This Fund Manager Is Among the Greats

The following is our latest Fund Analyst Report for T. Rowe Price Capital Appreciation PRWCX

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A highly talented manager and topnotch process give T. Rowe Price Capital Appreciation an edge. All of its share classes receive a Morningstar Analyst Rating of Gold. David Giroux has amassed one of the most impressive records in the asset-allocation space. During the past 10 calendar years, he placed in the top quartile of the allocation -- 50% to 70% equity Morningstar Category every year and beat a costless 60% S&P 500/40% Bloomberg Barclays U.S. Aggregate Bond Index benchmark in all but one year. Giroux's ability to identify mispricing across a wide array of asset classes--and act quickly when he does--is partly to thank for that record. Equities have ranged from 57% to 72% of assets, with Giroux upping risk after the drawdowns of 2008, 2011, 2018, and early 2020, and scaling back when markets become overheated, as in 2007 and late 2019. He opportunistically manages the rest of the portfolio, which can include high-yield bonds, leveraged loans, investment-grade credit, Treasuries, cash, and covered calls, in a similar way. Giroux and team conduct deep fundamental research to build a high-conviction, 40-stock portfolio. The equity sleeve outperformed the S&P 500 by 4.4 percentage points annualized over the past decade. His picks have added value in virtually every sector. Giroux has skillfully steered the fund so far in 2020 amidst extreme volatility. He entered the year with about 20% in cash and an 800-basis-point underweighting in equities. As the markets plummeted, he cut the cash stake in half and moved to an 1100-basis-point equity overweighting, emphasizing higher-beta names, such as semiconductors and industrials, and pockets of the market that were unreasonably punished, such as utilities and a handful of travel, leisure, and restaurant stocks with strong enough fundamentals to survive. That has led to a 6.6% gain through October that more than doubles a U.S.-focused 60/40 index. The fund has been closed to new investors since 2014. Process | High Giroux's highly disciplined and contrarian approach supports a High Process rating. He targets a delta-beta adjusted equity exposure--a measure of the fund's sensitivity to stocks after adjusting for covered calls, convertibles, and other derivatives--of 61.5% on average, because his research suggests that provides the best opportunity to beat the S&P 500 over a full cycle while not losing money over any three-year period, both objectives of the fund. That's not a constant target; he opportunistically shifts the fund's equity sensitivity by about 10 percentage points in either direction, and it jumped almost 90% in the depths of the global financial crisis. Stocks have ranged from about 55% to 70% of assets. Giroux favors misunderstood companies facing controversy but sticks to those with strong forward-looking fundamentals and skilled management teams. For instance, in late 2018 he bought General Electric GE, which has come under significant scrutiny in recent years. The stock has fallen since he purchased it, but he hasn't lost conviction, consistently upping his stake; it is now the fund's second-largest holding at 4% of total assets. Giroux opportunistically shifts the remainder of the portfolio between investment-grade corporates, Treasuries, high-yield bonds, leveraged loans, and cash, and writes call options on some stock holdings. People | High Giroux--an analyst at T. Rowe Price since 1998 and manager of this fund since 2006--takes the lead as this fund's sole named manager. He has amassed one of the most impressive records in the asset-allocation space, consistently beating peers and relevant indexes over short- and long-term periods. His ability to generate unique, contrarian, and often correct insights, along with a willingness to act on them before most competitors do, sets him apart and readily earns the fund a High People rating. Giroux represents key-person risk, but he has a solid supporting cast. However, Adam Poussard, associate portfolio manager since 2018, took on a new role at the firm as a senior analyst. The team has added two new dedicated analysts, plus it continues to receive full-time support from analyst Michael Signore and two quantitative analysts. Poussard's transition off the team isn't ideal, but with five dedicated team members and Giroux's continued leadership, the team remains in excellent shape. Giroux serves as chief investment officer and became the head of investment strategy in October 2018, which involves leading research projects across asset classes. Those duties take about 10% of his time, which isn't concerning, as he remains laser-focused on this fund. Parent | High T. Rowe Price remains well-positioned in an increasingly competitive industry, earning a High Parent rating. It has withstood the headwinds facing active managers with its rigorous research process, strong performance across asset classes, and continued investment in its research team. Head count grew 9% in 2019, and T. Rowe's debt-free balance sheet gives it flexibility to keep hiring amid an economic slowdown, as it did in past downturns. A build-out of its multi-asset team in recent years supported enhancements to its prized target-date suite in 2020, and the firm has bolstered its quantitative capabilities for internal and external use. While T. Rowe typically home-grows its talent, it has made several experienced equity analyst hires in key sectors lately. This strengthened analyst bench has allowed the firm to capably handle expected manager retirements with its characteristically smooth transitions as well as the rare surprise loss, such as when star manager Henry Ellenbogen left to start his own firm in 2019. T. Rowe is evolving from a business standpoint. It's broadening distribution outside the U.S., expanding its ESG capabilities, and planning for semitransparent exchange-traded funds, expected in late 2020. Yet it brings a measured, thoughtful approach to strategy launches and capacity management, with fundholders' interests at the forefront. Price It's critical to evaluate expenses, as they come directly out of returns. The share class on this report levies a fee that ranks in its Morningstar category's second-cheapest quintile. Based on our assessment of the fund's People, Process and Parent pillars in the context of these fees, we think this share class will be able to deliver positive alpha relative to the category benchmark index, explaining its Morningstar Analyst Rating of Gold. Performance The fund outpaced all of its peers in the allocation -- 50% to 70% equity category from Giroux's June 2006 start through October 2020 and beat more than 96% of rivals on a risk-adjusted basis. The fund is on track for another strong year in 2020, so far beating 93% of the group. Results look similarly impressive versus relevant indexes. Since Giroux began running the fund and over trailing one-, three-, five-, and 10-year periods, it beat a 60% S&P 500/40% Aggregate Index by about 2 percentage points annualized. It came out ahead of the Morningstar Moderate Target Risk Index by more than twice that margin, partially thanks to the index's dedicated foreign equity stake. The fund has also consistently turned in excellent risk-adjusted returns. Since mid-2006, its three-year rolling alpha was positive 87% of the time versus the former index and 99% of the time versus the latter index. Giroux has added value via security selection in both the equity and fixed-income sleeves. Although Giroux will boost the fund's equity exposure when valuations decline--potentially juicing volatility in the process--the fund has kept risk in check. Over the past decade, the fund lost 75% as much as its typical peer during downturns and captured 118% of its average peer's gains in rising markets. Portfolio Giroux consistently refines his approach. A recent internal review revealed that the vast majority of the fund's alpha has come from its larger, high-conviction names. Giroux reduced the number of stock holdings to about 40 from 50-70 historically, highly uncommon among funds of this size. (Total fund assets currently stand at more than $40 billion.) Giroux conducted another recent project that indicated about one third of companies in the S&P 500 face secular challenges. He's largely avoided those names. For instance, the stock portfolio has an overweighting in industrials, an area that's mostly avoiding disruption, and no exposure to energy, where many firms face challenges because of low oil prices and the rise of natural gas fracking. Other noticeable positions include a 10% overweighting in utilities and a 5% underweighting in consumer staples. The fund's effective equity weight stood at about 65% as of September 2020, a modest overweighting to risk relative to the fund's neutral 61.5% position. Giroux sees the potential for continued modest upside, partly due to the likelihood of additional stimulus packages. With rock-bottom interest rates, Giroux finds Treasuries and duration expensive. He also dislikes investment-grade corporates, instead preferring high-yield bonds and leveraged loans, which offer higher yields and are less susceptible to rising interest rates.