T. Rowe Price: A Deeper Look at the Performance

As Warren Buffett has often observed about investing, blue chip companies with established brand recognition hold a special competitive advantage in attracting U.S. investment dollars. 

Along those lines, venerable fund company T. Rowe Price has built a notable name for itself as an active fund manager, growing its base of managed assets to surpass $1 trillion and expanding globally across four continents. 

The publicly traded asset manager (TROW), which employs more than 7,000 workers, touts data showing its active fund managers through 2019 had generated peer-beating returns over 1-, 3-, 5- and 10-year periods.¹ 

The Baltimore-based investment manager gained early recognition based on its namesake founder's penchant for actively investing in growth-styled  stocks. A former broker and stock analyst, T. Rowe Price Jr., started his own firm in 1937 by focusing on serving wealthy families and their business associates. In 1950, the investment manager expanded by launching its first mutual fund for mass consumption, the T. Rowe Price Growth Stock Fund (PRGFX).

"In an environment where active fund managers are under assault for poor relative performance and high fees, we believe wide-moat-rated T. Rowe Price is the best positioned among the U.S.-based active asset managers we cover," noted Morningstar in a research report on the company.² 

At the same time, analyst Greggory Warren also pointed out that retirement-geared target-date funds "continue to generate the bulk of the firm's organic growth" and that T. Rowe Price's girth in the 401(K) plan and related workplace retirement marketplace has also been a key strength in terms of building assets. 

While we recognize T. Rowe Price's historic marketing prowess, IFA's investment committee views the company's claims of past outperformance by its fund managers against their active competitors as a relatively low bar to set. More to the point: How do T. Rowe Price's active strategies fare when compared to each fund's respective index? 

As we've chronicled in the past, academic luminaries such as Eugene Fama and Kenneth French have documented how active management on the whole has failed to serve as a panacea for investors paying up to generate index-beating results. (A favorite of IFA's on this topic is a piece by analyst Brad Steiman of Dimensional Fund Advisors titled "Paradox of Skill.")  

Another prime example of active management's history of empty promises is our "Deeper Look" research series. In this installment, we've put under our microscope the active mutual fund strategies run by T. Rowe Price.

Controlling for Survivorship Bias

It's important for investors to understand the idea of survivorship bias. While there are 100 active mutual funds that are currently offered by this asset management firm, it doesn't necessarily mean these are the only strategies this company has ever managed. In fact, there are 16 mutual funds that no longer exist. This can be for a variety of reasons including poor performance or the fact that they were merged with another fund. We will show what their aggregate performance looks like shortly.

Fees & Expenses

Let's first examine the costs associated with T. Rowe Price's surviving 100 strategies. It should go without saying that if investors are paying a premium for investment "expertise," then they should be receiving above average results consistently over time. The alternative would be to simply accept a market's return, less a significantly lower fee, via an index fund.

The costs we examine include expense ratios, front end (A), deferred (B) and level (C) loads, as well as 12b-1 fees. These are considered the "hard" costs that investors incur. Prospectuses, however, do not reflect the trading costs associated with mutual funds.

Commissions and market impact costs are real expenses associated with implementing a particular investment strategy and can vary depending on the frequency and size of the trades executed by portfolio managers.

We can estimate the costs associated with an investment strategy by looking at its annual turnover ratio. For example, a turnover ratio of 100% means that the portfolio manager turns over the entire portfolio in one year. This is considered an active approach and investors holding these funds in taxable accounts will likely incur a higher exposure to tax liabilities, such as short- and long-term capital gains distributions, than those incurred by passively managed funds.

The table below details the hard costs as well as the turnover ratio for all 100 surviving active funds offered by T. Rowe Price that have at least five years of complete performance history. You can search this page for a symbol or name by using Control F in Windows or Command F on a Mac. Then click the link to see the Alpha Chart. Also, remember that this is what is considered an in-sample test; the next level of analysis is to do an out-of-sample test (for more information see here).

^{Please read the prospectus carefully to review the investment objectives, risks, charges and expenses of the mutual funds before investing. T. Rowe Price prospectuses are available at https://www.troweprice.com/corporate/en/prospectuses.html}

On average, an investor who utilized an active equity strategy from T. Rowe Price experienced a 0.85% expense ratio. Similarly, an investor who utilized an active bond strategy from the company experienced a 0.57% expense ratio.

These expenses can have a substantial impact on an investor's overall accumulated wealth if they are not backed by superior performance. The average turnover ratios for active equity and bond strategies from T. Rowe Price were 47.41% and 65.53%, respectively. This implies an average holding period of 18.31 to 25.31 months.

In contrast, most index funds have very long holding periods -- decades, in fact, thus deafening themselves to the random noise that accompanies short-term market movements, and focusing instead on the long-term. Again, turnover is a cost that is not itemized to the investor but is definitely embedded in a fund's overall performance.

Performance Analysis

The next question we address is whether investors can expect superior performance in exchange for the higher costs associated with T. Rowe Price's implementation of active management. We compare each of its 116 strategies, which includes both current funds and funds no longer in existence, against its Morningstar assigned benchmark to see just how well each has delivered on their perceived value proposition.

We have included alpha charts for each of their current strategies at the bottom of this article. Here is what we found:

• 56.03% (65 of 116 funds) have underperformed their respective benchmarks or did not survive the period since inception.

• 43.97% (51 of 116 funds) have outperformed their respective benchmarks since inception, having delivered a POSITIVE alpha.

Here's the real kicker, however:

• 4.31% (5 of 116 funds) have outperformed their respective benchmarks consistently enough since inception to provide 97.5% confidence that such outperformance will persist as opposed to being based on random outcomes.

As a result, this study shows that a majority of funds offered by T. Rowe Price have not outperformed their Morningstar-assigned benchmark. The inclusion of the statistical significance of alpha is key to this exercise, as it indicates which outcomes are due to a skill that is likely to repeat and those that are more likely due to a random-chance outcome.

Regression Analysis

How we define or choose a benchmark is extremely important. If we relied solely on commercial indexes assigned by Morningstar, then we may form a false conclusion that T. Rowe Price has the "secret sauce" as active managers.

Since Morningstar is limited in terms of trying to fit the best commercial benchmark with each fund in existence, there is of course going to be some error in terms of matching up proper characteristics such as average market capitalization or average price-to-earnings ratio.

A better way of controlling these possible discrepancies is to run multiple regressions where we account for the known dimensions (betas) of expected return in the U.S. (i.e., market, size, relative price, etc.).

For example, if we were to look at all of the U.S.-based strategies from T. Rowe Price that've been around for the past 10 years, we could run multiple regressions to see what each fund's alpha looks like once we control for the multiple betas that are being systematically priced into the overall market.

The chart below displays the average alpha and standard deviation of that alpha for the past 10 years through 2019. Screening criteria includes funds with holdings of 90% or greater in U.S. equities and uses the oldest available share classes.

As shown above, although 11 mutual funds had a positive excess return over the stated benchmarks, only two produced a statistically significant level of alpha, based on a t-stat of 2.0 or greater. (For a review of how to calculate a fund's t-stat, see the section of this study that follows the individual Franklin Templeton alpha charts.)

Why is this important? It means that if we wanted to simply replicate the factor risk exposures to these T. Rowe Price funds with indexes of the factors, we could blend the indexes and capture similar returns. 

To get similar risks and returns in a mutual fund would require the additional fees of those passively managed funds. That would alter such an analysis, but not by much because of the relatively low fees of the passively managed funds compared to the actively managed funds.

Given the lower costs associated with index funds, we could have more confidence that we will experience a more desirable result compared to more expensive actively managed funds.

Conclusion

Like many of the other largest financial institutions, a deep analysis into the performance of T. Rowe Price has yielded a not so surprising result: Active management is likely to fail many investors. We believe this is due to market efficiency, costs and increased competition in the financial services sector.

As we always like to remind investors, a more reliable investment strategy for capturing the returns of global markets is to buy, hold and rebalance a globally diversified portfolio of index funds.

Below are the individual alpha charts for the existing T. Rowe Price actively managed mutual funds that have five years or more of a track record.

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Here is a calculator to determine the t-stat. Don't trust an alpha or average return without one.

The Figure below shows the formula to calculate the number of years needed for a t-stat of 2. We first determine the excess return over a benchmark (the alpha) then determine the regularity of the excess returns by calculating the standard deviation of those returns. Based on these two numbers, we can then calculate how many years we need (sample size) to support the manager's claim of skill.

Footnotes:

1.) T. Rowe Price, "Fourth Quarter and Full Year 2019 Results" report, Jan. 29, 2020.   

2.) Morningstar, analyst Greggory Warren, T. Rowe Price quarterly review, Jan. 29, 2020. 

This is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product or service. There is no guarantee investment strategies will be successful.  Investing involves risks, including possible loss of principal. Performance may contain both live and back-tested data. Data is provided for illustrative purposes only, it does not represent actual performance of any client portfolio or account and it should not be interpreted as an indication of such performance. IFA Index Portfolios are recommended based on time horizon and risk tolerance. Take the IFA Risk Capacity Survey (www.ifa.com/survey) to determine which portfolio captures the right mix of stock and bond funds best suited to you.  For more information about Index Fund Advisors, Inc, please review our brochure at https://www.adviserinfo.sec.gov/ or visit www.ifa.com.