Does T. Rowe Price Add Value for Investors?

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1 Does T. Rowe Price Add Value for Investors? May 3, 2016 by Larry Swedroe My series evaluating the performance of the market s most prominent actively managed mutual fund families continues with an in-depth analysis of offerings from T. Rowe Price. The firm has been entrusted with the assets of countless investors over its nearly 80-year history. Its eponymous founder popularized the concept of active management through growth-stock investing. I will examine whether the firm s funds have historically added value for investors relative to a passive benchmark. Morningstar reports that, as of March 31, T. Rowe Price had more than $580 billion in assets under management, down slightly from $613 billion at the end of That makes the firm one of the 10 largest mutual fund families. In Barron s 2015 annual report on mutual fund families, T. Rowe Price finished in fourth place, up from its 16th place ranking in The firm ranked second last year for five-year returns and fourth based on 10-year returns. The firm s website states: As a global investment manager, we actively listen, anticipate, and develop strategies that respond to the needs of our clients. Each strategy is supported by our proprietary global research platform and experienced investment teams. Our analysts and portfolio managers work together across regions, sectors, and asset classes to identify investment opportunities others might miss. They also assert that their diversity of product and distribution is a source of strength and stability and reduces the firm s reliance on any one strategy or segment and the potential impact of negative market cycles. They add: We believe our consistent, client-centered investment philosophy has helped us navigate all kinds of markets. The core of this philosophy utilizing proprietary research to guide active investment selection and diversification to reduce risk anchors our investment process. Our investment professionals share insights, ideas, and opinions across disciplines and time zones to find the best solutions for our clients in more than 40 countries. For nearly 80 years, this collaborative, disciplined approach has stood the test of time. And finally, they observe that their equity analysts have on average 20 years of investment experience. There is a key question: does the strategy and investment approach detailed above result in superior outcomes versus a passive strategy? To answer that, I ll compare the performance of T. Rowe Price s actively managed equity funds to similar offerings from two prominent providers of passively managed funds, Dimensional Advisors (DFA) and Vanguard. (Full disclosure: My firm, Buckingham, recommends DFA funds in constructing client portfolios.) Page 1, 2018 Advisor Perspectives, Inc. All rights reserved.

2 I should note that DFA funds can be purchased through some 529 and 401(k) plans but, generally, are available only through an advisor. An investor would incur fees from that advisor; those fees can vary greatly (in some cases they are very low) and cover the full range of financial planning services the advisor provides. Also, John Hancock recently introduced a series of ETFs that are managed through DFA (with expense ratios that differ from the DFA funds cited in this article). Those ETFs can be purchased directly by investors. All Vanguard funds can be purchased directly by investors. As is my practice, to keep the list to a manageable number of funds and to ensure that I examine longterm results through full economic cycles, I will analyze the 15-year period ending February I will use the lowest-cost shares available for the full period when more than one class of fund is available. And in cases where the fund family has more than one fund in an asset class, I ll use the average return of those funds in my comparison. The table below shows the performance of 18 actively managed funds (15 domestic and three international) offered by T. Rowe Price across six domestic equity asset classes and three international equity asset classes. March 2001-February 2016 Page 2, 2018 Advisor Perspectives, Inc. All rights reserved.

3 Expense Ratio Symbol Annualized Return U.S. Large-Cap Blend T. Rowe Price Capital Opportunity PRCOX T. Rowe Price Dividend Growth PRDGX Average DFA U.S. Large Company Portfolio DFUSX Vanguard 500 Institutional Index VFIIX U.S. Large-Cap Growth T. Rowe Price Blue Chip Growth TRBCX T. Rowe Price Growth and Income PRGIX T. Rowe Price Growth Stock PRGFX T. Rowe Price New America Growth PRWAX T. Rowe Price Spectrum Growth PRSGX Average Vanguard Growth Index VIGIX U.S. Large-Cap Value T. Rowe Price Equity Income PFRDX T. Rowe Price Institutional Large Cap Value TILCX T. Rowe Price Value TRVLX Average Page 3, 2018 Advisor Perspectives, Inc. All rights reserved.

4 DFA U.S. Large Cap Value III Portfolio DFUVX Vanguard Value Index VIVIX U.S. Small-Cap Growth T. Rowe Price Diversified Small Cap Growth PRDSX T. Rowe Price Institutional Small-Cap Stock TRSSX T. Rowe Price Small-Cap Stock OTCFX Average Vanguard Small Cap Growth Index VSGIX U.S. Small-Cap Value T. Rowe Price Small-Cap Value * PRSVX DFA U.S. Small Cap Portfolio DFSVX Vanguard Small Cap Index VSCIX U.S. Real Estate T. Rowe Price Real Estate TRREX DFA Real Estate Securities Portfolio DFREX Vanguard REIT Index VGSIX International Large-Cap Blend T. Rowe Price Spectrum International PSILX DFA Large Cap International Portfolio DFALX Vanguard Total Intl Stock Index VGSTX Page 4, 2018 Advisor Perspectives, Inc. All rights reserved.

5 International Large-Cap Value T. Rowe Price International Growth & Income TRIGX DFA International Value III Portfolio DFVIX Emerging Markets T. Rowe Price Emerging Markets Stock PRMSX DFA Emerging Markets DFEMX Vanguard Emerging Markets VEMAX *Morningstar categorizes the fund from an investment standpoint as small blend. I chose to use the small-value category because investors likely believed that they were investing in a small-value fund based on the name. In fact, the SEC requires that funds maintain at least 80% of holdings in the defined asset class. The DFA small blend fund (DFSTX) returned 8.5% (0.8% less than the DFA small-value fund) and the Vanguard small-blend fund (VSCIX) returned 8.0% (0.1% less than the Vanguard small-value fund). Thus, the results would be slightly more favorable to T. Rowe Price using the small-blend benchmarks. The following is a summary of the most important takeaways from the returns data: In the asset classes for which there was a comparable fund from Vanguard, the T. Rowe Price funds outperformed in 14 cases and underperformed in just two. There was one tie. In the asset classes for which there was a comparable DFA fund, the T. Rowe Price funds outperformed in five cases and underperformed in five. In the eight asset classes for which comparable Vanguard funds were available, an equalweighted portfolio of Vanguard funds returned 6.8% a year. The average expense ratio was 0.14%. An equal-weighted portfolio of T. Rowe Price funds returned 7.3% a year, outperforming the Vanguard portfolio by 0.5%. The average expense ratio for the T. Rowe Price portfolio was 0.85%. In the seven asset classes for which comparable DFA funds were available, an equal-weighted portfolio of DFA funds returned 6.9% a year. The average expense ratio was 0.28%. An equalweighted portfolio of T. Rowe Price funds returned the same 6.9% a year. The average expense ratio for the T. Rowe Price portfolio was 0.87%. Factor analysis Page 5, 2018 Advisor Perspectives, Inc. All rights reserved.

6 I will now look at the performance of T. Rowe Price s domestic funds using the analytical tools and data available at Portfolio Visualizer. Factor analysis provides important additional insights into fund performance because Morningstar asset class categories are very broad and actively managed funds often style drift (as I previously noted with the T. Rowe Price small-cap value fund). The table below shows the results of the three-factor (beta, size and value), four-factor (adding momentum) and six-factor (adding quality and low beta) analyses for T. Rowe Price s U.S. funds (excluding the REIT fund, for which a factor analysis isn t appropriate). The data covers the period from March 2001 through February Each t-statistic is in parentheses. Page 6, 2018 Advisor Perspectives, Inc. All rights reserved.

7 Symbol Three-Factor Annual Alpha Four-Factor Annual Alpha Six-Factor Annual Alpha T. Rowe Price Capital Opportunity 0.3 PRCOX (0.7) 0.4 (0.9) 0.0 (0) T. Rowe Price Dividend Growth 1.1 PRDGX (1.7) 1.1 (1.7) -0.2 (-0.4) T. Rowe Price Blue Chip Growth TRBCX 0.8 (0.8) 0.4 (0.4) 0.2 (0.1) T. Rowe Price Growth and Income PRGIX 0.4 (0.6) 0.3 (0.5) -0.5 (-0.7) 1.2 T. Rowe Price Growth Stock PRGFX (1.2) 0.6 (0.6) 0.4 (0.4) T. Rowe Price New America Growth 0.2 PRWAX (0.2) 0.3 (0.3) 0.8 (0.8) T. Rowe Price Spectrum Growth 0.0 PRSGX (0.0) 0.0 (0.0) 0.0 (0.0) T. Rowe Price Equity Income PFRDX 0.2 (0.2) 0.6 (0.8) -0.4 (0.5) T. Rowe Price Institutional Large Cap Value TILCX 1.1 (1.3) 1.5 (1.7) 0.9 (1.0) T. Rowe Price Value TRVLX Page 7, 2018 Advisor Perspectives, Inc. All rights reserved.

8 (0.8) (1.6) (0.9) T. Rowe Price Diversified Small Cap Growth -0.9 PRDSX (-0.1) 1.1 (1.0) 0.3 (0.2) T. Rowe Price Institutional Small- Cap Stock TRSSX 1.5 (1.5) 0.6 (0.6) 0.0 (0.0) T. Rowe Price Small-Cap Stock OTCFX 1.2 (1.1) 0.2 (0.2) -0.4 (-0.4) T. Rowe Price Small-Cap Value PRSVX 2.2 (2.0) 1.2 (1.4) -0.4 (-0.3) Average When we examine the results from the three-factor analysis, we find 12 of the 14 funds generated positive alphas while one generated a negative alpha (and one produced an alpha of 0). However, just one fund generated an alpha that was statistically significant at the 5% level of confidence (about what you would expect randomly). The average alpha was 0.7%. Examining the results from the four-factor analysis, we find that 13 of the 14 funds were able to generate positive alphas (though none were statistically significant at the 5% level of confidence), and one produced an alpha of 0. The average alpha was 0.7%. When all six factors are included in our analysis, we find that six of the funds generated positive alphas (although none were close to being statistically significant at the 5% level of confidence), five generated negative alphas (again, none were statistically significant) and three produced alphas of 0. The average alpha was slightly positive at 0.1. This is a good result because even low-cost index funds are expected to produce negative alphas roughly equal to their expense ratio. The analysis shows that the positive alphas we saw relative to the three- and four-factor models were due to the tendency of T. Rowe Price to buy high-quality, low-beta stocks. Summary T. Rowe Price is one of the most highly regarded fund families in the world, and investors have entrusted them with roughly $600 billion in assets. On average, relative to Vanguard s low-cost index funds, their funds added value, outperforming a comparable Vanguard portfolio by 0.5% per year. Page 8, 2018 Advisor Perspectives, Inc. All rights reserved.

9 That s something that only four of the other 14 fund families I have reviewed have been able to accomplish (and one of those four was the active fund arm of Vanguard itself). Only American s outperformed a Vanguard portfolio by a wider margin. Thus, the claims made on their website hold up to analytical scrutiny. Relative to the DFA funds, the T. Rowe Price funds didn t add any value. However, they didn t subtract any either. What s more, only one fund family, American s, has been able to outperform the DFA funds, and they did so by the slimmest of margins (0.1%). In addition, T. Rowe Price was one of just four fund families to produce positive alphas relative to the six-factor model. Based on these results, the firm s claims are supported by the empirical evidence. My analyses were done on a pre-tax basis. Actively managed funds often have high turnover that result in tax costs to the investor, and any advisor using these funds in a taxable account should study this issue closely. Reviewing results This is the 15th installment in my ongoing series reviewing the performance of leading mutual fund families. The following table shows the performance of the portfolios constructed for each of the fund families relative to the performance of comparable portfolios from Vanguard and DFA, as well as the results of the factor analyses. With TIAA-CREF, I did not originally perform the factor analyses. Thus, it wasn t in the original article. However, I ve now added that data so that I have the same analyses for each active fund family. Page 9, 2018 Advisor Perspectives, Inc. All rights reserved.

10 Family Portfolio Return Versus Vanguard Portfolio Return Versus DFA Three-Factor Average Alpha Four-Factor Average Alpha Six-Factor Average Alpha TIAA- CREF Goldman Sachs JPMorgan Chase American s Gabelli s Waddell & Reed John Hancock Morgan Stanley Wells Fargo Russell SEI Hartford Vanguard GMO T.R. Price Page 10, 2018 Advisor Perspectives, Inc. All rights reserved.

11 Average The following are some of the highlights from the table. Of the 15 actively managed fund family portfolios, just five outperformed their comparable Vanguard portfolios, and in one case the outperformance was just one-tenth of a percentage point. The average for all 15 was an underperformance of 0.2%. Compared to the DFA portfolios, just one of the active fund families (American s) managed to outperform, and that was by the slimmest of margins, just 0.1%. As mentioned previously, there was one tie in performance (T. Rowe Price). The average underperformance for all 15 was 0.8%. The three-factor regressions produced an average alpha for all 15 active fund families of -0.1%. The four-factor regressions produced an average alpha of -0.2%. And the six-factor regressions produced an average alpha of -0.9%. The negative alphas are an indication that the markets are highly efficient. The only actively managed fund family in the group that added value when compared to both Vanguard and DFA (though in the second case by only a small margin) was American s. American s also showed positive alphas relative to each of the factor regressions. Active funds from Vanguard were able to outperform the firm s own passive funds, but they underperformed the DFA portfolio by an amount four times greater. Vanguard s active funds posted positive alphas relative to each of the factor regressions as well. Waddell & Reed funds also showed positive alphas relative to each of the factor regressions, but they underperformed comparable portfolios from both Vanguard (by a small amount) and DFA. Finally, T. Rowe Price funds outperformed a comparable portfolio from Vanguard and matched the DFA portfolio, but also posted positive alphas relative to each of the factor regressions. Overall, the evidence is compelling. Leading mutual fund families (aside from American s, T. Rowe Price, Vanguard and Wells Fargo) have had a difficult time outperforming low-cost, passively managed alternatives. In addition, active fund families have had a tough time generating risk-adjusted alphas. This is strong evidence that, while the market may not be perfectly efficient, investors in most actively managed funds will not benefit from efforts to exploit any inefficiencies that do exist, especially once taxes are considered. Larry Swedroe is director of research for The BAM ALLIANCE, a community of more than 150 independent registered investment advisors throughout the country. Disclosure: The included data and analysis is a summary of 14 other pieces related to an ongoing series evaluating actively managed mutual fund families. For a complete list of those pieces, click to search Larry Swedroe at: The exception is the Hartford fund family analysis, which can be found at The corresponding portfolios are provided for informational purposes only, were constructed specifically for this review and are not portfolios that Buckingham recommends. The returns data included is from Morningstar, and the factor analysis tool Page 11, 2018 Advisor Perspectives, Inc. All rights reserved.

12 was provided by Portfolio Visualizer: Performance is historical and does not guarantee future results. Information comes from sources deemed reliable but its accuracy cannot be guaranteed. It should not be assumed that any of the securities listed were or will prove to be profitable. Page 12, 2018 Advisor Perspectives, Inc. All rights reserved.