Value Investing in Small Companies
for More Than 25 Years
THE
ROYCE
FUNDS
ROYCE TOTAL RETURN FUND
ROYCE LOW-PRICED STOCK FUND
ROYCE FINANCIAL SERVICES FUND
1998 Annual Report
www.roycefunds.com
<PAGE>
THE ROYCE FUNDS ROAD MAP
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TWO DISTINCT MARKETS
For more than 25 years, Royce & Associates has utilized a disciplined value
approach to select small-cap companies. We believe that the small-cap universe
is comprised of two distinct markets, small- and micro-cap, and that each
requires a distinct investment strategy.
[Blue Rule] SMALL-CAP
[Yellow Rule] MICRO-CAP
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<TABLE>
<S> <C>
CORE FUNDS
The small-cap universe (companies with market caps between $300 million and $1 [Blue Rule] ROYCE PREMIER FUND
billion) is no longer small, unknown or under-owned; therefore, we believe that Concentrated Small-Cap Portfolio
this higher level of efficiency requires greater portfolio concentration.
The micro-cap universe (companies with market caps less than $300 million) [Yellow Rule] ROYCE MICRO-CAP FUND
provides more choices (approximately 6,500 companies), yet greater trading Diversified Micro-Cap Portfolio
difficulties; therefore, we believe that broad diversification is appropriate
given the liquidity constraints of this sector.
COMBINED FUNDS
These portfolios invest in both small- and micro-cap companies and represent our [Blue Rule] PENNSYLVANIA MUTUAL FUND
flagship approach. Two of our combined portfolios, Pennsylvania Mutual Fund and [Yellow Rule] Diversified Small- and Micro-Cap
PMF II, employ a more diversified investment strategy and are designed for both Portfolio
individuals and institutions. Royce GiftShares Fund, one of the few gifting and
estate-planning portfolios, uses a more concentrated approach. [Blue Rule] PMF II
[Yellow Rule] Diversified Small- and Micro-Cap
Portfolio
[Blue Rule] ROYCE GIFTSHARES FUND
[Yellow Rule] Concentrated Small- and Micro-Cap
Portfolio
THEME FUNDS
These portfolios invest in securities primarily found in our Core Funds that [Blue Rule] ROYCE TOTAL RETURN FUND
have special attributes. One has low-volatility characteristics (dividends), one [Yellow Rule] Dividend-Paying Securities
has the potential for higher returns and volatility (low-priced stocks) and one
takes specific sector (financial services) risk. Performance and volatility may [Blue Rule] ROYCE LOW-PRICED STOCK FUND
be substantially different for each of these portfolios. [Yellow Rule] Stocks Priced Below $15
[Blue Rule] ROYCE FINANCIAL SERVICES FUND
[Yellow Rule] Financial Services Companies
</TABLE>
<PAGE>
[Graphic of a Magnifying Glass Displaying a Close-up of Royce Funds' Share Price
Information with background of a Clock and Printed Financial Information]
THE ROYCE FUNDS
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ANNUAL REPORT REFERENCE GUIDE
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<TABLE>
<S> <C>
Jump, Jive An' Wail: 1998's stock market provided 2
more than its share of swinging moments.
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It Don't Mean a Thing (If It Ain't Got That Swing): Recent changes to 5
small-cap stock definitions have little impact on our own small- and micro-cap work.
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Royce Total Return Fund's emphasis on dividend-paying securities helped it to 10
outperform its small-cap benchmark, the Russell 2000, for the one-, three-, five-year
and since inception (12/15/93) periods. The Fund has an overall four-star [Four Stars]
rating from Morningstar out of 2,802 domestic equity funds with a three-year history.
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Royce Low-Priced Stock Fund, one of only two low-priced stock funds available, 12
outperformed the Russell 2000 for the one-, three-, five-year and since inception
(12/15/98) periods.
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Royce Financial Services Fund outperformed the Russell 2000 for the 14
second half, the one-year and three-year periods.
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Updates and Notes: What's New on Our Website 16
(www.roycefunds.com) and a Y2K Update.
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Schedules of Investments and Other Financial Statements. 17
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Postscript: Furby-Mania. Inside Back Cover
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</TABLE>
For more than 25 years, our approach has focused on evaluating a
company's worth--what we believe a business would sell for
in a private transaction between rational and well-informed
parties. This requires a thorough analysis of the financial
and operating dynamics of a business, as though we were
purchasing the entire company. The price we pay for a security
must be substantially lower than our appraisal of its worth.
AVERAGE ANNUAL TOTAL RETURNS Through December 31, 1998
<TABLE>
<CAPTION>
SINCE
FUND (INCEPTION) 1-YEAR 3-YEAR 5-YEAR INCEPTION
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<S> <C> <C> <C> <C>
Royce Total Return Fund (12/15/93) 4.8% 17.6% 16.7% 16.6%
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Royce Low-Priced Stock Fund (12/15/93) 2.4 14.5 13.6 13.6
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Royce Financial Services Fund (12/15/94) 8.0 13.9 n/a 15.8
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</TABLE>
<PAGE>
[Begin Sidebar]
[Photo of Charles M. Royce]
Charles M. Royce, President
I feel very strongly that the
new market cycle will be
shorter, with more histori-
cally 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]
LETTER TO OUR SHAREHOLDERS
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[Cartoon of Swing Band and Couples Dancing with a Banner Reading, "WALL STREET
HOP"]
-C- Blaustein '99
JUMP, JIVE AN' WAIL
Although the stock market took a brief but dramatic downturn during the third
quarter, it was not enough to keep its swinging participants off the dance
floor. In three out of four quarters in 1998, large-cap stocks provided
investors with jazzed-up returns. In contrast, small-cap securities grooved in
quarters one and four, but sang the blues in quarters two and three.
This year's stock market soiree also produced swing in abundance. According
to Tim Hayes of Ned Davis Research, the average daily swing of the Dow Jones
Industrial Average ("Dow") in 1998 from the low to the high was 2.6% on an intra
day basis or about 225 points a day. On an intra-year basis, the large-cap S&P
500 was off 19.2% from its peak on July 17, 1998 to its trough on August 31,
1998, while the small-cap Russell 2000 was off 36.5% from its April 21, 1998
peak to its October 8 trough. Although both large- and small-cap securities
rallied in 1998's fourth quarter, the calendar-year performance disparity
between the two indices was the widest since the inception of the Russell 2000
Index in 1979.
THE JOINT IS JUMPIN'
Large-cap and technology stocks were at the top of the charts in 1998. Both the
Dow and S&P 500 reached record highs despite third quarter setbacks. The Dow
(+18.1%) generated its fourth consecutive year of double digit gains, and the
S&P 500 (+28.6%) posted an unprecedented fourth consecutive year of 20%+
returns.
If this were not amazing enough, consider the results of the Nasdaq
Composite, which was up 39.6% for the year. How much of a difference did
technology make? The tech-heavy Nasdaq 100 finished 1998 up 85.5% versus only
6.8% for the Nasdaq Industrials. Wow!
2 THE ROYCE FUNDS ANNUAL REPORT 1998
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I GOT IT BAD (AND THAT AIN'T GOOD)
While large-cap enjoyed cheers and applause in 1998, small-cap endured cat
calls. However, even though the small-cap oriented Russell 2000 did hit some
sour notes -- the index was down 2.6% for the full year -- it was not entirely
off key, considering it was down 23.9% for the combined second and third
quarters. Just how tough was it for small-cap mutual fund investors? According
to fund rating service Morningstar, out of 2,802 domestic equity funds overall,
only 12 of the 397 small-cap objective funds with a three-year history garnered
four or five star ratings as of December 31, 1998. This means that out of the
910 funds that received four or five star ratings, only 1.3% were small-cap
portfolios.
Fortunately for those of us in the small-cap business, there were some
smooth sounds to soothe the second and third quarter blues as small-caps staged
a short but impressive rally at year-end. From its bottom on October 8 through
December 31, the Russell 2000 was up 36.3%, comfortably ahead of the S&P 500,
which was up 28.1%. A little more of this in 1999 would be music to our ears.
[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]
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.
LATE '90s: SMALL CAPS LANGUISH
5/22/96 - 10/8/98
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<TABLE>
<S> <C>
Russell 2000 -12.0%
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S&P 500 47.6%
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</TABLE>
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.
EARLY '90s: A COMPLETELY DIFFERENT PICTURE
10/31/90 - 5/22/96
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<TABLE>
<S> <C>
Russell 2000 236.2%
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S&P 500 162.1%
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</TABLE>
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%+).
THE ROYCE FUNDS ANNUAL REPORT 1998 3
<PAGE>
[Begin Sidebar]
There has certainly been a
change in market leader-
ship, one that so far has
had its greatest effect within
large-cap. Global multina-
tionals 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]
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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.
[Bar Chart]
RUSSELL 2000 PEAK-TO-TROUGH-TO-PEAK PERFORMANCE PERIODS
Decline From Peak Subsequent Rise
----------------- ---------------
6/15/81 - -26.2%
8/12/82
8/12/82 - 115.5%
6/24/83
6/24/83 - -24.1%
7/25/84
7/25/84 - 72.5%
7/3/86
8/25/87 - -38.9%
10/28/87
10/28/87 - 76.8%
10/9/89
10/9/89 - -32.5%
10/31/90
10/31/90 - 83.1%
2/12/92
4/21/98 - -36.5%
10/8/98
10/8/98 - 36.3%
12/31/98
Historical market trends are not necessarily indicative of future market
movements.
[End Bar Chart]
WE WALK THE LINE
Twice each year, we provide details and offer commentary on our Funds' recent
performance. This exercise, while important in many ways, always gives us pause.
As long-term investors, it feels odd to spend time commenting on short-term
performance. Yet the investment world is captivated by the short term, with far
too much attention devoted to who has this year's -- or even this quarter's --
best returns. In contrast, we believe that investors should be neither too
encouraged nor too dismayed by short-term relative results.
We are less concerned about near-term performance -- even when, as in 1998,
we are pleased with the results -- because valuation and performance are rarely
in sync in the short run. In other words, we do not expect today's undervalued
stock to immediately reach what we think is its full value. Our investment
horizon for portfolio selection is three to five years;
TAKE THE "A" TRAIN
During a holiday season vacation, the intrepid advisor hopped on the New York
City subway and took the "A" train to the Columbus Circle stop. After joining in
on a jam session with the Duke Ellington Orchestra, he made his way to our
office and chatted with Chuck Royce about the relevance of the terms "growth"
and "value" in today's small-cap market.
With all the changes that have taken place in the small-cap world over the last
decade, do you think that the definitions of value and growth have changed as
well?
The definitions have not changed as much as their usefulness has. At some
level, we think that describing the way that we manage money exclusively as
"value" is incomplete. Although it's common practice within the investment
community to do so, we don't divide the equity world into growth and value
stocks. We spend our time thinking about how to limit risk without sacrificing
return. If we find a stock that we believe has terrific growth prospects, we
want to buy it with the least risk possible, i.e., at an attractive price -- we
don't worry about whether or not the stock is considered a value or a growth
stock.
4 THE ROYCE FUNDS ANNUAL REPORT 1998
<PAGE>
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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 Total Return Fund, Royce
Low-Priced Stock Fund and Royce Financial Services Fund did provide a short-term
performance advantage over the Russell 2000, we are most pleased that the Funds
have provided a long-term performance edge. For a complete review and discussion
of our results and our risk profiles, please see pages 10-15.
[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]
IT DON'T MEAN A THING
(IF IT AIN'T GOT THAT SWING)
Several years ago, Billboard magazine made changes in the criteria of its famous
chart system to more effectively track the changing music scene. In a similar
move, Morningstar, Inc. and Lipper Analytical, the fund industry's preeminent
ranking and analysis services, recently announced that they would be altering
their capitalization and style criteria to more accurately reflect the realities
of today's equity market. For instance, rather than use pre-established
market-cap cutoffs, with small-cap being defined as less than $1 billion,
Morningstar has now divided the equity universe based on the following
percentages: Large-cap will constitute the top 5% of the 5,000 largest U.S.
stocks in their database, mid-cap will be the next 15% of the 5,000 and
small-cap will comprise the remaining 80%. The net effect is a more liberal
definition of small-cap stocks and by
RUSSELL 2000'S EXPANDING MARKET CAPITALIZATION
<TABLE>
<CAPTION>
12/31/89 12/31/94 12/31/98
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<S> <C> <C> <C>
Weighted Average $190 $400 $880
- --------------------------------------------------------------
Median $70 $210 $430
- --------------------------------------------------------------
</TABLE>
Russell 2000 weighted average and median market capitalization in millions.
Source: Frank Russell Company
If value and growth have become less useful terms, what has been the effect on
the firm's selection process?
There really hasn't been an appreciable effect on our selection process. We
have always looked at our mission in life, so to speak, as wanting to be very
good small-cap investors who pay equal attention to risk and reward. We've never
been anti-growth, we just don't want to overpay for growth, so we try to be
conscious of all the risk elements when selecting securities. These elements may
include evaluating growth prospects relative to the stock price, as well as
trading strategy, ownership issues, business risk and liquidity risk.
Frankly, in most instances, we can't buy high-growth companies at
attractive prices, i.e., at "lower risk," because the world frequently tends to
overprice these securities. But it's important to remember that this has nothing
to do with how the outside world is classifying these stocks -- we are value
investors, but we don't confine ourselves to "value" stocks.
THE ROYCE FUNDS ANNUAL REPORT 1998 5
<PAGE>
[Begin Sidebar]
Relative valuations for
small-cap stocks remain
very strong in our view,
even after the recent run of
solid performance in the
fourth quarter. Although
valuation and performance
do not correlate in the
short term, we certainly
expect that over most full
market cycles they should.
[End Sidebar]
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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.
[pull quote]
[T]he difference between the
small- and micro-cap sectors
is critical to us because we
believe that they behave dif-
ferently and require different
investment strategies.
[end pull quote]
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,
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>
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cash flows and balance sheets, as well as solid growth prospects -- but on
non-quantitative research, such as competitive and strategic analysis.
[pull quote]
Investing in micro-caps more closely
resembles the way we have chosen
stocks historically, with close atten-
tion to quantitive factors such as
balance sheets and cash flows.
[end pull quote]
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
up per-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
twice in a decade. This past year's market downturn is the most recent instance,
but prior to that, we'd have to go back to 1990.
Do you think that more attractive valuations and risk factors still exist in the
less glamorous kind of company that traditionally draws attention from value
investors?
This may surprise people, but many of these companies -- those that the
industry would regard as "value" -- are not as attractively priced relative to
many small-cap stocks that might be considered growth. The reason is that within
small-cap, value has generally outperformed growth over the last two-and-a-half
years. These "value" stocks are therefore not quite the bargains that they were
a few years ago, which is another reason why we see less usefulness in terms
such as value and growth. Regardless of how the industry classifies them, we
have a strong preference for a company that has proven it can weather storms,
but whose stock price, for whatever reason, has been knocked off balance.
THE ROYCE FUNDS ANNUAL REPORT 1998 7
<PAGE>
[Begin Sidebar]
What sometimes hap-
pens in a period pre-
ceding an upswing
such as we experienced
recently is that small-
caps become extraordi-
narily 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]
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[Cartoon with Caption, "Guarded Optimism," of Two Men Carrying a Sign, "The
Future For Small Caps," Walking in a Building's Lobby, Accompanied by Three Men
Wearing Sunglasses]
-C- Hank Blaustein 1999
individual stocks or stock markets. The dominant theme in 1998 was change, as
declining prices produced significant investment opportunities and a shift in
market leadership.
This summer's decline gave us a rare investment opportunity, as virtually
all small-cap securities were repriced regardless of an individual company's
circumstances. According to a Salomon Smith Barney report published in July in
The Wall Street Journal, the average stock with a market value of $250 million
or less fell more than 40% from its 52-week high. The last time such a
substantial small-cap sector repricing occurred was 1990. If one believes (as we
do) that long-term outperformance is directly related to exploiting valuation
discrepancies, then this summer's downturn provided us with substantial future
performance potential.
In addition to creating numerous investment opportunities, the October
trough may have signaled the completion of the 1990's bull market. From October
31, 1990 through its trough on August 31, 1998, the S&P 500 compounded at an
18.8% average annual rate of return, well above its long-term norm of 10.5%
(Source: Ibbotson and Associates). Although it is difficult to say with any
certainty, we believe that the new cycle will be different, with chart toppers
coming from both large- and small-cap securities.
[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 substan-
tial future performance potential.
[end pull quote]
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
8 THE ROYCE FUNDS ANNUAL REPORT 1998
<PAGE>
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[Photo of Jack Fockler, Whitney George, Chuck Royce, Charlie Dreifus, and Buzz
Zaino]
(l-r) Jack Fockler, Whitney George, Chuck Royce,
Charlie Dreifus, Buzz Zaino
1998. Internet frenzy has recently consumed the market landscape. It seems a
fitting coda to this decade's bull market, an outsized, speculative phase to an
outsized market cycle. However, when this sector corrects, a subsequent
correction to the market as a whole seems likely, and a new cycle will be under
way for certain. It is in this new cycle that we believe our "guarded optimism"
for small-caps will be substantiated. We are also confident that in this
low-return environment, there will be great value in "value."
We appreciate your continued support and invite your questions and
comments.
Sincerely,
/s/ Charles M. Royce /s/ W. Whitney George /s/ Jack E. Fockler, Jr.
Charles M. Royce W. Whitney George Jack E. Fockler, Jr.
President Vice President Vice President
Fans of all musical genres may be interested to know that...
"Jump, Jive An' Wail" is a swing standard originally made famous by Louis Prima
that jumped back on the charts in 1998 thanks to a new version by the Brian
Setzer Orchestra, with a little help from a popular TV commercial for The Gap.
"The Joint Is Jumpin'" also enjoyed a second life when the music of Fats Waller
became the subject of the Broadway show Ain't Misbehavin' in the '80s.
"I Got It Bad (And That Ain't Good)," a swing classic, was one of the
centerpieces of the Duke Ellington Orchestra's repertoire through the '40s and
'50s.
"Every Picture Tells a Story" is the title track from Rod Stewart's
groundbreaking 1971 album, one of the first rock and roll records to emphasize
acoustic instruments.
"Take the 'A' Train," another in a long list of Duke Ellington classics, is
indeed one of the trains that stops just minutes from our midtown Manhattan
offices.
When it comes to small-cap stocks and a long-term investment horizon, like
country music legend Johnny Cash, "We Walk The Line."
"It Don't Mean A Thing (If It Ain't Got That Swing)," yet another Ellington gem,
is one of the best-known songs of the swing era, and says it all about the music
that once again has the country hopping.
"The Times They Are A-Changin," the title song from an early Bob Dylan record,
comes from what is probably the most famous protest album of all time.
THE ROYCE FUNDS ANNUAL REPORT 1998 9
<PAGE>
[Begin Sidebar]
WHAT WE DO
Royce Total Return Fund ("RTR")
seeks both long-term growth of
capital and current income. The
Fund invests primarily in a diversi-
fied portfolio of dividend-paying
small- and micro-cap companies
using a value approach.
HOW WE DID
Royce Total Return Fund's focus on
dividend-paying securities enabled it
to better weather the higher level of
volatility that affected many small-
and micro-cap funds in 1998. This
emphasis helped it to outperform its
benchmark index, the small-cap
oriented Russell 2000, for the one-,
three-, five-year and since inception
(12/15/93) periods ended December
31, 1998. In addition, RTR beat its
benchmark since the 1996 small-cap
market peak, with a return of 45.0%
versus 19.9% for the Russell 2000.
RTR's average annual total return
since inception was 16.6%.
RTR has an overall four-star
[Four Stars] rating from Morningstar
out of 2,802 domestic equity funds
with at least a three-year history
ended December 31, 1998. The Fund
also remains one of Morningstar's
lowest risk funds, with the lowest
Morningstar risk ratio out of the
397 small-cap funds with a three-
year history.
The Fund, which had total net assets
at year-end of $245 million, marked
five years of performance history in
December.
[End Sidebar]
ROYCE TOTAL RETURN FUND
- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS Through 12/31/98
<TABLE>
<S> <C>
Fourth Quarter 1998* 9.1%
- ----------------------------------------------------------------
Jul-Dec 1998* -2.4
- ----------------------------------------------------------------
1-Year 4.8
- ----------------------------------------------------------------
3-Year 17.6
- ----------------------------------------------------------------
5-Year 16.7
- ----------------------------------------------------------------
Since Inception (12/15/93) 16.6
</TABLE>
*Not annualized.
RISK/RETURN COMPARISON Inception (12/15/93) Through 12/31/98
<TABLE>
<CAPTION>
Average Annual Standard
Total Return Deviation RUR
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
Royce Total Return Fund 16.6% 8.6 1.93
- ------------------------------------------------------------------------------
Russell 2000 12.5% 16.7 0.75
- ------------------------------------------------------------------------------
</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 Total Return Fund has outperformed the Russell 2000
on BOTH an absolute and a risk-adjusted basis.
[Line Chart]
RECENT MARKET PERFORMANCE
PEAK 5/22/96
5/22/96 - 12/31/98
RTR 45.0%
Russell 2000 19.9%
PEAK 4/21/98
4/21/98 - 12/31/98
RTR -4.0%
Russell 2000 -13.4%
Russell 2000
------------
12/31/95 0.00%
1/31/96 -0.11%
2/28/96 3.01%
3/31/96 5.11%
4/30/96 10.73%
5/31/96 15.09%
6/30/96 10.36%
7/31/96 0.73%
8/31/96 6.58%
9/30/96 10.75%
10/31/96 9.04%
11/30/96 13.54%
12/31/96 16.51%
1/31/97 18.84%
2/28/97 15.95%
3/31/97 10.48%
4/30/97 10.79%
5/31/97 23.12%
6/30/97 28.40%
7/31/97 34.37%
8/31/97 37.45%
9/30/97 47.51%
10/31/97 41.04%
11/30/97 40.12%
12/31/97 42.57%
1/31/98 40.32%
2/28/98 50.69%
3/31/98 56.90%
4/30/98 57.76%
5/31/98 49.26%
6/30/98 49.57%
7/31/98 37.45%
8/31/98 10.73%
9/30/98 19.40%
10/31/98 24.27%
11/30/98 30.78%
12/31/98 38.88%
[End Line Chart]
Royce Total Return Fund has provided strong absolute and relative performance
since the small-cap peak in May 1996.
[Line Chart]
ROYCE TOTAL RETURN FUND vs. RUSSELL 2000 Value of $10,000 Invested on 12/15/93
Royce Total Return Russell 2000
------------------ ------------
12/15/93 10,000 10,000
12/31/93 10,000 10,353
3/31/94 9,940 10,078
6/30/94 9,960 9,686
9/30/94 10,360 10,358
12/31/94 10,514 10,165
3/31/95 11,150 10,634
6/30/95 12,012 11,630
9/30/95 12,998 12,779
12/31/95 13,336 13,056
3/31/96 13,961 13,724
6/30/96 15,234 14,410
9/30/96 15,512 14,459
12/31/96 16,734 15,211
3/31/97 17,159 14,423
6/30/97 18,861 16,762
9/30/97 20,483 19,256
12/31/97 20,698 18,611
3/31/98 22,129 20,482
6/30/98 22,212 19,527
9/30/98 19,873 15,594
12/31/98 21,682 18,138
[End Line Chart]
10 THE ROYCE FUNDS ANNUAL REPORT 1998
<PAGE>
PERFORMANCE AND PORTFOLIO REVIEW
- --------------------------------------------------------------------------------
DOWN MARKET PERFORMANCE COMPARISON
All Down Periods of 7.5% or Greater, in Percentages (%)
[Bar Chart]
Royce Total Return Fund Russell 2000
----------------------- ------------
3/18/94 - 1.8 -12.3
12/9/94
5/22/96 - -0.5 -15.4
7/24/96
1/22/97 - 0.2 -9.0
4/25/97
10/13/97 - -2.7 -11.3
1/12/98
4/21/98 - -19.0 -36.5
10/8/98
[End Bar Chart]
Royce Total Return Fund has outperformed the Russell 2000 during all five major
downturns since its inception.
PORTFOLIO DIAGNOSTICS
<TABLE>
<S> <C>
Median Market Cap. $399 million
- ----------------------------------------------
Weighted Average P/E Ratio 14.3x
- ----------------------------------------------
Weighted Average P/B Ratio 1.7x
- ----------------------------------------------
Weighted Average Yield 3.5%
- ----------------------------------------------
Net Assets $245 million
- ----------------------------------------------
Turnover Rate 66%
- ----------------------------------------------
Symbol RYTRX
</TABLE>
TOP 10 POSITIONS % of Net Assets
<TABLE>
<S> <C>
Charming Shoppes 1.9%
- ----------------------------------------------
Zenith National Insurance 1.6
- ----------------------------------------------
Lincoln Electric Holdings 1.6
- ----------------------------------------------
Sturm, Ruger & Company 1.6
- ----------------------------------------------
The Standard Register
Company 1.5
- ----------------------------------------------
Helmerich & Payne 1.5
- ----------------------------------------------
Applebee's International 1.4
- ----------------------------------------------
Velcro Industries 1.4
- ----------------------------------------------
PXRECorporation 1.3
- ----------------------------------------------
MacNeal-Schwendler
Corporation 1.3
</TABLE>
<TABLE>
<CAPTION>
PORTFOLIO SECTOR BREAKDOWN With Examples % of Net Assets
<S> <C>
Industrial Products Building Systems and Components, Construction Materials, Specialty Chemicals and Materials 19.2%
Industrial Services Transportation and Logistics, Printing, Engineering and Construction 14.3
Financial Intermediaries Insurance, Banking, Securities Brokers 12.0
Consumer Products Home Furnishings/Appliances, Apparel and Shoes, Publishing 8.2
Financial Services Insurance Brokers, Investment Management, Information and Processing 6.6
Natural Resources Oil and Gas, Energy Services, Real Estate 6.4
Technology Components and Systems, Software/Services, Semiconductors and Equipment 4.1
Consumer Services Retail Stores, Restaurants/Lodging, Leisure/Entertainment 2.1
Miscellaneous 4.9
Bonds & Preferred Stock 6.6
Treasuries, Net Cash & Cash Equivalents 15.6
</TABLE>
GOOD IDEAS THAT WORKED
1998 Realized and Unrealized Gain
<TABLE>
<S> <C>
Talbots $1,925,367
- ------------------------------------------------
Willis Corroon Group ADR 1,025,746
- ------------------------------------------------
LeaRonal 963,583
- ------------------------------------------------
Tiffany & Co. 910,304
- ------------------------------------------------
Alliance Capital Management L.P. 856,314
- ------------------------------------------------
Combined Gain $5,681,314
- ------------------------------------------------
</TABLE>
GOOD IDEAS AT THE TIME
1998 Realized and Unrealized Loss
<TABLE>
<S> <C>
DIMON Incorporated $2,310,506
- ------------------------------------------------
Sturm, Ruger & Company 854,021
- ------------------------------------------------
P.H Glatfelter Company 803,801
- ------------------------------------------------
Woodward Governor Company 777,386
- ------------------------------------------------
The Pioneer Group 734,373
- ------------------------------------------------
Combined Loss $5,480,087
- ------------------------------------------------
</TABLE>
Talbots -- One of our big losers from 1997 that was temporarily out of fashion,
this well-established retail franchise began to turn around in the first half of
1998, and continued its remarkable recovery in the second half. Both shoppers
and stockholders came back in droves throughout most of the year.
Willis Corroon Group ADR -- The world's fourth largest insurance broker was
taken over by Kohlberg Kravis Roberts & Co. in a management buyout during the
summer, thus producing a large gain for us. However, we view this as something
of a hollow victory in that it may ultimately be an even bigger winner for the
buyout group.
DIMON Incorporated -- The world's second largest tobacco leaf processor has
suffered from a downturn in its cyclical business, the turmoil in emerging
markets like Brazil and Southeast Asia from which it procures tobacco, and the
difficult circumstances surrounding a cautious U.S. customer base that is being
sued by its government. We continue to hold the stock under hopeful assumptions
that cycles turn, emerging markets recover and governments don't put tobacco
companies out of business.
Sturm, Ruger & Company -- Yet another year of growth eluded this premier gun
manufacturer, whose ventures in manufacturing golf clubs fell short of
expectations. Management did little to inspire, as yet another CEO departed the
company, but we do not believe that this will go on forever. Attracted to the
company's superior financial returns, solid balance sheet, an unusually high
dividend return and a strong brand name, we still have our fingers crossed on
this perennial underachiever.
THE ROYCE FUNDS ANNUAL REPORT 1998 11
<PAGE>
[Begin Sidebar]
WHAT WE DO
Royce Low-Priced Stock Fund
("RLP") seeks long-term growth of
capital by investing primarily in
small- and micro-cap companies
trading for less than $15 per share
using a value approach.
HOW WE DID
Royce Low-Priced Stock Fund outper-
formed its benchmark, the small-cap
oriented Russell 2000, for the one-,
three-, five-year and since inception
(12/15/93) periods ended December
31, 1998. The Fund's average annual
total returns for the three-year, five-
year and since inception periods were
14.5%, 13.6% and 13.6%.
Making the greatest positive impact
on the Fund's performance were
portfolio holdings in the technology
sector, which was a market-leading
group within both small- and large-
cap stocks. This increased exposure
to technology is not indicative of a
change in our investment style, but
instead reflects both the growing role
technology plays in the economy
(which includes a vastly expanding
universe of small-cap technology
companies) and the attractive values
brought about by this year's market
downturn. We remain committed to
absolute valuation measures in our
selection process.
RLP remains one of only two
low-priced stock funds available.
This sector of the market remains
underfollowed by institutions and,
therefore, we believe that it offers
significant investment opportunities.
The Fund, whose total net assets at
year-end were $21 million, now has
five years of performance history.
[End Sidebar]
ROYCE LOW-PRICED STOCK FUND
- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS Through 12/31/98
<TABLE>
<S> <C>
Fourth Quarter 1998* 13.2%
- ------------------------------------------------------------------
Jul-Dec 1998* -11.2
- ------------------------------------------------------------------
1-Year 2.4
- ------------------------------------------------------------------
3-Year 14.5
- ------------------------------------------------------------------
5-Year 13.6
- ------------------------------------------------------------------
Since Inception (12/15/93) 13.6
</TABLE>
*Not annualized.
RISK/RETURN COMPARISON Inception (12/15/93) Through 12/31/98
<TABLE>
<CAPTION>
Average Annual Standard
Total Return Deviation RUR
- ------------------------------------------------------------------------
<S> <C> <C> <C>
Royce Low-Priced Stock Fund 13.6% 14.5 0.94
- ------------------------------------------------------------------------
Russell 2000 12.5% 16.7 0.75
- ------------------------------------------------------------------------
</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 Low-Priced Stock Fund has provided better absolute
and risk-adjusted returns than the Russell 2000.
[Line Chart]
RECENT MARKET PERFORMANCE
PEAK 5/22/96
5/22/96 - 12/31/98
RLP 18.7%
Russell 2000 19.9%
PEAK 4/21/98
4/21/98 - 12/31/98
RLP -12.9%
Russell 2000 -13.4%
Russell 2000
------------
12/31/95 0.00%
1/31/96 -0.11%
2/28/96 3.01%
3/31/96 5.11%
4/30/96 10.73%
5/31/96 15.09%
6/30/96 10.36%
7/31/96 0.73%
8/31/96 6.58%
9/30/96 10.75%
10/31/96 9.04%
11/30/96 13.54%
12/31/96 16.51%
1/31/97 18.84%
2/28/97 15.95%
3/31/97 10.48%
4/30/97 10.79%
5/31/97 23.12%
6/30/97 28.40%
7/31/97 34.37%
8/31/97 37.45%
9/30/97 47.51%
10/31/97 41.04%
11/30/97 40.12%
12/31/97 42.57%
1/31/98 40.32%
2/28/98 50.69%
3/31/98 56.90%
4/30/98 57.76%
5/31/98 49.26%
6/30/98 49.57%
7/31/98 37.45%
8/31/98 10.73%
9/30/98 19.40%
10/31/98 24.27%
11/30/98 30.78%
12/31/98 38.88%
[End Line Chart]
Royce Low-Priced Stock Fund has provided a performance edge since the small-cap
peak in April 1998.
[Line Chart]
ROYCE LOW-PRICED STOCK FUND vs. RUSSELL 2000 Value of $10,000 Invested on
12/15/93
Royce Low-Priced Stock Fund Russell 2000
--------------------------- ------------
12/15/93 10,000 10,000
12/31/93 10,020 10,353
3/31/94 9,780 10,078
6/30/94 9,659 9,686
9/30/94 10,259 10,358
12/31/94 10,319 10,165
3/31/95 11,011 10,634
6/30/95 12,131 11,630
9/30/95 13,005 12,779
12/31/95 12,644 13,056
3/31/96 14,443 13,724
6/30/96 15,388 14,410
9/30/96 14,780 14,459
12/31/96 15,526 15,211
3/31/97 15,404 14,423
6/30/97 16,660 16,762
9/30/97 19,125 19,256
12/31/97 18,551 18,611
3/31/98 21,107 20,482
6/30/98 21,379 19,527
9/30/98 16,783 15,594
12/31/98 18,990 18,138
Includes reinvestment of distributions.
[End Line Chart]
12 THE ROYCE FUNDS ANNUAL REPORT 1998
<PAGE>
PERFORMANCE AND PORTFOLIO REVIEW
- --------------------------------------------------------------------------------
DOWN MARKET PERFORMANCE COMPARISON
All Down Periods of 7.5% or Greater, in Percentages (%)
[Bar Chart]
Royce Low-Priced Stock Fund Russell 2000
--------------------------- ------------
3/18/94 - -2.7 -12.3
12/9/94
5/22/96 - -10.5 -15.4
7/24/96
1/22/97 - -4.8 -9.0
4/25/97
10/13/97 - -9.9 -11.3
1/12/98
4/21/98 -31.3 -36.5
- - 10/8/98
[End Bar Chart]
Royce Low-Priced Stock Fund has outperformed the Russell 2000 during all five
major downturns since its inception.
PORTFOLIO DIAGNOSTICS
<TABLE>
<S> <C>
Median Market Cap. $232 million
- ---------------------------------------------
Weighted Average P/E Ratio 14.5x
- ---------------------------------------------
Weighted Average P/B Ratio 1.3x
- ---------------------------------------------
Weighted Average Yield 1.1%
- ---------------------------------------------
Net Assets $21 million
- ---------------------------------------------
Turnover Rate 111%
- ---------------------------------------------
Symbol RYLPX
</TABLE>
TOP 10 POSITIONS % of Net Assets
<TABLE>
<S> <C>
Charming Shoppes 3.9%
- ---------------------------------------------
Richardson Electronics 3.7
- ---------------------------------------------
Oakley 3.4
- ---------------------------------------------
Gibson Greetings 3.2
- ---------------------------------------------
Titan Exploration 3.2
- ---------------------------------------------
Morrison Knudsen Corporation 3.0
- ---------------------------------------------
The Topps Company 2.9
- ---------------------------------------------
Helix Technology Corporation 2.8
- ---------------------------------------------
Arnold Industries 2.8
- ---------------------------------------------
Sevenson Environmental
Services 2.6
</TABLE>
<TABLE>
<CAPTION>
PORTFOLIO SECTOR BREAKDOWN With Examples % of Net Assets
<S> <C>
Technology Components and Systems, Software/Services, Semiconductors and Equipment 17.4%
Industrial Services Transportation and Logistics, Printing, Engineering and Construction 17.1
Consumer Products Home Furnishings/Appliances, Apparel and Shoes, Publishing 16.0
Natural Resources Oil and Gas, Energy Services, Real Estate 11.8
Consumer Services Retail Stores, Restaurants/Lodging, Leisure/Entertainment 7.4
Health Surgical Products and Devices, Drugs and Biotech, Health Services 6.2
Industrial Products Building Systems and Components, Construction Materials, Specialty Chemicals and Materials 5.6
Financial Intermediaries Insurance, Banking, Securities Brokers 4.1
Financial Services Insurance Brokers, Investment Management, Information and Processing 3.7
Miscellaneous 5.0
Preferred Stock 1.1
Treasuries, Cash & Cash Equivalents 4.6
</TABLE>
GOOD IDEAS THAT WORKED
1998 Realized and Unrealized Gain
<TABLE>
<S> <C>
International Isotopes $416,974
- -------------------------------------------------
Xylan Corporation 360,049
- -------------------------------------------------
EarthWeb 342,306
- -------------------------------------------------
The Topps Company 339,034
- -------------------------------------------------
Catherines Stores Corporation 268,172
- -------------------------------------------------
Combined Gain $1,726,535
- -------------------------------------------------
</TABLE>
GOOD IDEAS AT THE TIME
1998 Realized and Unrealized Loss
<TABLE>
<S> <C>
Willbros Group $383,332
- -------------------------------------------------
Denbury Resources 319,727
- -------------------------------------------------
Perceptron 305,197
- -------------------------------------------------
Seattle Filmworks 263,248
- -------------------------------------------------
Input Output 238,643
- -------------------------------------------------
Combined Loss $1,510,147
- -------------------------------------------------
</TABLE>
International Isotopes -- One of our biggest winners last year, the good news of
International Isotopes continued. This biotech company has benefited from its
ability to utilize the government-failed investment in supercollider technology
equipment to commercially produce treatments for prostate cancer.
Xylan Corporation -- We were attracted to this rapidly growing manufacturer of
high-end telephone switches when technology stocks fell out of favor. The
company's solid customer base includes very large companies, such as IBM. We
successfully managed the volatility of this stock, benefiting from opportunistic
trading.
Willbros Group -- A global construction company specializing in energy projects,
the fortunes of this company were affected by the decline in energy prices, and
therefore energy projects, as well as uncertainties in international markets. We
took our tax loss but anticipate that this security may be in the portfolio in
the future because it is a company we still like.
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.
THE ROYCE FUNDS ANNUAL REPORT 1998 13
<PAGE>
[Begin Sidebar]
What We Do
Royce Financial Services Fund
("RFS") seeks long-term growth of
capital by investing primarily in
small- and micro-cap financial
services companies.
How We Did
Royce Financial Services Fund
outperformed its benchmark index,
the small-cap oriented Russell 2000
for the second half, the one-year
and three-year periods. The Fund's
one-year, three-year and since
inception returns were 8.0%, 13.9%
and 15.8%, respectively.
RFS performed relatively well in
1998, considering that it was a diffi-
cult year for many financial services
companies and small-cap stocks.
International currency woes saw
many financial services companies
relinquish their position as market
leaders in the second half, with the
Nasdaq 100 Financial index down
1.1% for the year. However, a com-
bination of the Fund's risk-averse
value approach and little foreign
exposure helped it avoid these prob-
lems and finish the year with positive
performance.
Although the Fund is not restricted
in terms of capitalization, the portfolio
consists primarily of small-cap
companies, an area of the market
that we know well and that we
believe offers substantial opportunities.
RFS's total net assets at year-end were
$2.2 million.
ROYCE FINANCIAL SERVICES FUND
- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS Through 12/31/98
<TABLE>
<S> <C>
Fourth Quarter 1998* 10.4%
- ----------------------------------------------------------------------
Jul-Dec 1998* -1.7
- ----------------------------------------------------------------------
1-Year 8.0
- ----------------------------------------------------------------------
3-Year 13.9
- ----------------------------------------------------------------------
Since Inception (12/15/94) 15.8
</TABLE>
*Not annualized.
RISK/RETURN COMPARISON Three Year Period Ended 12/31/98
<TABLE>
<CAPTION>
Average Annual Standard
Total Return Deviation RUR
- ------------------------------------------------------------------------
<S> <C> <C> <C>
Royce Financial Services Fund 13.9% 11.9 1.17
Russell 2000 11.6% 19.9 0.58
</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.
For the three year period ended 12/31/98, Royce Financial Services Fund
outperformed the Russell 2000 on BOTH an absolute and a risk-adjusted basis.
[Line Chart]
RECENT MARKET PERFORMANCE
PEAK 5/22/96
5/22/96 - 12/31/98
RFS 32.0%
Russell 2000 19.9%
PEAK 4/21/98
4/21/98 - 12/31/98
RFS -3.4%
Russell 2000 -13.4%
Russell 2000
------------
12/31/95 0.00%
1/31/96 -0.11%
2/28/96 3.01%
3/31/96 5.11%
4/30/96 10.73%
5/31/96 15.09%
6/30/96 10.36%
7/31/96 0.73%
8/31/96 6.58%
9/30/96 10.75%
10/31/96 9.04%
11/30/96 13.54%
12/31/96 16.51%
1/31/97 18.84%
2/28/97 15.95%
3/31/97 10.48%
4/30/97 10.79%
5/31/97 23.12%
6/30/97 28.40%
7/31/97 34.37%
8/31/97 37.45%
9/30/97 47.51%
10/31/97 41.04%
11/30/97 40.12%
12/31/97 42.57%
1/31/98 40.32%
2/28/98 50.69%
3/31/98 56.90%
4/30/98 57.76%
5/31/98 49.26%
6/30/98 49.57%
7/31/98 37.45%
8/31/98 10.73%
9/30/98 19.40%
10/31/98 24.27%
11/30/98 30.78%
12/31/98 38.88%
[End Line Chart]
Royce Financial Services Fund has provided a performance edge in the current
cycle.
[Line Chart]
ROYCE FINANCIAL SERVICES FUND vs. RUSSELL 2000 Value of $10,000 Invested on
12/15/94
Royce Financial Services Fund Russell 2000
----------------------------- ------------
12/15/94 10,000 10,000
12/31/94 10,120 10,520
3/31/95 10,860 11,005
6/30/95 11,699 12,036
9/30/95 12,260 13,225
12/31/95 12,268 13,512
3/31/96 12,765 14,203
6/30/96 13,218 14,913
9/30/96 13,304 14,964
12/31/96 14,062 15,742
3/31/97 14,483 14,926
6/30/97 16,325 17,347
9/30/97 17,421 19,929
12/31/97 16,790 19,261
3/31/98 18,304 21,197
6/30/98 18,440 20,209
9/30/98 16,411 16,139
12/31/98 18,125 18,771
Includes reinvestment of distributions.
[End Line Chart]
14 THE ROYCE FUNDS ANNUAL REPORT 1998
<PAGE>
PERFORMANCE AND PORTFOLIO REVIEW
- --------------------------------------------------------------------------------
DOWN MARKET PERFORMANCE COMPARISON
All Down Periods of 7.5% or Greater, in Percentages (%)
[Bar Chart]
Royce Financial Services Fund Russell 2000
----------------------------- ------------
5/22/96 - -7.7 -15.4
7/24/96
1/22/97 - -0.8 -9.0
4/25/97
10/13/97 - -8.0 -11.3
1/12/98
4/21/98 - -19.3 -36.5
10/8/98
[End Bar Chart]
Royce Financial Services Fund has outperformed the Russell 2000 during all four
major downturns since its inception.
PORTFOLIO DIAGNOSTICS
<TABLE>
<S> <C>
Median Market Cap. $755 million
- ---------------------------------------------
Weighted Average P/E Ratio 14.1x
- ---------------------------------------------
Weighted Average P/B Ratio 1.5x
- ---------------------------------------------
Weighted Average Yield 2.3%
- ---------------------------------------------
Net Assets $2.2 million
- ---------------------------------------------
Turnover Rate 62%
- ---------------------------------------------
Symbol RYGSX
</TABLE>
TOP 10 POSITIONS % of Net Assets
<TABLE>
<S> <C>
Zenith National Insurance 4.8%
- ---------------------------------------------
PMA Capital Corporation Cl. A 4.1
- ---------------------------------------------
Arthur J. Gallagher & Co. 4.0
- ---------------------------------------------
Trenwick Group 3.7
- ---------------------------------------------
Orion Capital Corporation 3.6
- ---------------------------------------------
E.W. Blanch Holdings 3.3
- ---------------------------------------------
Fund American Enterprises
Holdings 3.2
- ---------------------------------------------
W.R. Berkley 3.1
- ---------------------------------------------
Leucadia National Corporation 2.9
- ---------------------------------------------
The Navigators Group 2.8
</TABLE>
<TABLE>
<CAPTION>
PORTFOLIO SECTOR BREAKDOWN With Examples % of Net Assets
<S> <C>
Financial Services Insurance Brokers, Investment Management, Information and Processing 72.0%
Industrial Services Transportation and Logistics, Printing, Engineering and Construction 0.8
Miscellaneous 5.0
Treasuries, Net Cash & Cash Equivalents 22.2
</TABLE>
GOOD IDEAS THAT WORKED
1998 Realized and Unrealized Gain
<TABLE>
<S> <C>
Affiliated Managers Group $49,067
- -----------------------------------------------
Willis Corroon Group ADR 36,214
- -----------------------------------------------
LandAmerica Financial Group 34,433
- -----------------------------------------------
Arthur J. Gallagher & Co. 27,294
- -----------------------------------------------
Orion Capital Corporation 22,190
- -----------------------------------------------
Combined Gain $169,198
- -----------------------------------------------
</TABLE>
GOOD IDEAS AT THE TIME
1998 Realized and Unrealized Loss
<TABLE>
<S> <C>
The Pioneer Group $40,376
- -----------------------------------------------
Sevenson Environmental Services 25,546
- -----------------------------------------------
PICO Holdings 18,127
- -----------------------------------------------
Crawford & Company Cl. A 17,487
- -----------------------------------------------
Highlands Insurance Group 16,808
- -----------------------------------------------
Combined Loss $118,344
- -----------------------------------------------
</TABLE>
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.
Willis Corroon Group ADR -- The world's fourth largest insurance broker was
taken over by Kohlberg Kravis Roberts & Co. in a management buyout during the
summer, thus producing a large gain for us. However, we view this as something
of a hollow victory in that it may ultimately be an even bigger winner for the
buyout group.
The Pioneer Group -- An old line investment management company whose global
diversification backfired badly in 1998, causing them to write off investments
in Russian banks, timber and African gold mines, leaving shareholders
uninspired. We took our losses and moved on to more focused participants in the
industry.
Highlands Insurance Group -- We invested in this broad-line property casualty
insurer when new management, including some of the best turnaround managers and
business builders in this industry, came on board. Although an expected
turnaround failed to materialize, we continue to hold this security, believing
that the company is worth more than its current market price.
THE ROYCE FUNDS ANNUAL REPORT 1998 15
<PAGE>
UPDATES AND NOTES TO PERFORMANCE AND RISK INFORMATION
- --------------------------------------------------------------------------------
[Graphic of a Computer and Keyboard with the Words "THE ROYCE FUNDS" Displayed
on the Monitor]
NEW @ www.roycefunds.com
New this quarter on our website is the addition of Fund prices for our open-
and closed-end funds. Fund prices are updated daily on the site and can be found
in the Performance/Diagnostics/Prices section. Our What's New column continues
to be popular. What's New is updated each week on Monday and features fund
updates, market commentary and Chuck Royce's latest thoughts.
Y2K UPDATE
Royce & Associates recently filed its report on Year 2000 (Y2K) readiness
(Form ADV-Y2K), as required by the U.S. Securities and Exchange Commission. Form
ADV-Y2K -- which is available on our website in Up-to-the-Minute's Recent
Developments section -- asks for specific Y2K information, such as the existence
and progress of Y2K compliance plans and contingency plans, systems that may be
affected by Y2K and the Y2K readiness of third parties upon which Royce and its
clients may be relying to perform mission critical services. Royce and the Funds
are working to ensure that our systems and those of our service providers are
Y2K compliant, and we do not anticipate that any Y2K problems will have a
material impact on Royce's ability to provide services to the Funds at current
levels.
NOTES TO PERFORMANCE AND RISK INFORMATION
All performance information is presented on a total return basis and
reflects the reinvestment of distributions. Past performance is no guarantee of
future results. Investment return and principal value will fluctuate, so that
shares may be worth more or less than their original cost when redeemed. The
Royce Funds invest primarily in securities of small-cap and/or micro-cap
companies that may involve considerably more risk than investments in securities
of larger-cap companies (see "Investment Risks" in the prospectus). There can be
no assurance that securities mentioned in this report will be included in any
Royce-managed portfolio in the future.
Morningstar proprietary ratings reflect historical risk-adjusted
performance as of 12/31/98 and are subject to change monthly. The rating is
calculated from a fund's three-, five- and 10-year average annual total returns
with appropriate fee adjustments and a risk factor that reflects performance
relative to three-month Treasury bill returns. Royce Total Return Fund received
four stars for the three- and five-year periods ended 12/31/98 in the domestic
equity investment category out of 2,802 and 1,702 funds, respectively. Ten
percent of the funds in an investment category receive five stars and 22.5%
receive four stars. Morningstar proprietary risk ratio measures a fund's
downside volatility relative to all equity funds, which have an average score of
1.00. The average score for the 397 funds in the small-cap objective category
with a three-year history was 1.47 for the three years ended 12/31/98. The lower
the risk ratio, the lower a fund's downside volatility has been. The risk scores
for Royce Premier Fund, Royce Total Return Fund, Pennsylvania Mutual Fund and
Royce GiftShares Fund for this period were 0.78, 0.47, 0.77 and 0.68,
respectively. Standard deviation is a statistical measure within which a fund's
total returns have varied over time. The greater the standard deviation, the
greater a fund's volatility. The Russell 2000, Nasdaq Composite, Nasdaq 100,
Nasdaq Industrials, Nasdaq 100 Financials, S&P 500 and Dow Jones Industrial
Average are unmanaged indices of domestic common stocks. The Royce Funds and
Royce GiftShares Fund are service marks of The Royce Funds.
16 THE ROYCE FUNDS ANNUAL REPORT 1998
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
ROYCE TOTAL RETURN FUND DECEMBER 31, 1998
- --------------------------------------------------------------------------------
COMMON STOCKS -- 77.8%
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Consumer Products -- 8.2%
Apparel and Shoes - 2.2%
Garan Incorporated 74,300 $ 2,089,687
Superior Uniform Group 115,400 1,673,300
Wolverine World Wide 115,000 1,523,750
-----------
5,286,737
-----------
Collectibles - 1.2%
Enesco Group 129,600 3,013,200
-----------
Home Furnishings/Appliances - 1.9%
Bassett Furniture Industries 99,400 2,398,025
Flexsteel Industries 175,500 2,259,563
-----------
4,657,588
-----------
Sports and Recreation - 1.6%
Sturm, Ruger & Company 324,800 3,877,300
-----------
Other Consumer Products - 1.3%
Velcro Industries 22,200 3,307,800
-----------
20,142,625
===========
Consumer Services -- 2.1%
Restaurants/Lodging - 1.4%
Applebee's International 161,100 3,322,687
-----------
Retail Stores - 0.7%
Claire's Stores 20,000 410,000
Mikasa 101,900 1,299,225
-----------
1,709,225
-----------
5,031,912
===========
Financial Intermediaries -- 12.0%
Insurance - 10.7%
Capitol Transamerica Corporation 163,800 3,061,012
Chartwell Re Corporation 40,300 957,125
Chicago Title Corporation 32,000 1,502,000
The Commerce Group 47,800 1,693,913
Erie Indemnity Company Cl. A 49,700 1,553,125
NYMAGIC 59,400 1,232,550
Orion Capital Corporation 55,400 2,205,612
PMA Capital Corporation Cl. A 154,380 3,020,059
PXRE Corporation 131,424 3,293,814
Trenwick Group 75,550 2,464,819
Wesco Financial Corporation 4,000 1,419,000
Zenith National Insurance 172,800 3,996,000
-----------
26,399,029
-----------
Securities Brokers - 1.3%
Dain Rauscher Corporation 60,000 1,770,000
Legg Mason 43,000 1,357,188
-----------
3,127,188
-----------
29,526,217
===========
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Financial Services -- 6.6%
Insurance Brokers - 2.2%
Crawford & Company Cl. A 202,700 $ 2,711,112
Arthur J. Gallagher & Co. 58,400 2,576,900
-----------
5,288,012
-----------
Investment Management - 4.4%
Alliance Capital Management L.P. 27,000 695,250
The John Nuveen Company Cl. A 77,900 2,892,038
MacKenzie Financial Corporation 101,400 1,356,225
NVEST L.P. 102,500 2,850,781
Phoenix Investment Partners 354,000 2,986,875
-----------
10,781,169
-----------
16,069,181
===========
Industrial Products -- 19.2%
Building Systems and Components - 3.5%
Falcon Products 134,900 1,618,800
International Aluminum
Corporation 63,100 1,865,394
Juno Lighting 31,200 729,300
++ Paul Mueller Company 59,500 2,402,312
Thor Industries 75,000 1,912,500
-----------
8,528,306
-----------
Construction Materials - 2.6%
Ash Grove Cement Company Cl. B 27,000 2,470,500
Florida Rock Industries 73,400 2,275,400
Oregon Steel Mills 140,000 1,662,500
-----------
6,408,400
-----------
Industrial Components - 0.9%
Woodhead Industries 173,100 2,250,300
-----------
Machinery - 3.4%
Lincoln Electric Holdings 178,300 3,967,175
Minuteman International 140,500 1,703,563
Nordson Corporation 51,300 2,635,538
-----------
8,306,276
-----------
Paper and Packaging - 1.3%
P. H. Glatfelter Company 143,700 1,778,287
Peak TRENDS Trust 148,400 1,428,350
-----------
3,206,637
-----------
Pumps, Valves and Bearings - 2.9%
Franklin Electric 15,300 1,032,750
Kaydon Corporation 40,000 1,602,500
NN Ball and Roller 308,000 1,809,500
Roper Industries 100,000 2,037,500
Tech/Ops Sevcon 43,700 609,069
-----------
7,091,319
-----------
</TABLE>
THE ROYCE FUNDS ANNUAL REPORT 1998 17
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
ROYCE TOTAL RETURN FUND DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Industrial Products (continued)
Specialty Chemicals and Materials - 2.0%
Brady Corporation Cl. A 55,700 $ 1,500,419
Lilly Industries Cl. A 50,000 996,875
Synalloy Corporation 282,200 2,469,250
-----------
4,966,544
-----------
Textiles - 1.1%
Fab Industries 125,200 2,691,800
-----------
Other Industrial Products -1.5%
Landauer 49,600 1,605,800
Myers Industries 31,700 909,394
Tennant Company 30,000 1,203,750
-----------
3,718,944
-----------
47,168,526
===========
Industrial Services -- 14.3%
Advertising/Publishing - 0.7%
True North Communications 66,000 1,773,750
-----------
Commercial Services - 1.4%
ABM Industries Incorporated 59,800 2,070,575
Angelica Corporation 64,700 1,205,037
-----------
3,275,612
-----------
Engineering and Construction - 1.5%
Sevenson Environmental Services 96,960 824,160
Stone & Webster 87,300 2,902,725
-----------
3,726,885
-----------
Food/Tobacco Processors - 1.4%
DIMON Incorporated 178,300 1,326,106
Universal Corporation 60,000 2,107,500
-----------
3,433,606
-----------
Industrial Distribution - 1.1%
Central Steel & Wire Company 3,898 2,775,376
-----------
Printing - 2.8%
Ennis Business Forms 311,500 3,095,531
The Standard Register Company 122,100 3,777,469
-----------
6,873,000
-----------
Transportation and Logistics - 5.4%
Air Express International
Corporation 138,500 3,012,375
Airborne Freight Corporation 25,000 901,563
Arnold Industries 145,300 2,342,963
Circle International Group 151,400 3,103,700
Frozen Food Express Industries 186,135 1,465,813
The Pittston BAX Group 203,200 2,260,600
-----------
13,087,014
-----------
34,945,243
===========
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Natural Resources -- 6.4%
Energy Services - 2.3%
Carbo Ceramics 102,500 $ 1,793,750
Helmerich & Payne 192,100 3,721,938
------------
5,515,688
------------
Gold - 1.0%
Anglogold Limited ADR+ 128,600 2,515,737
------------
Oil and Gas - 2.0%
Devon Energy Corporation 87,300 2,679,019
Tidewater 95,000 2,202,813
------------
4,881,832
------------
Real Estate - 1.1%
Chelsea GCA Realty 78,000 2,778,750
------------
15,692,007
============
Technology -- 4.1%
Aerospace/Defense - 2.1%
Curtiss-Wright Corporation 66,800 2,546,750
Woodward Governor Company 116,600 2,579,775
------------
5,126,525
------------
Components and Systems - 0.6%
Penn Engineering and
Manufacturing Cl. A 78,300 1,546,425
------------
Distribution - 0.6%
Richardson Electronics 142,400 1,370,600
------------
Semiconductors and Equipment - 0.6%
Helix Technology Corporation 114,700 1,491,100
------------
Software/Services - 0.2%
Comdisco 32,600 533,088
------------
10,067,738
============
Miscellaneous -- 4.9% 12,098,184
============
TOTAL COMMON STOCKS
(Cost $189,041,042) 190,741,633
============
PREFERRED STOCK -- 0.3%
Vornado Realty Trust (Conv.)
(Cost $759,531) 15,000 727,500
============
</TABLE>
18 THE ROYCE FUNDS ANNUAL REPORT 1998
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
ROYCE TOTAL RETURN FUND DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT VALUE
------ -----
<S> <C> <C>
CORPORATE BONDS -- 6.3%
Amkor Technologies 5.75%
Conv. Sub. Note due 5/01/03 $ 500,000 $ 470,000
Charming Shoppes 7.50%
Conv. Sub. Note due 7/15/06 5,250,000 4,725,000
Credence Systems Corporation 5.25%
Conv. Sub. Note due 9/15/02 1,000,000 740,000
Cymer 3.50%
Conv. Sub. Note due 8/06/04 1,000,000 740,000
FirstWorld Communications 0%
Sr. Note due 4/15/08 1,000,000 303,750
HMT Technology Corporation 5.75%
Conv. Sub. Note due 1/15/04 2,500,000 2,009,375
MacNeal-Schwendler Corporation 7.875%
Conv. Sub. Deb. due 8/18/04 3,465,000 3,187,800
Richardson Electronics 8.25%
Conv. Sub. Deb. due 6/15/06 1,657,000 1,408,450
Standard Commercial 7.25%
Conv. Sub. Deb. due 3/31/07 500,000 365,000
Sunglass Hut International 5.25%
Conv. Sub. Note due 6/15/03 1,750,000 1,207,500
System Software Associates 7.00%
Conv. Sub. Note due 9/15/02 500,000 353,125
------------
TOTAL CORPORATE BONDS
(Cost $16,227,570) 15,510,000
============
<CAPTION>
PRINCIPAL
AMOUNT VALUE
------ -----
<S> <C> <C>
U.S. TREASURY OBLIGATION -- 2.9%
U.S. Treasury Note
4.625%, due 12/31/00
(Cost $7,009,844) $7,000,000 $ 7,010,920
============
REPURCHASE AGREEMENT -- 16.5%
State Street Bank and Trust Company, 4.25%
dated 12/31/98, due 1/04/99, maturity value
$40,419,078 (collateralized by U.S. Treasury
Bonds, 10.625% due 8/15/15, valued at
$41,214,709)
(Cost $40,400,000)
40,400,000
============
TOTAL INVESTMENTS -- 103.8%
(Cost $253,437,987)
254,390,053
LIABILITIES LESS CASH
AND OTHER ASSETS --(3.8)%
(9,400,696)
------------
NET ASSETS -- 100.0%
$244,989,357
============
</TABLE>
- --------------------------------------------------------------------------------
+ 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 $253,493,682. At December 31, 1998,net unrealized appreciation for
all securities was $896,371, consisting of aggregate gross unrealized
appreciation of $12,804,069 and aggregate gross unrealized depreciation of
$11,907,698. The Fund designated $3,116,503 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>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
ROYCE LOW-PRICED STOCK FUND DECEMBER 31, 1998
- --------------------------------------------------------------------------------
COMMON STOCKS -- 94.3%
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Consumer Products -- 16.0%
Food/Beverage/Tobacco - 1.6%
800-JR CIGAR* 15,000 $ 348,750
-----------
Home Furnishings/Appliances - 1.3%
Meadowcraft* 25,000 279,688
-----------
Publishing - 6.1%
Gibson Greetings* 57,000 676,875
The Topps Company* 121,900 609,500
-----------
1,286,375
-----------
Sports and Recreation - 5.5%
Oakley* 76,200 719,137
Sturm, Ruger & Company 37,700 450,044
-----------
1,169,181
-----------
Other Consumer Products - 1.5%
Lazare Kaplan International* 45,100 315,700
-----------
3,399,694
===========
Consumer Services -- 7.4%
Restaurants/Lodging - 1.7%
Buffets* 30,400 362,900
-----------
Retail Stores - 5.7%
Catherines Stores Corporation* 22,400 243,600
Charming Shoppes* 189,600 817,650
Suzy Shier 22,000 136,735
-----------
1,197,985
-----------
1,560,885
===========
Financial Intermediaries -- 4.1%
Insurance - 4.1%
Highlands Insurance Group* 30,000 391,875
PMA Capital Corporation Cl. A 24,800 485,150
-----------
877,025
===========
Financial Services -- 3.7%
Investment Management - 2.7%
Phoenix Investment Partners 22,900 193,219
The Pioneer Group 18,700 369,325
-----------
562,544
-----------
Other Financial Services - 1.0%
Aames Financial Corporation 67,000 213,563
-----------
776,107
===========
Health -- 6.2%
Commercial Service - 0.9%
Young Innovations* 15,000 196,875
-----------
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Drugs and Biotech - 5.3%
ImClone Systems Incorporated* 25,000 $ 226,562
International Isotopes* 15,000 240,000
The Liposome Company* 25,000 385,938
NeXstar Pharmaceuticals* 27,900 258,075
-----------
1,110,575
-----------
1,307,450
===========
Industrial Products -- 5.6%
Building Systems and Components - 2.2%
Falcon Products 39,000 468,000
-----------
Paper and Packaging - 1.3%
PalEx* 36,400 275,275
-----------
Pumps, Valves and Bearings - 0.4%
Sun Hydraulics Corporation 10,000 83,125
-----------
Specialty Chemicals and Materials - 1.7%
CFC International* 44,600 356,800
-----------
1,183,200
===========
Industrial Services -- 17.1%
Commercial Services - 0.9%
Cornell Corrections* 10,000 190,000
-----------
Engineering and Construction - 6.5%
Insituform Technologies Cl. A* 13,300 192,850
Morrison Knudsen Corporation* 65,300 636,675
Sevenson Environmental Services 63,660 541,110
-----------
1,370,635
-----------
Food/Tobacco Processors - 1.4%
Midwest Grain Products* 22,100 301,112
-----------
Printing - 2.3%
Ennis Business Forms 50,000 496,875
-----------
Transportation and Logistics - 6.0%
AirNet Systems* 10,000 143,750
Arnold Industries 36,200 583,725
Frozen Food Express Industries 68,000 535,500
-----------
1,262,975
-----------
3,621,597
===========
Natural Resources -- 11.8%
Energy Services - 3.8%
Global Industries* 60,000 367,500
Input Output* 60,000 438,750
-----------
806,250
-----------
Oil and Gas - 8.0%
Tom Brown* 51,500 516,609
Denbury Resources* 125,000 507,813
Titan Exploration* 102,700 673,969
-----------
1,698,391
-----------
2,504,641
===========
</TABLE>
20 THE ROYCE FUNDS ANNUAL REPORT 1998
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
ROYCE LOW-PRICED STOCK FUND DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Technology -- 17.4%
Components and Systems - 4.1%
Advanced Energy Industries* 10,000 $ 250,000
Coherent* 21,800 271,137
Newport Corporation 20,000 337,500
-----------
858,637
-----------
Distribution - 3.7%
Richardson Electronics 81,200 781,550
-----------
Semiconductors and Equipment - 3.9%
Electroglas* 20,000 235,000
Helix Technology Corporation 46,000 598,000
-----------
833,000
-----------
Software/Services - 2.7%
JDA Software Group* 35,100 340,031
Tyler Corporation* 38,500 235,813
-----------
575,844
-----------
Telecommunications - 3.0%
REMEC* 16,200 291,600
Xylan Corporation* 20,000 351,250
-----------
642,850
-----------
3,691,881
===========
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Miscellaneous -- 5.0% $ 1,054,531
===========
TOTAL COMMON STOCKS
(Cost $19,323,899)
19,977,011
===========
PREFERRED STOCK -- 1.1%
DECS Trust (Conv.)
(Cost $275,187) 25,000 234,375
===========
REPURCHASE AGREEMENT -- 3.8%
State Street Bank and Trust Company, 4.25%
dated 12/31/98, due 1/04/99, maturity value
$800,378 (collateralized by U.S. Treasury
Notes, 6.375% due 4/30/99, valued at
$818,050)
(Cost $800,000) 800,000
===========
TOTAL INVESTMENTS -- 99.2%
(Cost $20,399,086) 21,011,386
CASH AND OTHER ASSETS
LESS LIABILITIES -- 0.8%
162,221
-----------
NET ASSETS -- 100.0%
$21,173,607
===========
</TABLE>
- --------------------------------------------------------------------------------
* Non-income producing.
INCOME TAX INFORMATION: The cost of total investments for Federal income tax
purposes was $20,399,086. At December 31, 1998, net unrealized appreciation for
all securities was $612,300, consisting of aggregate gross unrealized
appreciation of $2,327,970 and aggregate gross unrealized depreciation of
$1,715,670. The Fund designated $38,584 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 21
<PAGE>
SCHEDULES OF INVESTMENTS
- --------------------------------------------------------------------------------
ROYCE FINANCIAL SERVICES FUND DECEMBER 31, 1998
- --------------------------------------------------------------------------------
COMMON STOCKS -- 77.8%
<TABLE>
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Financial Services -- 72.0%
Banking - 0.4%
Barclays ADR+ 100 $ 9,000
-----------
Information and Processing - 3.8%
American Express Company 100 10,225
Duff & Phelps Credit Rating 500 27,406
Fair Isaac and Company,
Incorporated 1,000 46,187
-----------
83,818
-----------
Insurance - 47.1%
Alleghany Corporation* 300 56,363
W. R. Berkley 2,000 68,125
CNA Surety Corporation* 2,000 31,500
Chicago Title Corporation 1,000 46,937
The Commerce Group 1,000 35,438
Fremont General Corporation 1,000 24,750
Fund American Enterprises
Holdings 500 70,031
Highlands Insurance Group* 3,000 39,187
Leucadia National Corporation 2,000 63,000
Medical Assurance* 1,364 45,097
NYMAGIC 1,500 31,125
The Navigators Group* 4,000 62,000
Orion Capital Corporation 2,000 79,625
PICO Holdings* 2,100 27,825
PMA Capital Corporation Cl. A 4,600 89,988
PXRE Corporation 1,500 37,594
Trenwick Group 2,500 81,562
Wesco Financial Corporation 100 35,475
Zenith National Insurance 4,500 104,063
-----------
1,029,685
-----------
Insurance Brokers - 7.3%
E.W. Blanch Holdings 1,500 71,156
Arthur J. Gallagher & Co. 2,000 88,250
-----------
159,406
-----------
<CAPTION>
SHARES VALUE
------ -----
<S> <C> <C>
Investment Management - 8.6%
Affiliated Managers Group* 1,600 $ 47,800
Amvescap ADR+ 200 7,700
C.I. Fund Management 2,000 18,319
The John Nuveen Company Cl. A 1,500 55,688
Phoenix Investment Partners 6,000 50,625
U.S. Global Investors Cl. A* 5,000 7,812
-----------
187,944
-----------
Securities Brokers - 4.8%
The Bear Stearns Companies 700 26,162
Legg Mason 1,500 47,344
Raymond James Financial 1,500 31,688
-----------
105,194
-----------
1,575,047
===========
Industrial Services -- 0.8%
Printing - 0.8%
Bowne & Co. 1,000 17,875
===========
Miscellaneous -- 5.0%
108,312
===========
TOTAL COMMON STOCKS
(Cost $1,545,923)
1,701,234
===========
REPURCHASE AGREEMENT -- 22.8%
State Street Bank and Trust Company, 4.25%
dated 12/31/98, due 1/04/99, maturity value
$500,236 (collateralized by Federal Home Loan
Bank, 5.60% due 8/24/00, valued at $512,249)
(Cost $500,000)
500,000
===========
TOTAL INVESTMENTS -- 100.6%
(Cost $2,045,923)
2,201,234
LIABILITIES LESS CASH AND
OTHER ASSETS -- (0.6)%
(13,685)
-----------
NET ASSETS -- 100.0%
$ 2,187,549
===========
</TABLE>
- --------------------------------------------------------------------------------
* Non-income producing.
+ American Depository Receipt.
INCOME TAX INFORMATION: The cost of total investments for Federal income tax
purposes was $2,045,923. At December 31, 1998, net unrealized appreciation for
all securities was $155,311, consisting of aggregate gross unrealized
appreciation of $227,842 and aggregate gross unrealized depreciation of $72,531.
The Fund designated $139,477 as a capital gain dividend for the purpose of the
dividend paid deduction.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
22 THE ROYCE FUNDS ANNUAL REPORT 1998
<PAGE>
STATEMENTS OF ASSETS AND LIABILITIES DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Royce Total Royce Low- Royce Financial
Return Fund Priced Stock Fund Services Fund
----------- ----------------- -------------
<S> <C> <C> <C>
ASSETS:
Investments at value (identified cost $213,037,987, $19,599,086 and
$1,545,923, respectively) $213,990,053 $20,211,386 $1,701,234
Repurchase agreements (at cost and value) 40,400,000 800,000 500,000
Cash 31,160 9,832 101,908
Receivable for investments sold 11,602,888 108,889 72,459
Receivable for capital shares sold 1,805,572 175,068 --
Receivable for dividends and interest 855,243 5,511 2,111
Prepaid expenses and other assets 7,110 996 3,549
- ------------------------------------------------------------------------------------------------------------------------------
Total Assets 268,692,026 21,311,682 2,381,261
- ------------------------------------------------------------------------------------------------------------------------------
LIABILITIES:
Payable for investments purchased 22,807,141 -- 187,396
Payable for capital shares redeemed 582,344 96,334 --
Payable for investment advisory fees 184,335 18,726 --
Accrued expenses 128,849 23,015 6,316
- ------------------------------------------------------------------------------------------------------------------------------
Total Liabilities 23,702,669 138,075 193,712
- ------------------------------------------------------------------------------------------------------------------------------
Net Assets $244,989,357 $21,173,607 $2,187,549
==============================================================================================================================
ANALYSIS OF NET ASSETS:
Undistributed net investment income $ -- $ -- $ 1,485
Accumulated net realized gain on investments 10,379,577 943,082 63,131
Net unrealized appreciation on investments 952,066 612,303 155,311
Capital shares 32,423 3,046 359
Additional paid-in capital 233,625,291 19,615,176 1,967,263
- ------------------------------------------------------------------------------------------------------------------------------
Net Assets $244,989,357 $21,173,607 $2,187,549
==============================================================================================================================
SHARES OUTSTANDING:
(unlimited number of $.001 par value shares authorized for each Fund) 32,423,315 3,045,939 358,766
==============================================================================================================================
NET ASSET VALUES (Net Assets [divided by] Shares Outstanding):
(offering and redemption price* per share) $ 7.56 $ 6.95 $ 6.10
==============================================================================================================================
</TABLE>
*Shares redeemed within one year of purchase are subject to a 1% redemption fee,
payable to the Fund.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
THE ROYCE FUNDS ANNUAL REPORT 1998 23
<PAGE>
STATEMENTS OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
================================
Royce Total Return Fund
--------------------------------
Year ended Year ended
December 31, December 31,
1998 1997
================================
<S> <C> <C>
INVESTMENT OPERATIONS:
Net investment income (loss) $ 4,629,697 $ 1,696,026
Net realized gain on investments 15,482,353 2,348,301
Net change in unrealized appreciation on investments (10,546,575) 5,872,331
- -----------------------------------------------------------------------------------------
Net increase in net assets from investment operations 9,565,475 9,916,658
- -----------------------------------------------------------------------------------------
DISTRIBUTIONS:
Net investment income (4,676,552) (1,647,104)
Net realized gain on investments (4,986,404) (2,179,092)
- -----------------------------------------------------------------------------------------
Total distributions (9,662,956) (3,826,196)
- -----------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS:
Value of shares sold 224,193,061 87,984,309
Value of shares issued in connection with the
merger of Royce Equity Income Fund -- 34,543,545
Distributions reinvested 8,855,052 3,420,793
Value of shares redeemed (108,407,737) (17,826,184)
- -----------------------------------------------------------------------------------------
Net increase (decrease) in net assets from capital
share transactions 124,640,376 108,122,463
- -----------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN NET ASSETS 124,542,895 114,212,925
NET ASSETS:
Beginning of year 120,446,462 6,233,537
- -----------------------------------------------------------------------------------------
End of year (a) $244,989,357 $120,446,462
=========================================================================================
CAPITAL SHARE TRANSACTIONS (in shares):
Shares sold 29,334,388 12,060,292
Shares issued in connection with the
merger of Royce Equity Income Fund -- 4,913,733
Shares issued for reinvestment of distributions 1,199,870 456,108
Shares redeemed (14,135,279) (2,396,674)
- -----------------------------------------------------------------------------------------
Net increase (decrease) in shares outstanding 16,398,979 15,033,459
- -----------------------------------------------------------------------------------------
<CAPTION>
==============================================================
Royce Low-Priced Stock Fund Royce Financial Services 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) $ (22,279) $ (80,293) $ 105 $ (329)
Net realized gain on investments 1,031,027 1,443,527 122,034 415,392
Net change in unrealized appreciation on investments (925,593) 1,637,540 24,356 (44,868)
- -----------------------------------------------------------------------------------------------------------------------
Net increase in net assets from investment operations 83,155 3,000,774 146,495 370,195
- -----------------------------------------------------------------------------------------------------------------------
DISTRIBUTIONS:
Net investment income -- -- -- (5,069)
Net realized gain on investments (95,688) (1,717,330) (201,736) (325,296)
- -----------------------------------------------------------------------------------------------------------------------
Total distributions (95,688) (1,717,330) (201,736) (330,365)
- -----------------------------------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS:
Value of shares sold 14,794,912 6,050,197 600,031 431,866
Value of shares issued in connection with the
merger of Royce Equity Income Fund -- -- -- --
Distributions reinvested 94,106 1,599,306 190,929 324,635
Value of shares redeemed (11,799,296) (6,741,432) (943,867) (348,519)
- -----------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in net assets from capital
share transactions 3,089,722 908,071 (152,907) 407,982
- -----------------------------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN NET ASSETS 3,077,189 2,191,515 (208,148) 447,812
NET ASSETS:
Beginning of year 18,096,418 15,904,903 2,395,697 1,947,885
- -----------------------------------------------------------------------------------------------------------------------
End of year (a) $21,173,607 $18,096,418 $2,187,549 $2,395,697
=======================================================================================================================
CAPITAL SHARE TRANSACTIONS (in shares):
Shares sold 2,009,166 873,778 93,061 63,855
Shares issued in connection with the
merger of Royce Equity Income Fund -- -- -- --
Shares issued for reinvestment of distributions 14,237 233,476 32,035 52,786
Shares redeemed (1,632,413) (978,403) (152,331) (53,525)
- -----------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in shares outstanding 390,990 128,851 (27,235) 63,116
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Includes undistributed net investment income of $0, $0 and $1,485 in 1998
and $35,955, $0 and $0 in 1997 for Royce Total Return Fund, Royce Low-Priced
Stock Fund and Royce Financial Services Fund, respectively.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
24 THE ROYCE FUNDS ANNUAL REPORT 1998
<PAGE>
STATEMENTS OF OPERATIONS YEAR ENDED DECEMBER 31, 1998
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Royce Total Royce Low- Royce Financial
Return Fund Priced Stock Fund Services Fund
----------- ----------------- -------------
INVESTMENT INCOME:
Income:
<S> <C> <C> <C>
Dividends $ 4,494,011 $ 168,600 $ 35,692
Interest 2,240,640 118,852 163
- -------------------------------------------------------------------------------------------------------------------
Total Income 6,734,651 287,452 35,855
- -------------------------------------------------------------------------------------------------------------------
Expenses:
Investment advisory fees 1,683,963 311,810 35,990
Distribution fees -- 51,968 5,998
Shareholder servicing 179,533 21,422 1,120
Shareholder reports 156,381 26,734 4,941
Custodian 71,550 26,596 7,759
Administrative and office facilities 60,020 9,203 1,157
Registration 47,185 14,420 9,278
Professional fees 44,948 12,033 5,601
Trustees' fees 19,838 2,607 319
Other expenses 15,374 4,200 4,546
- -------------------------------------------------------------------------------------------------------------------
Total Expenses 2,278,792 480,993 76,709
Fees Waived by Investment Adviser and Distributor (173,838) (171,262) (40,959)
- -------------------------------------------------------------------------------------------------------------------
Net Expenses 2,104,954 309,731 35,750
- -------------------------------------------------------------------------------------------------------------------
Net Investment Income (Loss) 4,629,697 (22,279) 105
- -------------------------------------------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Net realized gain on investments 15,482,353 1,031,027 122,034
Net change in unrealized appreciation on investments (10,546,575) (925,593) 24,356
- -------------------------------------------------------------------------------------------------------------------
Net realized and unrealized gain on investments 4,935,778 105,434 146,390
- -------------------------------------------------------------------------------------------------------------------
NET INCREASE IN NET ASSETS FROM INVESTMENT OPERATIONS $ 9,565,475 $ 83,155 $146,495
===================================================================================================================
</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 DISTRIBUTIONS
NET ASSET VALUE, NET INVESTMENT UNREALIZED FROM DISTRIBUTIONS FROM
BEGINNING INCOME GAIN ON NET INVESTMENT NET REALIZED GAIN
OF PERIOD (LOSS) INVESTMENTS INCOME ON INVESTMENTS
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
ROYCE TOTAL RETURN FUND (a)
1998 $7.52 $0.15 $0.20 $(0.15) $(0.16)
1997 6.29 0.11 1.38 (0.11) (0.15)
1996 5.76 0.14 1.28 (0.16) (0.73)
1995 5.12 0.13 1.24 (0.13) (0.60)
1994 5.00 0.02 0.24 (0.02) (0.12)
ROYCE LOW-PRICED STOCK FUND (b)
1998 $6.82 $(0.01) $0.17 $ -- $(0.03)
1997 6.30 (0.03) 1.26 -- (0.71)
1996 5.62 (0.03) 1.31 -- (0.60)
1995 5.07 -- 1.14 -- (0.59)
1994 5.01 (0.03) 0.18 -- (0.09)
ROYCE FINANCIAL SERVICES FUND (c)
1998 $6.21 $ -- $0.48 $ -- $(0.59)
1997 6.03 -- 1.16 (0.02) (0.96)
1996 5.68 0.01 0.81 -- (0.47)
1995 5.06 -- 1.07 -- (0.45)
1994 5.00 -- 0.06 -- --
<CAPTION>
NET ASSET RATIO OF NET
VALUE, NET ASSETS, RATIO OF EXPENSES INVESTMENT PORTFOLIO
END TOTAL END OF PERIOD TO AVERAGE INCOME (LOSS) TO TURNOVER
OF PERIOD RETURN (IN THOUSANDS) NET ASSETS AVERAGE NET ASSETS RATE
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
ROYCE TOTAL RETURN FUND (a)
$7.56 4.8% $244,989 1.25% 2.75% 66%
7.52 23.7% 120,446 1.25% 3.15% 26%
6.29 25.5% 6,234 1.25% 2.50% 111%
5.76 26.9% 2,548 1.67% 2.42% 68%
5.12 5.2% 1,656 1.96% 0.49% 88%
ROYCE LOW-PRICED STOCK FUND (b)
$6.95 2.4% $ 21,174 1.49% (0.11)% 111%
6.82 19.5% 18,096 1.49% (0.47)% 99%
6.30 22.8% 15,905 1.88% (0.67)% 137%
5.62 22.5% 4,215 1.97% (1.11)% 114%
5.07 3.0% 1,880 1.89% (1.11)% 95%
ROYCE FINANCIAL SERVICES FUND (c)
$6.10 8.0% $ 2,188 1.49% 0.00% 62%
6.21 19.4% 2,396 1.49% (0.01)% 66%
6.03 14.6% 1,948 1.56% 0.17% 81%
5.68 21.2% 1,627 1.97% (0.58)% 106%
5.06 1.2% 514 1.78% * 0.00% * 0%
</TABLE>
(a) Expense ratios are shown after fee waivers by the investment adviser and
distributor. For the periods ended December 31, 1998, 1997, 1996, 1995 and
1994, the expense ratios before the waivers would have been 1.35%, 1.67%,
2.23%, 2.38% and 3.21%, respectively.
(b) Expense ratios are shown after fee waivers by the investment adviser and
distributor. For the periods ended December 31, 1998, 1997, 1996, 1995 and
1994, the expense ratios before the waivers would have been 2.31%, 2.38%,
2.59%, 3.47% and 3.63%, respectively.
(c) Expense ratios are shown after fee waivers by the investment adviser and
distributor. For the periods ended December 31, 1998, 1997, 1996, 1995 and
1994, the expense ratios before the waivers would have been 3.20%, 3.04%,
3.31%, 3.72% and 3.69%, respectively. The Fund commenced operations on
December 15, 1994.
* Annualized.
THE ROYCE FUNDS ANNUAL REPORT 1998 25
<PAGE>
NOTES TO FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Summary of Significant Accounting Policies:
Royce Total Return Fund, Royce Low-Priced Stock Fund and Royce Financial
Services Fund (the "Fund" or "Funds") are three series of The Royce Fund (the
"Trust"), a diversified open-end management investment company organized as a
Delaware business trust. Royce Total Return Fund and Royce Low-Priced Stock
Fund commenced operations on December 15, 1993. Royce Financial Services Fund
commenced operations on December 15, 1994 as Royce Global Services Fund and
changed its name, investment objective and policies on November 25, 1997 to
concentrate its investments in the financial services industry.
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 the Fund's operations, while expenses
applicable to one or more series of the Trust are allocated in an equitable
manner. Allocated personnel costs of employees of The Royce Funds are included
in administrative and office facilities expenses.
Taxes:
As qualified regulated investment companies under Subchapter M of the
Internal Revenue Code, the Funds are not subject to income taxes to the extent
that each Fund distributes substantially all of its taxable income for its
fiscal year. The Schedules of Investments include information regarding income
taxes under the caption "Income Tax Information".
Distributions:
Any dividend and capital gain distributions are recorded on the ex-dividend
date and paid annually in December. These distributions are determined in
accordance with income tax regulations 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.
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%, 1.5% and 1.5% of
the average net assets of Royce Total Return Fund, Royce Low-Priced Stock Fund
and Royce Financial Services Fund, respectively. The Investment Adviser had
voluntarily committed to waive its fees to the extent necessary to maintain the
ratio of expenses to average net assets at or below 1.25%, 1.49% and 1.49% of
the average net assets of Royce Total Return Fund, Royce Low-Priced Stock Fund
and Royce Financial Services Fund, respectively for the year ended December 31,
1998. For the year ended December 31, 1998, Royce Total Return Fund, Royce
Low-Priced Stock Fund and Royce Financial Services Fund recorded advisory fees
of $1,510,125 (net of voluntary waivers of $173,838), $192,516 (net of
voluntary waivers of $119,294) and $1,029 (net of voluntary waivers of
$34,961), respectively.
26 THE ROYCE FUNDS ANNUAL REPORT 1998
<PAGE>
NOTES TO FINANCIAL STATEMENTS (continued)
- --------------------------------------------------------------------------------
Royce Fund Services, Inc. ("RFS"), the distributor of the Trust's shares,
is an affiliate of Royce. RFS voluntarily waived distribution fees for Royce
Low-Priced Stock Fund and Royce Financial Services Fund of $51,968 and $5,998,
respectively, for the year ended December 31, 1998. The 12b-1 distribution plan
provides for maximum fees at an annual rate of .25% of the average net assets
of each of these funds. Effective December 31, 1997, the 12b-1 distribution
plan for Royce Total Return Fund was terminated.
Purchases and Sales of Investment Securities:
For the year ended December 31, 1998, the cost of purchases and the
proceedsfrom sales of investment securities, other than short-term securities,
were as follows:
<TABLE>
<CAPTION>
========================================================================================
Royce Royce Royce
Total Return Fund Low-Priced Stock Fund Financial Services Fund
----------------- --------------------- -----------------------
<S> <C> <C> <C>
Purchases $208,412,692 $23,644,168 $1,148,661
- ----------------------------------------------------------------------------------------
Sales $102,799,672 $20,068,681 $1,503,053
========================================================================================
</TABLE>
Transactions in Shares of Affiliated Companies:
An "Affiliated Company", as defined in the Investment Company Act of 1940,
is a company in which a Fund owns at least 5% of the company's outstanding
voting securities. Royce Total Return Fund effected the following transactions
in shares of such companies for the year ended December 31, 1998.
<TABLE>
<CAPTION>
=============================================================================================
Purchases Sales
--------- -----
Affiliated Realized Dividend
Company Shares Cost Shares Cost Gain/Loss Income
------- ------ ---- ------ ---- --------- ------
<S> <C> <C> <C> <C> <C> <C>
Paul Mueller Company -- -- 1,300 $53,950 $1,574 $144,360
=============================================================================================
</TABLE>
Merger Information:
On June 17, 1997, Royce Total Return Fund acquired all of the assets and
assumed all of the liabilities of Royce Equity Income Fund. Based on the
opinion of Fund counsel, the acquisition, which was approved by the
shareholders of Royce Equity Income Fund on May 28, 1997, qualified as a
tax-free reorganization for Federal income tax purposes with no gain or loss
recognized to the Funds or their shareholders. Royce Equity Income Fund's net
assets, including $5,201,557 of unrealized appreciation, were combined with
Royce Total Return Fund for total net assets after the acquisition of
$63,558,350. Costs associated with the acquisition were borne by the Investment
Adviser.
THE ROYCE FUNDS ANNUAL REPORT 1998 27
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
- --------------------------------------------------------------------------------
To the Board of Trustees of The Royce Fund and the Shareholders of Royce Total
Return Fund, Royce Low-Priced Stock Fund and Royce Financial Services 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 Total Return
Fund, Royce Low-Priced Stock Fund, and Royce Financial Services 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
28 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.
[Begin Sidebar]
Furby-mania had taught
me an important lesson
about why we don't buy
stocks the way consumers
buy Furbies. If anything,
we stick to Barbies, foot-
balls and board games,
the predictable but steady
items that may never be
this (or any) year's "gotta
have it," but never really
go out of style, either.
[End Sidebar]
<PAGE>
THE
ROYCE
FUNDS
ONE OF THE INDUSTRY'S MOST EXPERIENCED AND
HIGHLY RESPECTED SMALL-COMPANY VALUE MANAGERS
Charles M. Royce, who has been our primary portfolio manager since 1973, enjoys
one of the longest tenures of any active mutual fund manager. Today, with $2.8
billion in total assets under management, Royce & Associates remains an
independent firm committed to the same principles that have served us well for
more than 25 years.
MULTIPLE FUNDS, COMMON FOCUS
Over the years, we have chosen to concentrate on small-company value investing.
Chuck Royce and his team provide investors with a range of funds that take full
advantage of the large and diverse small-cap sector. Our goal is to offer both
individual and institutional investors the best available small-cap value
portfolios by participating in the small-cap market's total returns with
below-average volatility.
REALISTIC EXPECTATIONS AND CONSISTENT DISCIPLINE
Royce Premier Fund, Royce Total Return Fund, Pennsylvania Mutual Fund and Royce
GiftShares Fund have been among the "lowest risk" small-cap equity funds
available. We cultivated our approach by paying close attention to risk and by
always maintaining the same discipline, regardless of market movements and
trends.
CO-OWNERSHIP OF FUNDS
As part of this commitment, it is important that our employees and shareholders
share a common financial goal; our officers, employees and their affiliates
currently have approximately $35 million invested in The Royce Funds.
THE ROYCE FUNDS
1414 AVENUE OF THE AMERICAS, NEW YORK NY 10019
GENERAL INFORMATION 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)
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.
