1999 Annual Report
Value Investing In Small Companies
For More Than 25 Years
The
Royce
Funds
Royce Special Equity Fund
www.roycefunds.com
<PAGE>
Annual Report Reference Guide
- -------------------------------------------------------------------------------
Letter to Shareholders 2
An Overview of Royce Special Equity Fund For 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.
<PAGE>
Letter to Shareholders
- -------------------------------------------------------------------------------
Dear Fellow Shareholder,
Royce Special Equity Fund (RSE) endured disappointing performance in
1999. The Fund was down 9.6% for the full year, well behind its small-cap
benchmark, the Russell 2000, which was up 21.3%. 1999 was truly an odd year
for small-cap value investing. Many companies, which in our view offered
both high quality and low risk, provided non-existent or even negative
returns. While we believe that RSE contained some excellent companies last
year - with solid balance sheets and high returns on assets - these qualities
in general did not translate into strong performance.
To get an idea of how strange 1999 was from a small-cap value investor's
perspective, consider the following: Approximately 93% of the Russell 2000's
gain for the year was attributable to technology stocks, a sector that as of
December 31, 1999 was the largest in the index. In addition, measuring the
index's 1999 returns by P/E quintiles revealed that the lowest P/E quintile
was down 10.6%, while the highest quintile was up 68.0%. Companies in the
Russell 2000 with no earnings, and thus not in the highest P/E quintile,
performed even better, posting an 85.3% return for the full year. From the
October 1998 small-cap market trough, small-cap companies in the technology
sector and those with higher market caps excelled. Not only was bigger
better in 1999, within small-cap, riskier was, too. Growth stocks, typically
those with high price/earnings and price/book ratios and high earnings growth
rates, handily trounced value stocks, typically those with low P/E and P/B
ratios and cyclical growth rates. It was indeed a narrow market (Source:
Prudential Securities).
In spite of the frustrating year, we remain enthusiastic about the risk-
averse small-cap value work that we have been doing for three decades. The
laws of gravity and economics are still very much with us, and businesses
must earn a return greater than their financing costs. The Fund's portfolio,
as demonstrated in the enterprise value calculations, remains in our view
very attractively priced, with many securities still waiting for an
opportunity to shine.
As I have done since joining Royce & Associates, I offer an explanation
of a term in the Portfolio X-Ray. "Total Assets Financed by Other than
Equity" is our gauge of leverage which
<PAGE>
measures the portion of total assets
that is financed by anything other than equity. It bespeaks an extremely
conservative approach, because, in addition to long-term debt, it includes
current liabilities and deferred taxes. The lower the number, the less
leverage. Why is it important? A low number suggests that there are
potential opportunities for increasing shareholder wealth, for example,
through the use of excess cash or by borrowing funds at attractive rates.
We appreciate your patience during what we believe is an anomaly in the
performance of our portfolio selections. We hope that you believe, as we do,
that a full market cycle - one that includes both up and down phases - must
occur in order to evaluate the effectiveness of RSE's conservative small-cap
value approach.
Sincerely,
/s/ Charlie Dreifus
Charlie Dreifus
Senior Portfolio Manager
February 8, 2000
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.
<PAGE>
Portfolio X-RAY as of December 31, 1999
Royce Special Russell
Equity Fund* 2000**
- -------------------------------------------------------------------------------
Fourth Quarter Total Return -6.1% 18.4%
July - December, 1999 Total Return -11.3% 11.0%
Average Annual Total Return From
Inception Date of 5/1/98 -9.8% 3.7%
Net Assets $2.6 million N/A
Trailing 12 Months Price/Earnings 9.7x 23.9x
Enterprise Value/Earnings
Before Interest and Taxes 5.9x 14.6x
Enterprise Value/Earnings Before Interest,
Taxes, Depreciation and Amortization 4.4x 11.3x
Price/Book 1.2x 3.5x
Yield 2.8% 1.4%
Return on Equity 12.2% 9.3%
Return on Assets 8.7% 4.5%
Total Assets Financed by Other Than Equity 28.4% 54.2%
Current Assets Less All Liabilities
as % of Market Price 40.7% -18.7%
Cash as % of Market Price 18.3% 11.3%
Average Market Capitalization $157 million $1,138 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
- ----------------------------------------
Lawson Products 5.8%
Value Line 5.6
National Presto Industries 5.5
Garan 5.0
Cato Cl. A 4.9
Starrett (L.S.) Company Cl. A 4.8
Ampco-Pittsburgh 4.7
Chromcraft Revington 4.5
Farmer Bros. 4.3
Aceto 4.3
Top Portfolio Industries % of Net Assets
- ------------------------------------------------
Home Furnishing/Appliances 19.5%
Industrial Distribution 13.0
Specialty Chemicals and Materials 6.6
Apparel and Shoes 6.2
Other Consumer Products 6.1
Retail Stores 6.0
Information and Processing 5.6
Building Systems and Components 5.4
Commercial Services 5.3
Royce Special Equity Fund vs. Russell 2000
Growth of a $10,000 Initial Investment,
From Inception (5/01/98) Through 12/31/99
[LINE GRAPH]
Royce Special Russell
Equity Fund 2000
------------- -------
May-1998 10000.00 10000.00
Jun-1998 9900.00 9440.00
Jul-1998 9540.00 8676.00
Aug-1998 8740.00 6991.00
Sep-1998 8780.00 7539.00
Oct-1998 8830.00 7846.00
Nov-1998 9140.00 8257.00
Dec-1998 9316.00 8769.00
Jan-1999 9046.00 8885.00
Feb-1999 8715.00 8165.00
Mar-1999 8475.00 8293.00
Apr-1999 9086.00 9036.00
May-1999 9356.00 9168.00
Jun-1999 9497.00 9582.00
Jul-1999 9537.00 9320.00
Aug-1999 9146.00 8975.00
Sep-1999 8966.00 8977.00
Oct-1999 8585.00 9013.00
Nov-1999 8665.00 9551.00
Dec-1999 8419.00 10632.00
[END LINE GRAPH]
<PAGE>
ROYCE SPECIAL EQUITY FUND
SCHEDULE OF INVESTMENTS December 31, 1999
- -------------------------------------------------------------------------------
COMMON STOCKS - 93.8%
SHARES VALUE
------ -----
Consumer Products- 34.8%
Apparel and Shoes- 6.2%
Garan 4,500 $128,813
Oxford Industries 1,500 29,719
------------
158,532
------------
Home Furnishing/Appliances- 19.5%
Chromcraft Revington* 11,000 115,500
Flexsteel Industries 7,000 93,625
Lifetime Hoan 14,000 73,500
National Presto Industries 4,000 142,000
Pulaski Furniture 5,000 77,500
------------
502,125
------------
Sports and Recreation- 3.0%
Allen Organ Cl. B 2,000 76,000
------------
Other Consumer Products- 6.1%
Boston Acoustics 2,500 34,844
Starrett (L. S.) Company Cl. A 5,500 123,406
------------
158,250
-----------
- -
894,907
------------
Consumer Services- 8.6%
Restaurants/Lodgings- 2.6%
Frisch's Restaurants 7,500 66,094
------------
Retail Stores- 6.0%
Cato Cl. A 10,000 126,250
Deb Shops 1,500 27,750
------------
154,000
------------
220,094
------------
Financial Services- 5.6%
Information and Processing- 5.6%
Value Line 4,000 144,000
------------
Industrial Products- 22.2%
Building Systems and Components- 5.4%
Ampco-Pittsburgh 12,000 121,500
Preformed Line
Products Company 1,000 16,500
------------
138,000
------------
Construction Materials- 0.3%
Friedman Industries 2,500 8,437
------------
SHARES VALUE
------ -----
Industrial Products (continued)
Industrial Components- 2.1%
Powell Industries* 8,000 $55,000
------------
Pumps, Valves and Bearings- 4.9%
Gorman-Rupp Company 3,500 61,250
Met-Pro 4,500 45,000
Tech/Ops Sevcon 2,000 20,000
------------
126,250
------------
Specialty Chemicals and Materials- 6.6%
Aceto 10,000 110,000
Hawkins Chemical 6,800 59,075
------------
169,075
------------
Other Industrial Products- 2.9%
Farr* 7,500 73,125
------------
569,887
------------
Industrial Services- 22.6%
Commercial Services- 5.3%
Superior Uniform Group 11,000 99,000
Wilmar Industries* 2,100 36,487
------------
135,487
------------
Food/Tobacco Processors- 4.3%
Farmer Bros. 700 111,300
------------
Industrial Distribution- 13.0%
Lawson Products 6,400 148,000
NCH 2,000 89,125
TBC* 15,500 96,875
------------
334,000
------------
580,787
------------
TOTAL COMMON STOCKS
(Cost $2,868,023) 2,409,675
------------
TOTAL INVESTMENTS - 93.8%
(Cost $2,868,023) 2,409,675
CASH AND OTHER ASSETS
LESS LIABILITIES - 6.2% 158,061
------------
NET ASSETS - 100.0% $2,567,736
=============
* Non-income producing.
INCOME TAX INFORMATION: The cost of total investments for Federal income tax
purposes was $2,868,023. At December 31, 1999, net unrealized depreciation
for all securities was $458,348, consisting of aggregate gross unrealized
appreciation of $61,707 and aggregate gross unrealized depreciation of
$520,055.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS
<PAGE>
ROYCE SPECIAL EQUITY FUND
STATEMENT OF ASSETS AND LIABILITIES December 31, 1999
- -------------------------------------------------------------------------------
ASSETS:
Investments at value (identified cost $2,868,023) $2,409,675
Cash 122,597
Receivable for investments sold 35,333
Receivable for dividends and interest 6,433
Prepaid expenses and other assets 2,886
- -------------------------------------------------------------------------------
Total Assets 2,576,924
- -------------------------------------------------------------------------------
LIABILITIES:
Payable for investments purchased 825
Payable for investment advisory fee 724
Accrued expenses 7,639
- -------------------------------------------------------------------------------
Total Liabilities 9,188
- -------------------------------------------------------------------------------
Net Assets $2,567,736
===============================================================================
ANALYSIS OF NET ASSETS:
Accumulated net realized loss on investments ($42,483)
Net unrealized depreciation on investments (458,348)
Capital shares 309
Additional paid-in capital 3,068,258
- -------------------------------------------------------------------------------
Net Assets $2,567,736
===============================================================================
SHARES OUTSTANDING:
(unlimited number of $.001 par value shares authorized) 308,901
===============================================================================
NET ASSET VALUE (Net Assets / Shares Outstanding):
(offering and redemption price* per share) $8.31
===============================================================================
* Shares redeemed within six months of purchase are subject to a 1%
redemption fee, payable to the Fund.
- -------------------------------------------------------------------------------
STATEMENT OF CHANGES IN NET ASSETS
===============================================================================
<TABLE>
<CAPTION>
Year ended Period ended
INVESTMENT OPERATIONS: December 31, 1999 December 31, 1998 (a)
----------------- -----------------
<S> <C> <C>
Net investment income $ 27,956 $ 5,878
Net realized gain (loss) on investments 29,538 (72,021)
Net change in unrealized depreciation on investments (348,344) (110,004)
- -------------------------------------------------------------------------------------------------
Net decrease in net assets from investment operations (290,850) (176,147)
- -------------------------------------------------------------------------------------------------
DISTRIBUTIONS:
Net investment income (29,988) (5,252)
- -------------------------------------------------------------------------------------------------
Total distributions (29,988) (5,252)
- -------------------------------------------------------------------------------------------------
CAPITAL SHARE TRANSACTIONS:
Value of shares sold 154,156 3,256,162
Distributions reinvested 29,487 4,996
Value of shares redeemed (374,792) (36)
- -------------------------------------------------------------------------------------------------
Net increase (decrease) in net assets from capital
share transactions (191,149) 3,261,122
- -------------------------------------------------------------------------------------------------
NET INCREASE (DECREASE) IN NET ASSETS (511,987) 3,079,723
NET ASSETS:
Beginning of period 3,079,723 --
- -------------------------------------------------------------------------------------------------
End of period (includes undistributed net investment
income of $626 in 1998) $ 2,567,736 $3,079,723
=================================================================================================
CAPITAL SHARE TRANSACTIONS (in shares):
Shares sold 16,417 330,671
Shares issued for reinvestment of distributions 3,536 548
Shares redeemed (42,267) (4)
- -------------------------------------------------------------------------------------------------
Net increase (decrease) in shares outstanding (22,314) 331,215
- -------------------------------------------------------------------------------------------------
</TABLE>
(a) The Fund commenced operations on May 1, 1998.
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL TATEMENTS.
<PAGE>
ROYCE SPECIAL EQUITY FUND
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1999
- -------------------------------------------------------------------------------
INVESTMENT INCOME:
Income:
Dividends $69,562
Interest 1,897
- -------------------------------------------------------------------------------
Total Income 71,459
- -------------------------------------------------------------------------------
Expenses:
Investment advisory fees 29,197
Custodian 10,818
Shareholder servicing 7,825
Audit 4,750
Registration 4,033
Shareholder reports 1,606
Administrative and office facilities 1,382
Trustees' fees 478
Legal 165
Other expenses 1,785
- -------------------------------------------------------------------------------
Total Expenses 62,039
Fees Waived by Investment Adviser (18,536)
- -------------------------------------------------------------------------------
Net Expenses 43,503
- -------------------------------------------------------------------------------
Net Investment Income 27,956
- -------------------------------------------------------------------------------
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS:
Net realized gain on investments 29,538
Net change in unrealized depreciation on investments (348,344)
- -------------------------------------------------------------------------------
Net realized and unrealized gain (loss) on investments (318,806)
- -------------------------------------------------------------------------------
NET DECREASE IN NET ASSETS FROM INVESTMENT OPERATIONS ($290,850)
===============================================================================
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 the period, and to assist shareholders in evaluating the Fund's
performance for the periods presented.
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Year ended Period ended
December 31, 1999 December 31, 1998 (a)
----------------- ---------------------
<S> <C> <C>
Net Asset Value, Beginning of Period $9.30 $10.00
Investment Operations:
Net investment income 0.09 0.02
Net realized and unrealized gain (loss) on investments (0.98) (0.70)
Total from investment operations (0.89) (0.68)
Distributions:
Net investment income (0.10) (0.02)
Total distributions (0.10) (0.02)
Net Asset Value, End of Period $8.31 $9.30
Total Return: -9.6% -6.8%
Ratios Based on Average Net Assets:
Total expenses (b) 1.49% 1.49% *
Net investment income 0.96% 0.33% *
Supplemental Data:
Net Assets, End of Period (in thousands) $2,568 $3,080
Portfolio Turnover Rate 57% 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 December 31, 1999 and 1998, the
expense ratios before the waivers would have been 2.12% and 2.20%,
respectively.
* Annualized.
<PAGE>
NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
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
the disclosure of contingent assets and liabilities at the date of the
financial statements, and the reported amounts of income and expenses during
the reporting period. Actual results could differ from those estimates.
Valuation of investments:
Securities listed on an exchange or on the Nasdaq National Market System
are valued on the basis of the last reported sale prior to the time the
valuation is made or, if no sale is reported for such day, at their bid price
for exchange-listed securities and at the average of their bid and asked
prices for Nasdaq securities. Quotations are taken from the market where the
security is primarily traded. Other over-the-counter securities for which
market quotations are readily available are valued at their bid price.
Securities for which market quotations are not readily available are valued
at their fair value under procedures established 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. The Fund has
adopted a deferred fee agreement that allows the Trustees to defer the
receipt of all or a portion of Trustees Fees payable on or after July 1,
1999. The deferred fees remain invested in certain Royce funds until
distribution in accordance with the agreement.
<PAGE>
NOTES TO FINANCIAL STATEMENTS (continued)
- -------------------------------------------------------------------------------
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". At December 31, 1999, the
Fund had capital loss carryforwards of $111 and $42,372, expiring in 2006 and
2007, respectively, which, subject to certain limitations, can be utilized to
offset future capital gains.
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
that are computed daily and payable monthly, at an annual rate of 1.0% of the
average net assets of the Fund. Royce contractually committed 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 year ended December 31, 1999, the Fund
recorded advisory fees of $10,661 (net of waivers of $18,536).
Purchases and Sales of Investment Securities:
For the year ended December 31, 1999, the cost of purchases and the
proceeds from sales of investment securities, other than short-term
securities, were $1,579,887 and $1,862,602, respectively.
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
- -------------------------------------------------------------------------------
To the Board of Trustees of The Royce Fund
and the Shareholders of Royce Special Equity Fund
In our opinion, the accompanying statement of assets and liabilities,
including the schedule of investments, and the related statement of
operations and of changes in net assets and the financial highlights present
fairly, in all material respects, the financial position of Royce Special
Equity Fund (one of the portfolios constituting The Royce Fund, hereafter
referred to as the "Fund") at December 31, 1999, the results of its
operations, the changes in its net assets and the financial highlights for
each of the periods indicated, in conformity with accounting principles
generally accepted in the United States. These financial statements and
financial highlights (hereafter referred to as "financial statements") are
the responsibility of the Fund's 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 auditing
standards generally accepted in the United States, which require that we plan
and perform the audit 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 securities at December 31, 1999 by correspondence with the
custodian and brokers, provide a reasonable basis for the opinion expressed
above.
PricewaterhouseCoopers LLP
Boston, Massachusetts
February 10, 2000
