How Investment Professionals Make Decisions
T. Rowe Price stock and bond analysts and portfolio managers seek to identify the best investment opportunities for clients—and to understand the range of risks those investments face. This rigorous process of evaluation and collaboration is at the core of the firm’s investment approach.
Earlier this year, a T. Rowe Price fixed income analyst spotted a potential investment opportunity in the bonds of a major U.S. automaker. Credit rating agencies had downgraded the company to below investment-grade status during the financial crisis that began in 2008. Despite steadily improving operations since then, the company’s bond rating had not been rewarded with a higher rating by any of the three major independent agencies. However, the T. Rowe Price analyst who covers automakers informed colleagues that he believed the company deserved a higher rating. He felt strongly that the rating agencies finally shared his view, and told colleagues that an upgrade of the bonds to investment-grade status would come soon. “He presented a convincing case to the team for buying the bonds before they were upgraded—and, a month before the upgrade, we did,” says Steven Brooks, a senior credit analyst with T. Rowe Price. “We were a bit ahead of the curve and able to benefit from capital appreciation when the upgrade occurred.”
This detail-oriented approach to research is the cornerstone of the investment process at T. Rowe Price. Portfolio managers base decisions to buy or sell a security on hundreds of hours of collective work by analysts throughout the company. The firm’s worldwide staff of analysts employs a disciplined approach that includes site visits, in-depth financial analysis, and detailed discussions of the investment thesis for each security. “I work with some of the best analysts in the industry,” says Ken Allen, portfolio manager of the T. Rowe Price Science & Technology Fund (PRSCX) and a former software analyst at the firm. “They make me a better investor—and that helps me do a better job for our clients.”
“…steel analysts, for example, will know everything they can about the steel industry and all the companies in the industry …You want the analysts to be experts in the companies and the sectors in which they invest.” —Michael McGonigle, head of fixed income research, T. Rowe Price
T. Rowe Price equity and bond analysts are organized into sector teams and assigned industries on which to focus their efforts.
- 44 analysts, divided into five sector teams
- 23 traders
- 23 quantitative analysts
- 123 analysts, divided into eight sector teams
- 21 traders
- 3 quantitative analysts
The wide reach across markets and the depth of expertise in every major industry enable the research group to identify opportunities other investors may overlook. “When I was an analyst, my focus was solely software,” says Allen. “I could be a true expert on the software industry as a whole, as well as on the specific companies I was covering.”
Industry expertise enables analysts and portfolio managers to understand the position of a company or debt issuer in relation to its competitors and to other key players. “High yield steel analysts, for example, will know everything they can about the steel industry and all the companies in the industry,” says Michael McGonigle, head of fixed income research at T. Rowe Price. “It’s a very similar model to the way our equity team operates—and the purpose is exactly the same: You want the analysts to be experts in the companies and the sectors in which they invest.”
LOOKING AT THE NUMBERS
In the early phase of research, analysts investigate a company’s business model, its future earnings prospects, and its capacity to service debt, among a wide range of other factors. That initial work culminates in an “initiation of coverage” report that presents the rationale for investigating the company further. Like all T. Rowe Price research reports, the initiation of coverage report is written for an internal audience, which fosters a candid and comprehensive assessment of the security under consideration.
Equity analysts generally focus their research efforts on a company’s cash flow position, earnings prospects, and approach to allocating capital. “Management teams with astute capital allocation practices have typically generated good performance,” notes Charles Pepin, a director of equity research for North America at T. Rowe Price. Analysts and portfolio managers primarily rely on their assessments of fundamental factors to make investment decisions. They also turn to analysis from the quantitative research group, whose members sift through financial information in order to reveal qualities of a company that might not be apparent from traditional measures. Fixed income analysts also use a variety of financial metrics in their analyses—cash flow being one of the most important. Because a bond issuer needs to service—or cover—interest payments due to investors, credit analysts want to be sure interest obligations won’t consume too much cash flow. The overall goal of these efforts is to grasp the full picture of a potential investment. “When our view is very different from what other investors think,” Pepin says, “we’ve often found a good investment opportunity.”
Pepin recalls an instance when a T. Rowe Price analyst with a degree in applied physics uncovered inconsistencies in the data presented by a biotechnology company. He also concluded that a competitor’s technology would undermine the company’s product. Based on his research, T. Rowe Price avoided investing in the company. Says Pepin, “We invest a lot of time and effort in the recruiting process to find individuals with tremendous capacity.”
“If you interview six management teams in an industry and ask them about each other, you’re going to get some interesting—and useful—insights.” — charles Pepin, director of equity research, North America, T. Rowe Price
BEYOND THE NUMBERS
Analysts spend roughly half their time on the road— talking face to face with a CEO, touring a production facility with a mid-level manager, or meeting with an executive team at an industry conference. Last year the firm conducted more than 5,000 meetings with corporate management teams around the world. Analysts and portfolio managers also meet with industry experts and competitors to gain additional perspective on an investment or a company. “If you interview six management teams in an industry and ask them about each other,” notes Pepin, “you’re going to get some interesting—and useful—insights.”
In-person, proactive research helps analysts gain insights into a company or bond issuer. Prior to the collapse of the subprime mortgage market, for example, Susan Troll, a T. Rowe Price mortgage analyst, visited several companies that serviced subprime loans. She attended calls with clients who were struggling to meet their payments after adjustable rate mortgage loans had reset to much higher levels. Despite assurances to the contrary from industry insiders, Troll said her doubts about the subprime market grew. After much debate inside the firm, Troll prevailed, and the managers who held subprime securities decided to sell them before many other professional investors did. Likewise, Brooks, the credit analyst, recalls attending a presentation by managers at Enron long before the energy company’s collapse. “I didn’t like management’s demeanor and body language—and I couldn’t figure out what they did or how they did it,” he says. “So we avoided investing in the company.”
Analysts on site in developed and emerging market countries are able to assess the impact local and regional concerns are likely to have on companies and bond issuers. Having resources around the world is particularly important today, as growth in emerging markets and the fiscal crisis in Europe can move markets and affect individual securities.
T. Rowe Price’s emphasis on collaboration enables analysts and portfolio managers around the world to communicate their insights throughout the company. McGonigle points out that the firm has nine London-based fixed income analysts and two based in Hong Kong, who bolster the firm’s staff in the U.S. “It’s critical to be in local markets and to understand their political and fiscal developments,” he notes. “These resources give us the ability to analyze more corporate credit—we have sovereign debt expertise that is crucial with the current situation in Europe.”
IN-DEPTH KNOWLEDGE, NEW INSIGHT
In the later phases of research, analysts write detailed evaluations that lay out the thought process behind their recommendations and provide details about key factors such as the company’s management team, its financial strength, and potential risks. Analysts and portfolio managers refine the investment thesis on an ongoing basis, incorporating new information and taking advantage of the extensive experience within the firm’s fixed income and equity teams. Portfolio managers at T. Rowe Price generally come up through the ranks as analysts, so they may have an especially deep understanding of management teams—their skills, experience, and personalities—throughout an industry. Says Allen, the portfolio manager of the T. Rowe Price Science & Technology Fund, “Each person’s work gets amplified and strengthened by the insights and the perspectives of others with whom he or she is working.”
THE INVESTMENT DECISION
The ultimate investment decisions rest with individual portfolio managers. When a portfolio manager and an analyst disagree about their assessments of a particular security, the discussion often becomes a catalyst for further research and exploration. “I tread somewhat carefully if an analyst doesn’t like a stock as much as I do,” Allen says. “I spend time to really understand his or her perspective and assess whether I may be missing something and shouldn’t be as positive as I am.”
The research process at T. Rowe Price continues throughout the investment phase and often long after a security is sold, as it may offer compelling investment possibilities down the road. The complexity of global financial markets and the ever-changing dynamics that are part of any industry or sector require constant monitoring. Analysts provide portfolio managers with frequent updates on their recommendations and stay current with developments at a particular company or bond issuer—and they follow industry and sector trends closely. Their reports, both written and verbal, help management teams around the world distill enormous amounts of information and construct mutual funds that seek the best opportunities in today’s investment climate, while adhering to the firm’s long-term perspective.