Long-Term Benefits of the T. Rowe Price Approach to Active Management
- T. Rowe Price has demonstrated that skilled active management, backed by in-depth fundamental research, can add value for clients over longer time horizons. Focusing solely on short-term relative performance could be a critical mistake, as active portfolio strategies may take time to come to fruition.
- We reviewed the performance of 18 T. Rowe Price diversified active U.S. equity funds over the 20 years ending in 2016, or since inception in cases where the fund had less than a full 20-year track record. On average, the funds included in the study generated positive excess returns, net of fees, versus their designated benchmarks over rolling 1-, 3-, 5-, and 10-year periods.1
- The likelihood that T. Rowe Price’s diversified U.S. equity funds would outperform the relevant benchmarks increased as rolling time periods were extended.
- We attribute the value we have been able to create for our U.S. equity clients to the strengths of our underlying investment process and research platform, which we believe match many of the characteristics linked to active management success.
T. Rowe Price believes strongly that skilled, risk-aware active management has the potential to add value over longer-term time horizons. Evaluating active manager performance, however, requires investors and/or their financial advisors to distinguish between signal and noise—that is, to see past the many factors that may create a distorted short-term picture (either positive or negative) of manager skill.
As active equity managers, we are primarily interested in whether our own investment process has created long-term value for our clients. To gain a clearer understanding of this issue, we conducted a study of the performance of T. Rowe Price’s diversified U.S. equity funds over the two decades ending 12/31/2016 (or since inception for funds that lacked a full 20-year track record).
Our study covered 18 of the 22 active diversified U.S. equity funds currently advised by T. Rowe Price, including two institutional portfolios that are not directly available to individual investors. Institutional funds that are clones of other diversified equity funds were omitted from the study to avoid double counting. The 18 funds included in the study represented approximately 76% of total U.S. equity assets in the domestic and global equity mutual funds advised by the firm as of 12/31/2016. The funds, their primary style benchmarks, and the dates of their inclusion in the study are shown in Figure 1.2
For each fund in the study, we examined performance over rolling 1-, 3-, 5-, and 10-year periods (rolled monthly) from 12/31/1996 through 12/31/2016. We then calculated excess returns relative to the appropriate benchmark for each fund in each time period. Fund returns were based on net asset value (NAV) data, and thus were net of fees and trading costs.
For each fund, we calculated hit rates (the percentage of periods in which the fund outperformed its benchmark) and average excess returns relative to that benchmark for each time frame (i.e., over all rolling 1-, 3-, 5-, and 10-year periods).3 The results are displayed in Figures 2 and 3.
Past performance cannot guarantee future results. See Important Information below for standardized performance.
One of the more consistent findings in the study was that hit rates and excess returns both tended to improve over most longer time periods.
- While 15 of the 18 funds had positive hit rates (i.e., higher than 50%) over rolling three-year periods, 16 had positive five-year hit rates, and 16 had positive 10-year hit rates.
- Half of the funds (9 of 18) outperformed their benchmarks over every rolling 10-year period, while two other funds outperformed in at least 98% of their rolling 10-year periods.
- Thirteen of the 18 funds had positive excess returns, on average, over rolling one-year periods, while 14 funds had positive three-year excess return averages, 16 had positive five-year averages, and all but one had positive 10-year averages.
- For 15 out of 18 funds, five-year annualized excess returns were higher, on average, than one-year average excess returns. Average 10-year excess returns were higher than average one-year excess returns in 13 of 18 cases.
The diverse range of investment objectives represented in the study made it inappropriate to calculate simple performance averages across all 18 funds. The universe of smaller stocks is typically less deeply researched than the large-cap market, potentially making it easier for small-cap managers to generate excess returns by exploiting market inefficiencies. Thus, the excess returns for the small-cap managers in the study could have biased a simple average higher, concealing relatively weak results for large-cap managers.
Performance averages could also be distorted by the fact that five of the 18 funds did not have histories that spanned the entire 20-year study period.7 As of 12/31/2016, for example, the Diversified Mid-Cap Growth Fund had completed only 37 rolling 10-year periods since its inception at the end of 2003. Yet results for all 18 funds would have equal weight in a simple average.
To correct for these potential biases, we divided the 18 funds in the study into three capitalization categories—large-, mid-, and small-cap—based on their designated benchmarks. We then calculated average hit rates and average excess returns for each category. These averages were time weighted—that is, the results were weighted by the percentage of the total performance periods in each category that were provided by each fund (Figures 4 and 5).8
- As expected, time-weighted performance results for T. Rowe Price’s small-cap managers were, on average, stronger than for large-cap managers—with average excess returns for mid-cap managers, not surprisingly, falling somewhere in the middle.
- Time-weighted excess returns for small-cap managers were especially strong (relative to mid- and large-cap managers) over shorter-term periods. However, average excess returns for small-cap managers weakened slightly at the 10-year time horizon.
- Time-weighted hit rates for T. Rowe Price large-cap managers were positive (above 50%) over all periods. Average excess returns also were positive over all periods, although here, too, excess returns weakened slightly at the 10-year time horizon.
Past performance cannot guarantee future results. See Important Information below for standardized performance.
The excess returns shown in Figure 5 may seem rather modest relative to the absolute returns that investors typically have been able to achieve in the U.S. equity markets over longer periods. However, even a small improvement in annualized returns can make a significant difference in ending portfolio value over longer time horizons.
Take, for example, a hypothetical equity portfolio that appreciated at a rate equal to the 7.68% annualized total return on the S&P 500 Index over the two-decade period covered by our study. A portfolio that achieved even a 100-basis-point improvement in annualized return over those two decades, after fees and costs, could have increased its ending value by more than 20%.
A Focus on Long-Term Value
To the extent T. Rowe Price’s diversified U.S. equity funds have been able to deliver strong long-term active performance, net of fees, over the past two decades, we believe it reflects the strengths of our investment process in a number of key areas.
Fundamental analysis, backed by a well-resourced global research platform, is the core of our approach, providing a strong foundation for bottom-up stock picking. Our 154 equity research professionals follow nearly 2,500 public companies worldwide—equaling 63% of total global market capitalization.9
Our portfolio managers also tend to be long-tenured, with an average of 15 years of experience at T. Rowe Price and 20 years in the investment industry.10 Our recruiting and internal mentoring programs help us attract and develop talented analysts, who in turn provide a pool of experienced candidates to fill open portfolio manager positions.
Finally, T. Rowe Price’s culture and research structure encourage close collaboration among managers, between managers and analysts, and between our equity and fixed income professionals. We believe a collaborative approach can lead to significant idea sharing and investment decisions that are based on the full breadth of the firm’s resources.
In addition, T. Rowe Price’s performance evaluation and compensation practices—such as annual bonuses and other incentives—are heavily focused on long-term results. They are also designed to encourage collegiality and cooperation and discourage a “star system” mentality.
By remaining focused on the underlying factors that we believe support strong active performance, T. Rowe Price will continue to seek long-term value creation for our U.S. equity clients.
Appendix: STUDY METHODOLOGY
We examined the performance of 18 of T. Rowe Price’s current lineup of active diversified U.S. equity funds over a 20-year period beginning 12/31/1996 and ending 12/31/2016, or since their inception. Diversified funds were defined as those that had the ability to invest across one or more U.S. equity categories, such as large-cap growth and large-cap value; mid-cap growth and mid-cap value; small-cap growth and small-cap value; or the core large-, mid-, and small-cap universes. One of the 18 funds, the Capital Appreciation Fund, also has the ability to invest in fixed income assets but is primarily an equity portfolio and is benchmarked to the S&P 500 Index.
Our study was limited to diversified U.S. equity funds primarily for two reasons:
- Many of T. Rowe Price’s international and global equity products have significantly more limited performance records than our U.S. diversified equity offerings. This could have significantly skewed average performance comparisons over shorter and longer rolling time periods and between the early and later years of the study.
- U.S. equity markets are widely regarded as the world’s most efficient, transparent, and intensively researched, making them particularly formidable tests of active management skill.
More specialized sector portfolios—such as T. Rowe Price’s Health Sciences and Media & Telecommunications Funds—were excluded from the study because the narrow, sector-specific performance benchmarks used by these funds made direct comparisons to diversified funds inappropriate, in our view. It is our belief that including these funds would not have had a materially negative impact on the study’s conclusions, as most T. Rowe Price sector funds show positive excess returns against their specialized benchmarks that in many cases are larger than for the firm’s diversified U.S. equity funds.
Four of T. Rowe Price’s diversified U.S. equity funds were excluded from the study. The Large-Cap Core Fund incepted in June 2009 and thus had an extremely limited longer-term performance track record consisting of only 31 five-year rolling periods—a statistically invalid sample. Two recently incepted funds—the QM U.S. Small & Mid-Cap Core Equity Fund and the QM U.S. Value Equity Fund—had even shorter performance histories, with neither of the funds showing even a one-year track record as of the end of 2016. Given that the purpose of the study was to examine T. Rowe Price active performance over longer time frames, we believe inclusion of these three funds would have been inappropriate.
The T. Rowe Price Tax-Efficient Equity Fund was also excluded from the study. The fund’s objective of seeking to maximize after-tax portfolio growth results in an active management process that is fundamentally different from funds focused on before-tax performance and makes comparisons of hit rates and excess returns relative to taxable benchmarks inappropriate, in our view.
Funds were included in the study universe as of 12/31/1996 or, for funds without full 20-year track records for the period covered by the study, as of the date of their inception. An exception was the New America Growth Fund, which incepted 10/31/1985 but was included in the study as of 4/30/2000. Prior to its study inclusion date, the New America Growth Fund was a specialized sector fund focused on the U.S. services sector. The fund was added to the study as of the date of an investment program change that broadened its objective to include investing in a diversified portfolio of U.S. growth companies.
Because T. Rowe Price has not liquidated or merged any diversified U.S. equity funds offered to its clients since the beginning of the study period, there was no survivorship bias in the results.
Fund and benchmark return data were taken from T. Rowe Price’s internal performance database, which is used by T. Rowe Price to calculate returns for its quarterly, semiannual, and annual client reports; for marketing materials; and for regulatory disclosures. Benchmark returns in the T. Rowe Price database are collected from the index providers—in this case, the Standard & Poor’s Corporation and Russell Investment Group. All study results were based on total returns, including dividends reinvested. Fund returns are based on the reported net asset values (NAV) and SEC standardized returns for the T. Rowe Price mutual funds included in the composites for each strategy, from which management fees and operating expenses have been subtracted. In other words, the fund returns used in the study are based on the after-cost performance of the Investor Class for each fund (which has the lowest expenses among the share classes for that fund). In recent years, some of the T. Rowe Price funds included in the study have launched Advisor and R Classes that include 12b-1 fees paid to intermediaries for distributing these funds. However, given the limited track records of these share classes, and the fact that they are not the lowest-expense share class available, we believe it was more accurate to base our study on performance results of the Investor Classes.
For each fund in the study, T. Rowe Price analysts calculated 1-, 3-, 5-, and 10-year rolling returns, rolled monthly. Returns for the 3-, 5-, and 10-year rolling periods were annualized. To ensure these periods all covered the equivalent two-decade slice of U.S. equity market history, each rolling series began on 12/31/1996 and ended on 12/31/2016 (Figure A1). This produced:
- 229 rolling one-year periods,
- 205 rolling three-year periods,
- 181 rolling five-year periods, and
- 121 rolling 10-year periods.11
For each rolling period, the returns for each fund’s current size and/or style benchmark were subtracted from the fund return, producing an excess return. The percentage of rolling periods in each time series in which excess returns were positive was then calculated, producing a hit rate for each fund across each time horizon. Excess returns were averaged across every rolling period in each time frame for each fund to arrive at the results shown in Figure 3.
Firmwide performance averages were calculated for three capitalization categories in the study universe: large-cap funds, mid-cap funds, and small-cap funds. Managers were placed in these categories based on their designated benchmarks:
- Funds benchmarked to the S&P 500 Index, the Russell 1000 Value Index, or the Russell 1000 Growth Index were included in the large-cap category.
- Funds benchmarked to the Russell Midcap Growth Index or the Russell Midcap Value Index were included in the mid-cap category.
- Funds benchmarked to the Russell 2000 Index, the Russell 2000 Growth Index, or the Russell 2000 Value Index were included in the small-cap category.
To adjust for the fact that a number of funds had performance histories considerably shorter than the full 20-year period covered by the study, performance averages in each category were time weighted, meaning the results were adjusted to reflect the percentage of the total performance periods in each category that were provided by each strategy. The capitalization categories and time weights used are shown in Figure A2.
Overall, time weighting had relatively little impact on average performance results for the large-cap and small-cap categories. However, average excess returns for the mid-cap category improved significantly, especially over longer rolling time periods, reflecting the relatively short performance history of the Diversified Mid-Cap Growth Fund.
Due to the relatively small sample sizes in each capitalization category (11 large-cap funds, three mid-cap funds, and four small-cap funds), the results of this analysis are of limited statistical significance and should be regarded as indicative only.
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1Given that the U.S. equity market is generally considered the world’s most efficient, transparent market, we believe it provides a strong test for active management skill. See the appendix for additional information on the performance study methodology.
2Four T. Rowe Price diversified U.S. equity funds—the Large-Cap Core Fund (LCC), the Tax-Efficient Equity Fund (TEE), the Quantitatively Managed (QM) Small & Mid-Cap Core Equity Fund, and the QM U.S. Value Equity Fund—were excluded from the study. The LCC incepted in June 2009 and thus had no 10-year rolling returns and only 31 5-year rolling returns in the period covered by the study, making a long-term performance analysis unreliable. The two QM funds incepted in February 2016 and thus had no rolling performance periods in the time frame covered by our study. The TEE’s exclusion stemmed from the fact that its objective of seeking to maximize after-tax portfolio growth was inconsistent with the study’s use of before-tax benchmarks and its focus on before-tax excess returns. Performance is available upon request and on troweprice.com. More detailed information about the study methodology can be found in the appendix.
3Excess returns for the 3-, 5-, and 10-year rolling periods were annualized.
4The Capital Opportunity Fund transitioned from a U.S.-unconstrained all-cap strategy to a U.S. structured research strategy on 4/30/1999. T. Rowe Price’s U.S. Structured Research Equity Strategy uses a portfolio construction process that emphasizes stock selection by the firm’s industry-focused analysts. While the majority of the Capital Opportunity Fund’s assets are invested in U.S. large-cap stocks, U.S. small- and mid-cap and foreign stocks may also be purchased in keeping with the fund’s objectives. The fund’s sector weightings are approximately the same as for the S&P 500 Index.
5Formerly the Diversified Small-Cap Growth Fund.
6The New America Growth Fund incepted in September 1985 but was added to the study as of the date of an investment program change that broadened its objective to include investing in a diversified portfolio of U.S. growth companies. See the appendix for additional information.
7Four funds did not have full 20-year performance histories for the period covered by the study: the QM U.S. Small-Cap Growth Equity Fund, the Institutional Large-Cap Value Fund, the Institutional Large-Cap Growth Fund, and the Diversified Mid-Cap Growth Fund. A fifth fund, the New America Growth Fund, did not have a full 20-year history for its current strategy objective (see footnote 6).
8The time weights and capitalization categories used are shown in Figure A2.
9Number of equity professionals as of 12/31/2016. Company coverage as of 12/31/2016. Equity analyst staff includes 11 sector portfolio managers, 90 research analysts, 42 associate research analysts, 6 quantitative analysts, and 5 specialty analysts.
10As of 12/31/2016.
11Since not all funds had performance records covering the full 20-year study, the number of rolling periods was smaller for some funds.
This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.
All investments are subject to risk, including the possible loss of principal. Small- and mid-cap stocks are generally more volatile and risky than large-cap stocks because they generally have more limited operating histories, narrower product lines, and tend to focus on smaller markets. Growth and value investing tend to go in and out of favor and may underperform the broader equity markets over certain time periods. Dividends are not guaranteed and are subject to change. For a more complete discussion of the funds’ risks, see the applicable mutual fund prospectus.
The views contained herein are those of the authors as of November 2017 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.
MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein.
The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI.
Russell Investment Group is the source and owner of the trademarks, service marks, and copyrights related to the Russell indexes. Russell® is a trademark of Russell Investment Group.
This information is not intended to reflect a current or past recommendation, investment advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Investors will need to consider their own circumstances before making an investment decision.
Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy.
Past performance cannot guarantee future results. All investments involve risk. All charts and tables are shown for illustrative purposes only.
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