1999 Semi-Annual Report
Value Investing In Small Companies
For More Than 25 Years
THE
ROYCE
FUNDS
ROYCE SPECIAL EQUITY FUND
www.roycefunds.com
<PAGE>
SEMI-ANNUAL REPORT REFERENCE GUIDE
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LETTER TO SHAREHOLDERS 2
An Overview of Royce Special Equity Fund Year-to-Date Through
June 30, 1999
PORTFOLIO DIAGNOSTICS 4
An X-Ray of the Portfolio
SCHEDULE OF INVESTMENTS AND OTHER FINANCIAL STATEMENTS 5
For more than 25 years, our value approach has focused on evaluating a
company's current worth - what we believe an enterprise would sell for in a
private transaction between rational and well-informed parties. This
requires a thorough analysis of the financial and operating dynamics of a
business, as though we were purchasing the entire company. The price we will
pay for a security must be significantly lower than our appraisal of its
current worth.
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LETTER TO SHAREHOLDERS
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Dear Fellow Shareholders:
Small-cap stocks rebounded in the second quarter with performance that
was as impressive as the first quarter's was dismal. Strong second-quarter
performance by the Fund's small-cap benchmark, the Russell 2000, enabled it
to outperform the large-cap oriented S&P 500 (+15.6% versus +7.1%) for the
first time since 1997's third quarter. The Russell 2000 also benefited from
strong performance by relatively larger issues, including many of its
technology (Internet) holdings. Although Royce Special Equity Fund's (RSE)
selections tend to be smaller, less glamorous and more conservatively managed
than its benchmark's, this recent small-cap outperformance is welcome news.
At times, especially during 1999's difficult first quarter, it seemed as
if owning companies with positive earnings was a liability; many of these
companies seemed as incapable of attracting investors' attention as they were
successful in generating profits. Even in light of the second-quarter
turnaround, we would argue that on both an absolute and relative valuation
basis, small-cap stocks remain statistically attractive, particularly the
ones that we own.
Since Royce Special Equity Fund's inception on May 1, 1998, small-cap
performance has been volatile, with the sector peaking on April 21, 1998 just
prior to our launch. While the Fund initially managed to more than hold its
own (in a relative sense), it has subsequently lagged in the more recent
dynamic period. From its inception through the market bottom on October 8,
1998, the Fund was down 18.6% versus a decline of 35.7% for the Russell 2000.
From October 8 through June 30, 1999, the Fund was up 16.7% versus 48.9% for
its benchmark, with the net result that the Fund trailed its benchmark by
less than one percent since its inception. Year-to-date through June 30,
1999, the Fund was up 1.9%. Although we are disappointed with performance,
we are excited about the portfolio, especially its valuation relative to the
Russell 2000.
We believe that the securities in the Russell 2000 as a whole are more
attractively valued than those of the S&P 500 index. Furthermore, our
portfolio is less expensive than the Russell 2000 across many valuation
measures (see the attached Portfolio X-Ray for more details). However, we
think that there is a much more important point - RSE's portfolio is, in our
opinion, attractively valued on an absolute basis. This factor gives us
confidence in the Fund's ability to potentially provide solid long-term
returns.
What is the basis for the portfolio's absolute valuation? Several
factors are relevant, but most important to us is the Enterprise
Value/Earnings before Interest and Taxes ratio (EV/EBIT) shown in the X-Ray.
Considering how timely the EV/EBIT is right now, we have chosen to describe
it in more detail in this report. EV/EBIT is one of the more commonly used
ratios in the merger and acquisition area, and in essence it states the price
one pays for earnings. In that sense, it resembles the price-to-earnings
ratio, although it is a more sophisticated measure.
To determine EV/EBIT, we take the portfolio companies' market
capitalization (number of shares multiplied by price), add long-term debt,
preferred stock and minority interest, then subtract the companies' total
cash. The resulting enterprise value, or price, is then divided by earnings
before interest and taxes (all figures are portfolio weighted). We use the
current market price, while in corporate transactions (mergers and
acquisitions, leveraged buy-outs, etc.) the transaction price would be used.
The current X-Ray shows a portfolio-weighted EV/EBIT of 6.1 for the
Fund's portfolio securities. If one inverts this ratio to EBIT/EV, the
figure is 16.4%. In other words, if one bought our entire portfolio at the
current market price, one would earn 16.4% before interest and taxes (with no
credit for depreciation and amortization). Not bad in an environment where
long-term U.S. Treasuries yield a little more than 6%.
<PAGE>
At current market
price, there is a huge spread between the return one would earn and the cost
one would incur in such a hypothetical transaction.
There has been a revival in merger and acquisitions as well as leverage
buy-out activity in the small-cap sector of late. We believe that EV/EBIT
analysis is a large part of what drives these activities, and so far only a
few of our holdings have directly benefited from this. There had been a
perception in the market place that the type of stocks that we own were
uninteresting, however the reality is that, from a real economic perspective,
we think that they are quite attractive.
We remain concerned about what we believe is an overvalued large-cap
market. One observer pointed out recently that more than 79% of the massive
appreciation from the August 1982 low through July 16, 1999 has been due to
expanding P/E ratios, compared to less than 22% from rising earnings (Source:
The DeVoe Report). The New York Stock Exchange alone has a market value
greater than the nation's GDP. So while the overall U.S. economy remains
strong - aided to some degree by the wealth effect - there can be little
question that changes in our stock market will have a greater impact on the
real economy than ever before.
While we certainly cannot guarantee what will happen in the future, we
draw a great deal of encouragement from the renewed interest in small-caps.
Further, as we look at the Fund's portfolio as measured by the X-Ray, we
think that our demanding, intensive value approach is working well in
distinguishing perception from reality - finding what we believe are
inexpensive, well-run, financially solid companies that typically aren't very
glamorous. While some may view RSE's portfolio as contrary to accepted
market wisdom, it is anything but that with respect to economic and business
wisdom. We believe that we are well-positioned in the current environment.
Sincerely,
/s/ Charlie Dreifus
Charlie Dreifus
Senior Portfolio Manager
August 6, 1999
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 thoughts concerning future prospects for small-company stocks are solely
those of Charlie Dreifus, and there can be no assurance with respect to
future market movements. This report must be preceded or accompanied by a
current prospectus. Royce Special Equity Fund invests in small- and/or micro-
cap companies that may involve considerably more risk than investments in
securities of larger-cap companies (see "Primary Risks" in the prospectus).
Please read the prospectus carefully before investing or sending money.
The Russell 2000 and S&P 500 are unmanaged indices of domestic common stocks.
Distributor: Royce Fund Services, Inc.
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Portfolio Diagnostics
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Royce Special Equity Fund X-RAY
As of June 30, 1999
Royce Special Russell
Equity Fund* 2000**
Second Quarter Total Return 12.1% 15.6%
January - June, 1999 Total Return 1.9% 9.3%
Total Return From Inception Date of
5/1/98 (not annualized) -5.0% -4.2%
Net Assets $3.0 million N/A
Trailing 12 Months Price/Earnings 11.7x 23.2x
Enterprise Value/Earnings Before Interest and Taxes 6.1x 13.5x
Enterprise Value/Earnings Before Interest,
Taxes, Depreciation and Amortization 5.4x 10.5x
Price/Book 1.6x 3.3x
Yield 2.0% 1.4%
Return on Equity 13.1% 10.4%
Return on Assets 9.9% 4.5%
Total Assets Financed by Other Than Equity 26.5% 57.2%
Current Assets Less All Liabilities
as % of Market Price 38.2% -22.8%
Cash as % of Market Price 19.8% 11.9%
Average Market Capitalization $186 million $1,242 million
Source: Prudential Securities Inc. - Small-Cap Quantitative Research (except
for assets and performance figures)
* Portfolio Weighted
** Market Capitalization Weighted
Enterprise Value is calculated by adding a company's market capitalization,
long-term debt, preferred stock and minority interest, then subtracting cash.
Top 10 Positions % of Net Assets
- ------------------------------------
Garan 5.9%
TSI 5.4
Ampco-Pittsburgh 5.1
Lawson Products 5.0
Deb Shops 4.6
National Presto Industries 4.5
Superior Uniform Group 4.2
Met-Pro 4.2
Chromcraft Revington 4.1
Farmer Bros. 4.1
Top Portfolio Industries % of Net Assets
- --------------------------------------------
Home Furnishing/Appliances 14.9%
Apparel and Shoes 13.4
Industrial Distribution 11.0
Building Systems and Components 7.2
Retail Stores 6.7
Pumps, Valves and Bearings 5.5
Components and Systems 5.4
Food/Tobacco Processors 4.0
See the Schedule of Investments for a complete list of portfolio holdings.
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ROYCE SPECIAL EQUITY FUND
SCHEDULE OF INVESTMENTS June 30, 1999 (unaudited)
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COMMON STOCKS - 98.5%
SHARES VALUE
------ -----
Consumer Products- 35.0%
Apparel and Shoes- 13.4%
Barry (R.G.)* 12,000 $ 99,000
Garan 5,500 176,688
Superior Uniform Group 10,000 125,000
---------
400,688
---------
Home Furnishing/Appliances- 14.9%
Chromcraft Revington* 8,500 122,719
Flexsteel Industries 5,600 74,550
Lifetime Hoan 12,500 114,062
National Presto Industries 3,500 133,875
---------
445,206
---------
Sports and Recreation- 3.0%
Allen Organ Cl. B 2,500 91,562
---------
Other Consumer Products- 3.7%
Starrett (L. S.) Company Cl. A 4,100 110,188
---------
1,047,644
---------
Consumer Services- 9.0%
Restaurants/Lodgings- 2.3%
Sbarro* 2,500 67,656
---------
Retail Stores- 6.7%
Cato Cl. A 5,500 63,938
Deb Shops 6,900 137,137
---------
201,075
---------
268,731
---------
Financial Services- 3.9%
Information and Processing- 3.9%
Value Line 3,000 117,000
---------
Industrial Products- 21.8%
Building Systems and Components- 7.2%
Ampco-Pittsburgh 12,000 153,750
Preformed Line Products Company 1,000 18,625
Thor Industries 1,500 42,562
---------
214,937
---------
Industrial Components- 2.5%
Powell Industries* 8,000 74,000
---------
Pumps, Valves and Bearings- 5.5%
Gorman-Rupp Company 2,500 41,250
Met-Pro 10,000 125,000
---------
166,250
---------
SHARES VALUE
------ -----
Specialty Chemicals and Materials- 3.5%
Aceto 9,000 $ 103,500
---------
Other Industrial Products- 3.1%
Farr* 8,500 93,500
---------
652,187
---------
Industrial Services- 17.4%
Commercial Services- 2.4%
Wilmar Industries* 5,500 71,500
---------
Food/Tobacco Processors- 4.0%
Farmer Bros. 600 121,500
---------
Industrial Distribution- 11.0%
Lawson Products 6,000 151,125
NCH 1,500 74,250
TBC* 14,700 103,819
---------
329,194
---------
522,194
---------
Technology- 7.7%
Components and Systems- 5.4%
TSI 14,000 162,750
---------
Telecommunication- 2.3%
Communications Systems 5,500 68,063
---------
230,813
---------
Miscellaneous-3.7% 110,437
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TOTAL COMMON STOCKS
(Cost $2,975,301) 2,949,006
---------
TOTAL INVESTMENTS - 98.5%
(Cost $2,975,301) 2,949,006
CASH AND OTHER ASSETS
LESS LIABILITIES - 1.5% 44,815
---------
NET ASSETS - 100.0% $ 2,993,821
==============
* Non-income producing.
INCOME TAX INFORMATION: The cost of total investments for Federal income tax
purposes was $2,975,301. At June 30, 1999, net unrealized depreciation for
all securities was $26,295, consisting of aggregate gross unrealized
appreciation of $235,602 and aggregate gross unrealized depreciation of
$261,897.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
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ROYCE SPECIAL EQUITY FUND
STATEMENT OF ASSETS AND LIABILITIES AT JUNE 30, 1999 (unaudited)
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ASSETS:
Investments at value (identified cost $2,975,301) $ 2,949,006
Cash 60,782
Receivable for investments sold 5,486
Receivable for dividends and interest 2,282
Prepaid expenses and other assets 3,325
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Total Assets 3,020,881
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LIABILITIES:
Payable for investments purchased 20,034
Payable for investment advisory fee 634
Accrued expenses 6,392
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Total Liabilities 27,060
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Net Assets $ 2,993,821
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ANALYSIS OF NET ASSETS:
Undistributed net investment income $15,236
Accumulated net realized loss on investments (109,269)
Net unrealized depreciation on investments (26,295)
Capital shares 316
Additional paid-in capital 3,113,833
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Net Assets $ 2,993,821
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SHARES OUTSTANDING:
(unlimited number of $.001 par value shares authorized) 315,700
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NET ASSET VALUE (Net Assets / Shares Outstanding):
(offering and redemption price* per share) 9.48
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* Shares redeemed within one year of purchase are subject to a 1% redemption
fee, payable to the Fund.
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STATEMENT OF CHANGES IN NET ASSETS
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<TABLE>
<CAPTION>
Six months ended
June 30, 1999 Period ended
INVESTMENT OPERATIONS: (unaudited) December 31, 1998 (a)
---------------- ------------------
<S> <C> <C>
Net investment income $ 14,610 $5,878
Net realized loss on investments (37,248) (72,021)
Net change in unrealized depreciation on investments 83,709 (110,004)
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Net increase (decrease) in net assets from investment operations 61,071 (176,147)
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DISTRIBUTIONS:
Net investment income -- (5,252)
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Total distributions -- (5,252)
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CAPITAL SHARE TRANSACTIONS:
Value of shares sold 39,750 3,256,162
Distributions reinvested -- 4,996
Value of shares redeemed (186,723) (36)
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Net increase (decrease) in net assets from capital share transactions (146,973) 3,261,122
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NET INCREASE (DECREASE) IN NET ASSETS (85,902) 3,079,723
NET ASSETS:
Beginning of period 3,079,723 --
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End of period (includes undistributed net investment income of
$15,236 in 1999 and $626 in 1998) $ 2,993,821 $ 3,079,723
==================================================================================================================
CAPITAL SHARE TRANSACTIONS (in shares):
Shares sold 4,591 330,671
Shares issued for reinvestment of distributions -- 548
Shares redeemed (20,106) (4)
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Net increase (decrease) in shares outstanding (15,515) 331,215
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</TABLE>
(a) The Fund commenced operations on May 1, 1998.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
<PAGE>
ROYCE SPECIAL EQUITY FUND
STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 1999 (unaudited)
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INVESTMENT INCOME:
Income:
Dividends $ 34,519
Interest 1,896
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Total Income 36,415
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Expenses:
Investment advisory fees 14,634
Registration 5,165
Custodian 5,155
Shareholder servicing 3,911
Audit 2,250
Shareholder reports 809
Administrative and office facilities 729
Trustees' fees 229
Legal 75
Other expenses 1,255
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Total Expenses 34,212
Fees Waived by Investment Adviser (12,407)
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Net Expenses 21,805
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Net Investment Income 14,610
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REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Net realized loss on investments (37,248)
Net change in unrealized depreciation on investments 83,709
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Net realized and unrealized gain on investments 46,461
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NET INCREASE IN NET ASSETS FROM INVESTMENT OPERATIONS $ 61,071
===============================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.
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FINANCIAL HIGHLIGHTS
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This table is presented to show selected data for a share outstanding
throughout each period, and to assist shareholders in evaluating the Fund's
performance for the periods presented.
===============================================================================
<TABLE>
<CAPTION>
Six months ended
June 30, 1999 Period ended
(Unaudited) December 31, 1998 (a)
----------- ---------------------
<S> <C> <C>
Net Asset Value, Beginning of Period $ 9.30 $ 10.00
Investment Operations:
Net investment income 0.05 0.02
Net realized and unrealized gain (loss) on investments 0.13 (0.70)
- ----------------------------------------------------------------------------------------
Total from investment operations 0.18 (0.68)
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Distributions:
Net investment income -- (0.02)
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Total distributions -- (0.02)
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Net Asset Value, End of Period $ 9.48 $ 9.30
========================================================================================
Total Return: 1.9% -6.8%
Ratios Based on Average Net Assets:
Total expenses (b) 1.49* 1.49%*
Net investment income 1.00%* 0.33%*
Supplemental Data:
Net Assets, End of Period (in thousands) $ 2,994 $ 3,080
Portfolio Turnover Rate 31% 13%
</TABLE>
(a) The Fund commenced operations on May 1, 1998.
(b) Expense ratios are shown after fee waivers by the investment
adviser. For the periods ended June 30, 1999 and December 31, 1998,
the expense ratios before the waivers would have been 2.34% and 2.20%,
respectively.
* Annualized.
<PAGE>
Royce Special Equity Fund
Notes to Financial Statements (unaudited)
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Summary of Significant Accounting Policies:
Royce Special Equity Fund (the "Fund") is a series of The Royce Fund
(the "Trust"), a diversified open-end management investment company
organized as a Delaware business trust. The Fund commenced operations on May
1, 1998.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of income and expenses during the
reporting period. Actual results could differ from those estimates.
Valuation of investments:
Securities listed on an exchange or on the Nasdaq National Market System
are valued on the basis of the last reported sale prior to the time the
valuation is made or, if no sale is reported for such day, at their bid price
for exchange-listed securities and at the average of their bid and asked
prices for Nasdaq securities. Quotations are taken from the market where the
security is primarily traded. Other over-the-counter securities for which
market quotations are readily available are valued at their bid price.
Securities for which market quotations are not readily available are valued
at their fair value by the Board of Trustees. Bonds and other fixed income
securities may be valued by reference to other securities with comparable
ratings, interest rates and maturities, using established independent pricing
services.
Investment transactions and related investment income:
Investment transactions are accounted for on the trade date. Dividend
income is recorded on the ex-dividend date and any non-cash dividend income
is recorded at the fair market value of the securities received. Interest
income is recorded on the accrual basis. Realized gains and losses from
investment transactions are determined on the basis of identified cost for
book and tax purposes.
Expenses:
The Fund incurs direct and indirect expenses. Expenses directly
attributable to the Fund are charged to the Fund's operations, while expenses
applicable to more than one series of the Trust are allocated in an equitable
manner. Allocated personnel and occupancy costs related to The Royce Funds
are included in administrative and office facilities expenses.
Taxes:
As a qualified regulated investment company under Subchapter M of the
Internal Revenue Code, the Fund is not subject to income taxes to the extent
that it distributes substantially all of its taxable income for its fiscal
year. The Schedule of Investments includes information regarding income
taxes under the caption "Income Tax Information".
<PAGE>
Royce Special Equity Fund
Notes to Financial Statements (unaudited) (continued)
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Distributions:
Any dividend and capital gain distributions are recorded on the ex-
dividend date and paid annually in December. These distributions are
determined in accordance with income tax regulations that may differ from
generally accepted accounting principles. Permanent book and tax basis
differences relating to shareholder distributions will result in
reclassifications within the capital accounts. Undistributed net investment
income may include temporary book and tax basis differences, which will
reverse in a subsequent period. Any taxable income or gain remaining
undistributed at fiscal year end is distributed in the following year.
Repurchase agreements:
The Fund enters into repurchase agreements with respect to portfolio
securities solely with State Street Bank and Trust Company ("SSB&T"), the
custodian of the Fund's assets. The 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 the Fund to dispose of its underlying
securities.
Investment Adviser:
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% of
the average net assets of the Fund. Royce has contractually agreed to waive
its fees and reimburse expenses to the extent necessary to maintain a net
annual operating expense ratio of expenses to average net assets at or below
1.49% through December 31, 1999. For the period ended June 30, 1999, the Fund
recorded advisory fees of $2,227 (net of waivers of $12,407).
Purchases and Sales of Investment Securities:
For the period ended June 30, 1999, the cost of purchases and the
proceeds from sales of investment securities, other than short-term
securities, were $874,025 and $982,676, respectively.
