------------------
</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 Micro-Cap Fund has outperformed the Russell 2000 on
BOTH an absolute and a risk-adjusted basis.
[line chart]
RECENT MARKET PERFORMANCE
<TABLE>
- --------------------
5/22/96 - 12/31/98
- --------------------
<S> <C>
RMC 22.8%
- --------------------
Russell 2000 19.9%
- --------------------
</TABLE>
<TABLE>
- --------------------
4/21/98 - 12/31/98
- --------------------
<S> <C>
RMC -14.2%
- --------------------
Russell 2000 -13.4%
- --------------------
</TABLE>
<TABLE>
<CAPTION>
Date Russell 2000
---- ------------
<S> <C>
12/31/1995 0.00%
1/31/1996 -0.11%
2/28/1996 3.01%
3/31/1996 5.11%
4/30/1996 10.73%
5/31/1996 15.09%
6/30/1996 10.36%
7/31/1996 0.73%
8/31/1996 6.58%
9/30/1996 10.75%
10/31/1996 9.04%
11/30/1996 13.54%
12/31/1996 16.51%
1/31/1997 18.84%
2/28/1997 15.95%
3/31/1997 10.48%
4/30/1997 10.79%
5/31/1997 23.12%
6/30/1997 28.40%
7/31/1997 34.37%
8/31/1997 37.45%
9/30/1997 47.51%
10/31/1997 41.04%
11/30/1997 40.12%
12/31/1997 42.57%
1/31/1998 40.32%
2/28/1998 50.69%
3/31/1998 56.90%
4/30/1998 57.76%
5/31/1998 49.26%
6/30/1998 49.57%
7/31/1998 37.45%
8/31/1998 10.73%
9/30/1998 19.40%
10/31/1998 24.27%
11/30/1998 30.78%
12/31/1998 38.88%
</TABLE>
[end line chart]
Royce Micro-Cap Fund has provided a performance edge since the small-cap peak in
May 1996.
[line chart]
ROYCE MICRO-CAP FUND vs. RUSSELL 2000 Value of $10,000 Invested on 12/31/91
Royce Micro-Cap Fund Russell 2000
<TABLE>
<CAPTION>
Royce Russell
Date Micro-Cap 2000
---- --------- ----
<S> <C> <C>
12/31/91 10,000 10,000
03/31/92 11,100 10,750
06/30/92 10,700 10,017
09/30/92 11,421 10,303
12/31/92 12,941 11,841
03/31/93 14,184 12,346
06/30/93 14,207 12,615
09/30/93 15,316 13,718
12/31/93 16,004 14,079
03/31/94 16,127 13,704
06/30/94 15,855 13,171
09/30/94 16,770 14,085
12/31/94 16,572 13,823
03/31/95 17,185 14,460
06/30/95 18,464 15,815
09/30/95 19,717 17,378
12/31/95 19,731 17,755
03/31/96 20,544 18,662
06/30/96 21,906 19,595
09/30/96 21,172 19,662
12/31/96 22,798 20,684
03/31/97 22,602 19,613
06/30/97 25,095 22,794
09/30/97 29,015 26,186
12/31/97 28,427 25,309
03/31/98 31,362 27,852
06/30/98 30,244 26,553
09/30/98 23,985 21,199
12/31/98 27,480 24,656
</TABLE>
Includes reinvestment of distributions.
[end line chart]
+ All performance and risk information presented herein is for RMC's Investment
Class. Shares of RMC's Consultant Class, which commenced operations on May 4,
1998, bear an annual distribution expense which is not borne by the Investment
Class.
12 | 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>
Royce Micro-Cap Fund Russell 2000
<S> <C> <C>
2/12/92 - -1.5 -12.0
7/8/92
3/18/94 - -4.4 -12.3
12/9/94
5/22/96 - -8.7 -15.4
7/24/96
1/22/97 - -5.1 -9.0
4/25/97
10/13/97 - -7.8 -11.3
1/12/98
4/21/98 - -33.6 -36.5
10/8/98
</TABLE>
[end bar chart]
Royce Micro-Cap Fund has outperformed the Russell 2000 during all six major
downturns since its inception.
<TABLE>
- ------------------------------------
PORTFOLIO DIAGNOSTICS
- ------------------------------------
<S> <C>
Median Market Cap. $177 million
- ------------------------------------
Weighted Average P/E Ratio 15.1x
- ------------------------------------
Weighted Average P/B Ratio 1.5x
- ------------------------------------
Weighted Average Yield 0.6%
- ------------------------------------
Net Assets $166 million
- ------------------------------------
Turnover Rate 56%
- ------------------------------------
Symbol (Investment Class) RYOTX
(Consultant Class) RYMCX
- ------------------------------------
</TABLE>
<TABLE>
- -------------------------------------
TOP 10 POSITIONS % of Net Assets
- -------------------------------------
<S> <C>
Richardson Electronics 2.0%
- -------------------------------------
Kronos Incorporated 1.9
- -------------------------------------
VideoServer 1.8
- -------------------------------------
REMEC 1.6
- -------------------------------------
Oshkosh B'Gosh Cl. A 1.6
- -------------------------------------
Newport Corporation 1.6
- -------------------------------------
Midwest Grain Products 1.6
- -------------------------------------
Coherent 1.5
- -------------------------------------
Electroglas 1.5
- -------------------------------------
MacNeal-Schwendler Corporation 1.5
- -------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
PORTFOLIO SECTOR BREAKDOWN With Examples % of Net Assets
- --------------------------------------------------------------------------------------------------------------------
<S> <C>
Technology Components and Systems, Software/Services, Semiconductors and Equipment 33.2%
- --------------------------------------------------------------------------------------------------------------------
Industrial Products Building Systems and Components, Construction Materials, Specialty Chemicals and Materials 15.8
- --------------------------------------------------------------------------------------------------------------------
Industrial Services Transportation and Logistics, Printing, Engineering and Construction 13.9
- --------------------------------------------------------------------------------------------------------------------
Consumer Products Home Furnishings/Appliances, Apparel and Shoes, Publishing 13.5
- --------------------------------------------------------------------------------------------------------------------
Consumer Services Retail Stores, Restaurants/Lodging, Leisure/Entertainment 4.3
- --------------------------------------------------------------------------------------------------------------------
Health Surgical Products and Devices, Drugs and Biotech, Health Services 4.1
- --------------------------------------------------------------------------------------------------------------------
Natural Resources Oil and Gas, Energy Services, Real Estate 3.9
- --------------------------------------------------------------------------------------------------------------------
Financial Intermediaries Insurance, Banking, Securities Brokers 2.4
- --------------------------------------------------------------------------------------------------------------------
Financial Services Insurance Brokers, Investment Management, Information and Processing 1.7
- --------------------------------------------------------------------------------------------------------------------
Utilities 0.6
- --------------------------------------------------------------------------------------------------------------------
Miscellaneous 4.9
- --------------------------------------------------------------------------------------------------------------------
Treasuries, Cash & Cash Equivalents 1.7
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
- -----------------------------------------
GOOD IDEAS THAT WORKED
1998 Realized and Unrealized Gain
- -----------------------------------------
<S> <C>
MovieFone Cl. A $1,888,257
- -----------------------------------------
Unitrode Corporation 1,529,691
- -----------------------------------------
REMEC 1,514,090
- -----------------------------------------
Advanced Energy Industries 1,462,626
- -----------------------------------------
The Topps Company 1,423,259
=========================================
Combined Gain $7,817,923
=========================================
</TABLE>
<TABLE>
- -----------------------------------------
GOOD IDEAS AT THE TIME
1998 Realized and Unrealized Loss
- -----------------------------------------
<S> <C>
Denbury Resources $2,344,671
- -----------------------------------------
Perceptron 2,175,319
- -----------------------------------------
RockShox 1,815,526
- -----------------------------------------
Willbros Group 1,466,941
- -----------------------------------------
Special Metals Corporation 1,399,582
=========================================
Combined Loss $9,202,039
=========================================
</TABLE>
MovieFone Cl. A - Patience paid off in 1998 as this company was discovered by
investors looking for promising Internet plays. MovieFone, which provides
information for moviegoers, successfully migrated to the web with a business
model that may actually be profitable - unlike many Internet companies.
Unitrode Corporation - We bought the stock of this mid-sized semiconductor
manufacturer opportunistically after a significant decline in the entire
industry caused by the Asian crisis. An early 1998 loser, this stock turned
around and recovered very nicely.
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. We have increased our position due to our confidence in this company's
ability to develop new products and technology.
The Royce Funds Annual Report 1998 | 13
<PAGE>
Updates and Notes to Performance and Risk Information
- --------------------------------------------------------------------------------
[graphic: desktop computer, THE ROYCE FUNDS displayed on the 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 and excludes early redemption fees
applicable to shares held less than one year. 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 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 398 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. Morningstar proprietary ratings reflect historical risk-adjusted
performance as of 12/31/98 and are subject to change monthly. The "Star" rating
is calculated from a fund's three-, and, if applicable, five- and 10-year
average annual total returns and reflects a risk factor that reflects
performance relative to three-month Treasury bill returns. Ten percent of the
funds in an investment category receive five stars and 22.5% receive four stars.
The Russell 2000, S&P 500, Dow Jones Industrial Average, Nasdaq Composite,
Nasdaq 100, and Nasdaq Industrials are unmanaged indices of domestic common
stocks. The Royce Funds and Royce GiftShares Fund are service marks of The Royce
Funds.
14 | The Royce Funds Annual Report 1998
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
ROYCE PREMIER FUND DECEMBER 31, 1998
- --------------------------------------------------------------------------------
COMMON STOCKS -- 91.2%
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Consumer Products -- 7.0%
Apparel and Shoes - 1.0%
Wolverine World Wide 447,700 $ 5,932,025
------------
Collectibles - 2.5%
Enesco Group 611,900 14,226,675
------------
Publishing - 1.8%
++ Gibson Greetings* 875,400 10,395,375
------------
Sports and Recreation - 1.7%
Oakley* 1,008,800 9,520,550
------------
40,074,625
============
Consumer Services -- 3.3%
Restaurants/Lodging - 0.8%
Buffets* 384,185 4,586,208
------------
Retail Stores - 2.5%
Charming Shoppes* 3,228,000 13,920,750
------------
18,506,958
============
Financial Intermediaries -- 12.1%
Insurance - 11.7%
The Commerce Group 376,600 13,345,763
Medical Assurance* 126,390 4,178,769
PMA Capital Corporation Cl. A 363,382 7,108,660
Trenwick Group 409,100 13,346,888
Wesco Financial Corporation 36,730 13,029,968
Zenith National Insurance 678,200 15,683,375
------------
66,693,423
------------
Securities Brokers - 0.4%
Legg Mason 64,300 2,029,469
------------
68,722,892
============
Financial Services -- 12.2%
Insurance Brokers - 5.2%
E.W. Blanch Holdings 311,600 14,781,525
Arthur J. Gallagher & Co. 330,700 14,592,137
------------
29,373,662
------------
Investment Management - 7.0%
Affiliated Managers Group* 643,800 19,233,525
The John Nuveen Company Cl. A 216,800 8,048,700
The Pioneer Group 650,100 12,839,475
------------
40,121,700
------------
69,495,362
============
Health -- 5.2%
Drugs and Biotech - 2.5%
Chiron Corporation* 548,400 14,361,225
------------
Surgical Products and Devices - 2.7%
Haemonetics Corporation* 668,900 15,217,475
------------
29,578,700
============
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Industrial Products -- 19.2%
Building Systems and Components - 3.4%
Juno Lighting 287,400 $ 6,717,975
Simpson Manufacturing* 332,000 12,429,250
------------
19,147,225
------------
Construction Materials - 3.8%
CalMat 214,800 6,631,950
Florida Rock Industries 486,700 15,087,700
------------
21,719,650
------------
Machinery - 4.0%
Lincoln Electric Holdings 641,790 14,279,828
Nordson Corporation 169,700 8,718,337
------------
22,998,165
------------
Pumps, Valves and Bearings - 3.4%
Kaydon Corporation 349,700 14,009,856
Roper Industries 263,500 5,368,813
------------
19,378,669
------------
Specialty Chemicals and Materials - 2.1%
Lilly Industries Cl. A 587,500 11,713,281
------------
Textiles - 2.5%
Unifi 737,300 14,423,431
------------
109,380,421
============
Industrial Services -- 10.6%
Engineering and Construction - 2.2%
Morrison Knudsen Corporation* 1,281,500 12,494,625
------------
Printing - 4.6%
Bowne & Co. 457,000 8,168,875
New England Business Service 454,900 17,797,963
------------
25,966,838
------------
Transportation and Logistics - 3.8%
Air Express International
Corporation 201,500 4,382,625
AirNet Systems* 410,000 5,893,750
Arnold Industries 574,800 9,268,650
Expeditors International of
Washington 50,800 2,133,600
------------
21,678,625
------------
60,140,088
============
Natural Resources -- 3.9%
Oil and Gas - 3.9%
Barrett Resources* 159,000 3,816,000
Tom Brown* 1,079,010 10,823,819
Renaissance Energy* 685,800 7,829,381
------------
22,469,200
============
</TABLE>
The Royce Funds Annual Report 1998 | 15
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
ROYCE PREMIER FUND DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Technology -- 17.7%
Aerospace/Defense - 3.5%
Curtiss-Wright Corporation 346,600 $ 13,214,125
Woodward Governor Company 293,556 6,494,926
------------
19,709,051
------------
Components and Systems - 1.4%
Dionex Corporation* 214,700 7,863,388
------------
Distribution - 4.3%
Avnet 151,600 9,171,800
Marshall Industries* 621,600 15,229,200
------------
24,401,000
------------
Semiconductors and Equipment - 3.4%
Dallas Semiconductor
Corporation 271,300 11,055,475
KLA-Tencor Corporation* 194,000 8,414,750
------------
19,470,225
------------
Software/Services - 5.1%
Comdisco 100,000 1,687,500
JDA Software Group* 223,800 2,168,063
National Computer Systems 680,200 25,167,400
------------
29,022,963
------------
100,466,627
============
TOTAL COMMON STOCKS
(Cost $422,754,880) 518,834,873
============
</TABLE>
<TABLE>
<CAPTION>
VALUE
-----
<S> <C>
REPURCHASE AGREEMENT -- 5.0%
State Street Bank and Trust Company,
4.25% dated 12/31/98, due 1/04/99,
maturity value $28,313,364 (collateralized by
U.S. Treasury Notes, 7.50% due 2/15/05,
valued at $28,866,950)
(Cost $28,300,000) $ 28,300,000
============
TOTAL INVESTMENTS -- 96.2%
(Cost $451,054,880) 547,134,873
CASH AND OTHER ASSETS
LESS LIABILITIES -- 3.8% 21,853,710
------------
NET ASSETS -- 100.0% $568,988,583
============
</TABLE>
- --------------------------------------------------------------------------------
* Non-income producing.
++ At December 31, 1998, the Fund owned 5% or more of the Company's outstanding
voting securities thereby making the Company an Affiliated Company as that
term is defined in the Investment Company Act of 1940.
INCOME TAX INFORMATION: The cost of total investments for Federal income tax
purposes was $452,060,510. At December 31, 1998, net unrealized appreciation
for all securities was $95,074,363, consisting of aggregate gross unrealized
appreciation of $126,470,940 and aggregate gross unrealized depreciation of
$31,396,577. The Fund designated $5,571,075 as a capital gain dividend for the
purpose of the dividend paid deduction.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
16 | The Royce Funds Annual Report 1998
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
ROYCE MICRO-CAP FUND DECEMBER 31, 1998
- --------------------------------------------------------------------------------
COMMON STOCKS -- 98.3%
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Consumer Products -- 13.5%
Apparel and Shoes - 2.1%
The North Face* 60,000 $ 780,000
Oshkosh B'Gosh Cl. A 134,400 2,713,200
------------
3,493,200
------------
Food/Beverage/Tobacco - 1.2%
800-JR CIGAR* 89,000 2,069,250
------------
Home Furnishings/Appliances - 4.2%
Bassett Furniture Industries 85,000 2,050,625
Conso International
Corporation* 252,200 1,481,675
Fedders Corporation Cl. A 71,900 377,475
Lifetime Hoan Corporation 127,780 1,245,855
Meadowcraft* 145,600 1,628,900
Neutral Posture Ergonomics* 20,200 80,800
------------
6,865,330
------------
Publishing - 1.7%
Franklin Electronic Publishers* 67,000 787,250
The Topps Company* 414,200 2,071,000
------------
2,858,250
------------
Sports and Recreation - 1.2%
Aldila* 425,000 1,062,500
Johnson Worldwide Associates Cl. A* 105,250 973,563
------------
2,036,063
------------
Other Consumer Products - 3.1%
Lazare Kaplan International* 297,700 2,083,900
Rock Of Ages Corporation Cl. A* 83,500 1,189,875
Velcro Industries 12,700 1,892,300
------------
5,166,075
------------
22,488,168
============
Consumer Services -- 4.3%
Leisure/Entertainment - 1.3%
MovieFone Cl. A* 135,600 2,220,450
------------
Restaurants/Lodging - 0.5%
Pizza Inn 176,000 781,000
------------
Retail Stores - 2.5%
The Bombay Company* 53,000 294,812
Lechters* 237,300 585,834
Mikasa 70,000 892,500
Suzy Shier 120,000 745,829
Urban Outfitters* 99,500 1,679,063
------------
4,198,038
------------
7,199,488
============
Financial Intermediaries -- 2.4%
Banking - 0.7%
Bay Bancshares 20,000 290,000
Oriental Financial Group 25,533 799,502
------------
1,089,502
------------
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Insurance - 1.7%
Capitol Transamerica Corporation 20,835 $ 389,354
Highlands Insurance Group* 86,300 1,127,294
The Navigators Group* 25,200 390,600
Nobel Insurance Limited 33,750 26,367
RLI 29,000 964,250
------------
2,897,865
------------
3,987,367
============
Financial Services -- 1.7%
Information and Processing - 1.6%
Duff & Phelps Credit Rating 35,400 1,940,362
Investors Financial Services
Corporation 11,774 702,025
------------
2,642,387
------------
Investment Management - 0.1%
U.S. Global Investors Cl. A* 137,000 214,063
------------
2,856,450
============
Health -- 4.1%
Commercial Service - 1.5%
ChiRex* 58,000 1,239,750
Young Innovations* 98,100 1,287,562
------------
2,527,312
------------
Drugs and Biotech - 1.9%
BioReliance Corporation* 166,500 1,332,000
International Isotopes* 110,600 1,769,600
------------
3,101,600
------------
Personal Care - 0.7%
Jean-Philippe Fragrances* 183,000 1,120,875
------------
6,749,787
============
Industrial Products -- 15.8%
Building Systems and Components - 4.2%
Falcon Products 159,600 1,915,200
Holophane Corporation* 13,000 333,938
Simpson Manufacturing* 40,800 1,527,450
Skyline Corporation 40,000 1,300,000
Thor Industries 73,200 1,866,600
------------
6,943,188
------------
Construction Materials - 1.9%
Florida Rock Industries 62,200 1,928,200
Puerto Rican Cement Company 37,000 1,292,687
------------
3,220,887
------------
Industrial Components - 0.7%
Woodhead Industries 85,800 1,115,400
------------
Machinery - 1.8%
Lund International Holdings* 213,750 1,816,875
Oshkosh Truck Corporation Cl. B 35,600 1,179,250
------------
2,996,125
------------
</TABLE>
The Royce Funds Annual Report 1998 | 17
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
ROYCE MICRO-CAP FUND DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Industrial Products (continued)
Paper and Packaging - 1.0%
PalEx* 216,400 $ 1,636,525
------------
Pumps, Valves and Bearings - 1.1%
Denison International ADR*+ 60,800 760,000
Sun Hydraulics Corporation 137,600 1,143,800
------------
1,903,800
------------
Specialty Chemicals and Materials - 3.3%
CFC International* 158,600 1,268,800
Chemfab Corporation* 102,200 2,114,262
Hauser* 173,300 769,019
Synalloy Corporation 154,400 1,351,000
------------
5,503,081
------------
Textiles - 0.4%
Fab Industries 31,200 670,800
------------
Other Industrial Products - 1.4%
BHA Group Holdings 143,225 1,987,247
Mestek* 12,000 240,000
------------
2,227,247
------------
26,217,053
============
Industrial Services -- 13.9%
Commercial Services - 3.2%
BHI Corporation* 62,800 1,931,100
++ Business Resource Group* 473,900 1,599,413
Cornell Corrections* 93,900 1,784,100
------------
5,314,613
------------
Engineering and Construction - 2.6%
Insituform Technologies Cl. A* 82,800 1,200,600
Sevenson Environmental Services 259,580 2,206,430
Willbros Group* 173,800 966,762
------------
4,373,792
------------
Food/Tobacco Processors - 2.4%
Midwest Grain Products* 189,550 2,582,619
Standard Commercial Corporation 166,755 1,427,840
------------
4,010,459
------------
Industrial Distribution - 1.3%
Vallen Corporation* 109,300 2,186,000
------------
Printing - 0.8%
Ennis Business Forms 129,900 1,290,881
------------
Transportation and Logistics - 3.6%
Circle International Group 105,700 2,166,850
Frozen Food Express Industries 252,650 1,989,619
Kenan Transport Company 46,730 1,565,455
MARK VII* 10,000 186,250
------------
5,908,174
------------
23,083,919
============
</TABLE>
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Natural Resources -- 3.9%
Energy Services - 0.8%
Carbo Ceramics 70,600 $ 1,235,500
------------
Oil and Gas - 3.1%
Denbury Resources* 390,100 1,584,781
Petro Incorporated* 235,800 1,355,850
Titan Exploration* 346,600 2,274,563
------------
5,215,194
------------
6,450,694
============
Technology -- 33.2%
Aerospace/Defense - 2.1%
Cubic Corporation 52,900 991,875
Special Metals Corporation* 204,300 1,825,931
Woodward Governor Company 30,448 673,662
------------
3,491,468
------------
Components and Systems - 13.9%
Advanced Energy Industries* 90,600 2,265,000
CEM Corporation* 85,700 840,931
Coherent* 205,300 2,553,419
Control Devices 30,932 494,912
HMT Technology Corporation* 169,000 2,165,312
Indigo* 10,000 39,688
Industrial Scientific Corporation 55,700 1,295,025
Kentek Information Systems 73,400 431,225
Kofax Image Products* 37,500 290,625
Mackie Designs* 69,600 435,000
Modern Controls 170,975 983,106
Newport Corporation 155,700 2,627,437
PCD* 126,500 1,644,500
Penn Engineering and
Manufacturing 29,300 655,588
Perceptron* 65,000 430,625
Performance Technologies* 79,500 1,043,438
Rainbow Technologies* 103,450 1,946,153
VideoServer* 161,800 2,973,075
------------
23,115,059
------------
Distribution - 4.4%
Jaco Electronics* 127,800 511,200
Kent Electronics Corporation* 80,000 1,020,000
Pioneer-Standard Electronics 259,200 2,430,000
Richardson Electronics 344,000 3,311,000
------------
7,272,200
------------
Semiconductors and Equipment - 5.1%
Electroglas* 217,000 2,549,750
Exar Corporation* 148,000 2,386,500
Intevac* 222,900 1,420,987
Unitrode Corporation* 80,900 1,415,750
Veeco Instruments* 14,600 775,625
------------
8,548,612
------------
</TABLE>
18 | The Royce Funds Annual Report 1998
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
ROYCE MICRO-CAP FUND DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Technology (continued)
Software/Services - 5.5%
CFI ProServices* 20,000 $ 232,500
CSP* 112,294 891,334
JDA Software Group* 112,400 1,088,875
Kronos Incorporated* 71,300 3,159,481
MacNeal-Schwendler
Corporation* 359,000 2,513,000
New Horizons Worldwide* 10,000 231,250
Tyler Corporation* 168,400 1,031,450
------------
9,147,890
------------
Telecommunications - 2.2%
InterVoice* 25,000 862,500
REMEC* 151,700 2,730,600
------------
3,593,100
------------
55,168,329
============
Utilities -- 0.6%
Southern Union Company* 43,810 1,067,869
============
</TABLE>
<TABLE>
<CAPTION>
VALUE
-----
<S> <C>
Miscellaneous -- 4.9% $ 8,078,653
============
TOTAL COMMON STOCKS
(Cost $144,951,356) 163,347,777
============
REPURCHASE AGREEMENT -- 0.1%
State Street Bank and Trust
Company,
4.25% dated 12/31/98, due
1/04/99, maturity value
$100,047 (collateralized
by U.S. Treasury Bills,
due 6/17/99, valued at
$102,848)(Cost $100,000) 100,000
============
TOTAL INVESTMENTS -- 98.4%
(Cost $145,051,356) 163,447,777
CASH AND OTHER ASSETS
LESS LIABILITIES -- 1.6% 2,722,925
------------
NET ASSETS -- 100.0% $166,170,702
============
</TABLE>
- --------------------------------------------------------------------------------
* Non-income producing.
+ American Depository Receipt.
++ At December 31, 1998, the Fund owned 5% or more of the Company's outstanding
voting securities thereby making the Company an Affiliated Company as that
term is defined in the Investment Company Act of 1940.
INCOME TAX INFORMATION: The cost of total investments for Federal income tax
purposes was $145,278,107. At December 31, 1998, net unrealized appreciation
for all securities was $18,169,670, consisting of aggregate gross unrealized
appreciation of $34,995,852 and aggregate gross unrealized depreciation of
$16,826,182. The Fund designated $9,511,278 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 | 19
<PAGE>
STATEMENTS OF ASSETS AND LIABILITIES DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Royce Royce
Premier Fund Micro-Cap Fund
------------ --------------
<S> <C> <C>
ASSETS:
Investments at value (identified cost $422,754,880 and $144,951,356, respectively) $518,834,873 $163,347,777
Repurchase agreements (at cost and value) 28,300,000 100,000
Cash 188,623 56,959
Receivable for investments sold 23,812,889 2,857,650
Receivable for capital shares sold 1,790,199 652,506
Receivable for dividends and interest 694,085 59,046
Prepaid expenses 26,939 9,673
- ------------------------------------------------------------------------------------------------------------------------
Total Assets 573,647,608 167,083,611
- ------------------------------------------------------------------------------------------------------------------------
LIABILITIES:
Payable for capital shares redeemed 3,637,749 476,614
Payable for investments purchased 354,727 171,337
Payable for investment advisory fees 466,615 166,915
Accrued expenses 199,934 98,043
- ------------------------------------------------------------------------------------------------------------------------
Total Liabilities 4,659,025 912,909
- ------------------------------------------------------------------------------------------------------------------------
Net Assets $568,988,583 $166,170,702
========================================================================================================================
ANALYSIS OF NET ASSETS:
Undistributed net investment income $ 297,955 $ --
Accumulated net realized gain on investments 10,857,066 1,222,420
Net unrealized appreciation on investments 96,079,993 18,396,444
Capital shares 62,234 19,430
Additional paid-in capital 461,691,335 146,532,408
- ------------------------------------------------------------------------------------------------------------------------
Net Assets $568,988,583 $166,170,702
Investment Class $568,988,583 $165,419,635
Consultant Class $ 751,067
========================================================================================================================
SHARES OUTSTANDING:
(unlimited number of $.001 par value shares authorized for each Fund)
Investment Class 62,234,316 19,341,820
Consultant Class 88,402
========================================================================================================================
NET ASSET VALUES (Net Assets [divided by] Shares Outstanding):
Investment Class (offering and redemption price* per share) $9.14 $8.55
Consultant Class (offering and redemption price** per share) $8.50
========================================================================================================================
</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.
20 | The Royce Funds Annual Report 1998
<PAGE>
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
====================================================================
Royce Premier Fund Royce Micro-Cap 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) $ 3,026,370 $ 5,186,475 $ (1,077,422) $ 66,866
Net realized gain on investments 16,476,014 24,051,632 11,052,305 13,409,911
Net change in unrealized appreciation on investments 15,256,788 33,005,954 (17,036,282) 21,410,808
- ---------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in net assets from investment
operations 34,759,172 62,244,061 (7,061,399) 34,887,585
- ---------------------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS:
Net investment income
Investment Class (3,095,427) (5,132,573) (72,742) --
Consultant Class (293) --
Net realized gain on investments
Investment Class (5,571,075) (26,952,526) (9,504,473) (14,659,824)
Consultant Class (44,548) --
- ---------------------------------------------------------------------------------------------------------------------------
Total distributions (8,666,502) (32,085,099) (9,622,056) (14,659,824)
- ---------------------------------------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS:
Value of shares sold
Investment Class 221,957,563 253,092,118 55,074,780 88,285,531
Consultant Class 925,930 --
Distributions reinvested
Investment Class 8,428,754 30,221,025 9,270,159 13,665,774
Consultant Class 39,659 --
Value of shares redeemed
Investment Class (220,631,891) (97,354,274) (81,986,610) (63,871,463)
Consultant Class (106,404) --
- ---------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in net assets from capital share
transactions 9,754,426 185,958,869 (16,782,486) 38,079,842
- ---------------------------------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN NET ASSETS 35,847,096 216,117,831 (33,465,941) 58,307,603
NET ASSETS:
Beginning of year 533,141,487 317,023,656 199,636,643 141,329,040
- ---------------------------------------------------------------------------------------------------------------------------
End of year (a) $568,988,583 $533,141,487 $166,170,702 $199,636,643
===========================================================================================================================
CAPITAL SHARE TRANSACTIONS (in shares):
Shares sold
Investment Class 24,809,013 28,478,270 5,872,063 9,367,527
Consultant Class 96,259 --
Shares issued for reinvestment of distributions
Investment Class 963,284 3,457,777 1,138,769 1,453,806
Consultant Class 4,902 --
Shares redeemed
Investment Class (24,840,814) (11,226,941) (8,912,344) (6,947,247)
Consultant Class (12,759) --
- ---------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in shares outstanding 931,483 20,709,106 (1,813,110) 3,874,086
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Includes undistributed net investment income of $297,955 and $0 in 1998 and
$367,012 and $66,866 in 1997 for Royce Premier Fund and Royce Micro-Cap
Fund, respectively.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
The Royce Funds Annual Report 1998 | 21
<PAGE>
STATEMENTS OF OPERATIONS YEAR ENDED DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Royce Royce
Premier Fund Micro-Cap Fund
------------ --------------
<S> <C> <C>
INVESTMENT INCOME:
Income:
Dividends $ 7,134,820 $ 1,345,157
Interest 2,681,996 373,129
- ----------------------------------------------------------------------------------------------------
Total Income 9,816,816 1,718,286
- ----------------------------------------------------------------------------------------------------
Expenses:
Investment advisory fees 5,516,894 2,810,672
Distribution fees - Consultant Class -- 3,773
Shareholder servicing - Investment Class 370,127 143,571
Shareholder servicing - Consultant Class -- 5,206
Shareholder reports - Investment Class 298,205 140,224
Shareholder reports - Consultant Class -- 711
Administrative and office facilities 250,973 91,729
Custodian 112,658 83,398
Trustees' fees 71,409 25,568
Professional fees 67,579 43,251
Registration - Investment Class 41,689 29,212
Registration - Consultant Class -- 1,049
Other expenses 60,912 24,590
- ----------------------------------------------------------------------------------------------------
Total Expenses 6,790,446 3,402,954
Fees Waived by Investment Adviser -- (600,867)
Expenses Reimbursed by Investment Adviser - Consultant Class -- (6,379)
- ----------------------------------------------------------------------------------------------------
Net Expenses 6,790,446 2,795,708
- ----------------------------------------------------------------------------------------------------
Net Investment Income (Loss) 3,026,370 (1,077,422)
- ----------------------------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Net realized gain on investments 16,476,014 11,052,305
Net change in unrealized appreciation on investments 15,256,788 (17,036,282)
- ----------------------------------------------------------------------------------------------------
Net realized and unrealized gain (loss) on investments 31,732,802 (5,983,977)
- ----------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN NET ASSETS FROM INVESTMENT OPERATIONS $34,759,172 $ (7,061,399)
====================================================================================================
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
FINANCIAL HIGHLIGHTS
- --------------------------------------------------------------------------------
This table is presented to show selected data for a share outstanding
throughout each period, and to assist shareholders in evaluating a Fund's
performance for the periods presented.
<TABLE>
<CAPTION>
Net Realized and
Net Asset Value, Net Investment Unrealized Gain
Beginning Income (Loss) On
of Period (Loss) Investments
--------- ------ -----------
<S> <C> <C> <C>
ROYCE PREMIER FUND (a)
1998 $ 8.70 $ 0.05 $ 0.53
1997 7.81 0.09 1.35
1996 7.12 0.10 1.18
1995 6.48 0.10 1.05
1994 6.41 0.06 0.15
ROYCE MICRO-CAP FUND -- INVESTMENT CLASS (b)
1998 $ 9.40 $ (0.05) $ (0.29)
1997 8.14 -- 2.01
1996 7.53 (0.01) 1.17
1995 6.48 -- 1.24
1994 6.47 -- 0.23
ROYCE MICRO-CAP FUND -- CONSULTANT CLASS (c)
1998 $ 10.58 $ (0.07) $ (1.50)
- -------------------------------------------------------------------
<CAPTION>
Distributions
From Net Distributions From Net Asset Net Assets,
Investment Net Realized Gain Value, End Total End of Period
Income On Investments of Period Return (In Thousands)
------ -------------- --------- ------ --------------
<S> <C> <C> <C> <C> <C>
ROYCE PREMIER FUND (a)
1998 $ (0.05) $ (0.09) $ 9.14 6.7% $568,989
1997 (0.09) (0.46) 8.70 18.4% 533,141
1996 (0.10) (0.49) 7.81 18.1% 317,024
1995 (0.09) (0.42) 7.12 17.8% 302,239
1994 (0.05) (0.09) 6.48 3.3% 202,390
ROYCE MICRO-CAP FUND -- INVESTMENT CLASS (b)
1998 $ (0.01) $ (0.50) $ 8.55 ( 3.3)% $165,420
1997 -- (0.75) 9.40 24.7% 199,637
1996 -- (0.55) 8.14 15.5% 141,329
1995 -- (0.19) 7.53 19.1% 97,729
1994 -- (0.22) 6.48 3.6% 26,774
ROYCE MICRO-CAP FUND -- CONSULTANT CLASS (c)
1998 $ (0.01) $ (0.50) $ 8.50 (14.6)% $ 751
------- ------- ------- ----- --------
<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>
ROYCE PREMIER FUND (a)
1998 1.23% 0.55% 46%
1997 1.24% 1.20% 18%
1996 1.25% 1.25% 34%
1995 1.25% 1.48% 39%
1994 1.38% 1.19% 38%
ROYCE MICRO-CAP FUND -- INVESTMENT CLASS (b)
1998 1.49% (0.57)% 56%
1997 1.49% 0.04 % 38%
1996 1.79% (0.20)% 70%
1995 1.94% 0.10 % 25%
1994 1.99% 0.02 % 54%
ROYCE MICRO-CAP FUND -- CONSULTANT CLASS (c)
1998 2.49%* (1.62)%* 56%
----- ------- ---
</TABLE>
(a) Expense ratios are shown after fee waiver by the investment adviser. For
the period ended December 31, 1996, the expense ratio before the waiver
would have been 1.28%.
(b) Expense ratios are shown after fee waivers by the investment adviser. For
the periods ended December 31, 1998, 1997, 1996, 1995 and 1994, the
expense ratios before the waivers would have been 1.81%, 1.80%, 1.87%,
1.97% and 2.34%, respectively.
(c) Expense ratios are shown after fee waiver and expense reimbursement by the
investment adviser. For the period ended December 31, 1998, the expense
ratio before the waiver would have been 4.52%. The Class commenced
operations on May 4, 1998.
* Annualized.
22 | The Royce Funds Annual Report 1998
<PAGE>
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Summary of Significant Accounting Policies:
Royce Premier Fund and Royce Micro-Cap Fund (the "Fund" or "Funds") are two
series of The Royce Fund (the "Trust"), a diversified open-end management
investment company organized as a Delaware business trust. Royce Premier Fund
and the Investment Class of Royce Micro-Cap Fund commenced operations on
December 31, 1991. The Consultant Class of Royce Micro-Cap Fund commenced
operations on May 4, 1998.
Classes of shares have equal rights as to earnings and assets, except that
each class may bear different 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 Funds incur direct and indirect expenses. Expenses directly attributable
to a Fund are charged to that Fund's operations, while expenses applicable to
one or more 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 which may differ from generally accepted
accounting principles. Permanent book and tax basis differences relating to
shareholder distributions will result in reclassifications within the capital
accounts. Undistributed net investment income may include temporary book and tax
basis differences, which will reverse in a subsequent period. Any taxable income
or gain remaining 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.
The Royce Funds Annual Report 1998 | 23
<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, at an annual rate of 1.0% and 1.5% of the average net
assets of Royce Premier Fund and Royce Micro-Cap Fund, respectively. 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 1.49% of the average net assets of Royce
Micro-Cap Fund--Investment Class and 2.49% of the average net assets of Royce
Micro-Cap Fund--Consultant Class for the period ended December 31, 1998. For the
year ended December 31, 1998, Royce Premier Fund and Royce Micro-Cap Fund
recorded advisory fees of $5,516,894 and $2,209,805 (net of voluntary waivers of
$600,867), respectively.
Royce Fund Services, Inc. ("RFS"), the distributor of the Trust's shares, is
an affiliate of Royce. For the period ended December 31, 1998, RFS received
12b-1 distribution fees of $3,773 from the Consultant Class of Royce Micro-Cap
Fund. The distribution agreement provides for maximum fees at an annual rate of
1.0% of the average net assets of the Consultant Class of Royce Micro-Cap 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>
============================================================
Royce Premier Fund Royce Micro-Cap Fund
-------------------- ---------------------
<S> <C> <C>
Purchases $239,548,216 $100,166,373
- ------------------------------------------------------------
Sales $251,376,191 $109,414,248
============================================================
</TABLE>
Transactions in Affiliated Companies:
An "Affiliated Company," as defined in the Investment Company Act of 1940,
is a company in which a Fund owns at least 5% of the company's outstanding
voting securities. The following transactions were effected in shares of such
companies for the year ended December 31, 1998.
<TABLE>
<CAPTION>
Purchases Sales Realized
Affiliated --------------------- ------------------- Gain Dividend
Company Shares Cost Shares Cost (Loss) Income
=====================================================================================
<S> <C> <C> <C> <C> <C> <C> <C>
Royce Premier Fund Gibson
Greetings 327,900 $5,644,125 100,000 $2,243,750 $ (179,163) --
Royce Micro-Cap Fund Business
Resource
Group 473,900 $1,380,299 -- -- -- --
=====================================================================================
</TABLE>
REPORT OF INDEPENDENT ACCOUNTANTS
- --------------------------------------------------------------------------------
To the Board of Trustees of The Royce Fund and the Shareholders of Royce
Premier Fund and Royce Micro-Cap 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 Royce Premier Fund
and Royce Micro-Cap 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
24 | The Royce Funds Annual Report 1998
<PAGE>
Postscript
- --------------------------------------------------------------------------------
[background graphic: rubber ball and jacks]
"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.
[pull quote]
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 pull quote]
<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
<TABLE>
<S> <C>
General Information Advisor Services
Additional Report Copies For Fund Materials, Performance Updates,
and Prospectus Inquiries Transactions or Account Inquiries
(800) 221-4268 (800) 33-ROYCE (337-6923)
Shareholder Services Broker/Dealer Services
(800) 841-1180 For Fund Materials and Performance Updates
(800) 59-ROYCE (597-6923)
Automated Telephone Services
(800) 78-ROYCE (787-6923)
</TABLE>
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.
