Small-cap growth stocks rose strongly in the third quarter, extending this year's impressive rally, despite moderating corporate fundamentals. In addition to growth stocks, lower-quality companies, higher-beta stocks, and companies without earnings have been some of this year's best performers. During the quarter, the market overcame an increase in long-term interest rates, which was driven by expectations that the Federal Reserve would begin reducing its asset purchases after its September 17-18 monetary policy meeting. The central bank surprised many investors by deciding to delay the taper until it receives "more evidence" that the economic recovery "will be sustained." Shares sagged somewhat as the quarter ended amid concerns about the underlying strength of the economy and the growing probability of a federal government shutdown and debt ceiling showdown in October.
The Diversified Small-Cap Growth Fund returned 13.52% in the quarter compared with 12.76% for the MSCI US Small Cap Growth Index and 12.86% for the Lipper Small-Cap Growth Funds Index. For the 12 months ended September 30, 2013, the fund returned 33.76% versus 35.06% for the MSCI US Small Cap Growth Index and 30.91% for the Lipper Small-Cap Growth Funds Index. The fund's average annual total returns were 33.76%, 16.23%, and 10.83% for the 1-, 5-, and 10-year periods, respectively, as of September 30, 2013. The fund's expense ratio was 0.91% as of its fiscal year ended December 31, 2012.
For up-to-date standardized total returns, including the most recent month-end performance, please click on the Performance tab, above.
Current performance may be lower or higher than the quoted past performance, which cannot guarantee future results.
Share price, principal value, and return will vary and you may have a gain or loss when you sell your shares.
The Diversified Small-Cap Growth Fund charges a 1%
redemption fee on shares held 90 days or less.
The performance information shown does not reflect the deduction of the redemption fee;
if it did, the performance would be lower.
Fund performance versus the MSCI benchmark was helped by good stock selection in the health care and financials sectors. However, our investments in the energy and materials sectors underperformed their benchmark peers, which reduced our performance advantage. The fund's sector allocations, which are usually similar to those of the benchmark, had little impact on relative performance. At the end of the quarter, we had slight underweights to information technology and industrials and business services and a slight overweight in health care. While stock selection is based on a quantitative model, we also take into consideration T. Rowe Price's fundamental equity research and, given the unusual economic environment, macroeconomic conditions. Our strategy of having neutral sector weights versus our benchmark helps us avoid risks due to large moves in any one sector.
Our analysis suggests that small-caps are expensive relative to large-cap stocks, which would suggest that large-caps may have a relative performance advantage at some point. However, in a slow-growth economy in which central banks are providing a high degree of liquidity, small-caps, especially growth stocks, could continue outperforming. We believe the direction of the markets in the next few weeks will be influenced by expectations of future Fed actions. The breakdown in the budget process in Washington and the government shutdown and debt ceiling showdown will also have an impact on the economy and the Fed's decisions regarding stimulus.