Is T. Rowe's Split a Smart Way to Handle Growth?

T. Rowe Price Group TROW announced on Nov. 19 that it plans to split its investment-research organization in two with the launch of T. Rowe Price Investment Management in 2022’s second quarter. Six existing strategies and supporting analytical resources will move to the new entity, and this cohort will remain entirely separate from the legacy T. Rowe Price Associates; the two teams will not share research or investment resources once divided.

The move is a logical solution to the firm’s long-standing capacity challenges that have particularly constrained its renowned small- and mid-cap strategies. Indeed, 10 strategies, totaling around 30% of the U.S. Equity Division's $883 billion in assets under management as of September 2020, are closed to new investors or capacity constrained. Beyond the sheer asset size of T. Rowe’s small- and mid-cap franchises, the shrinking universe of small-cap public companies has also contributed to a limited opportunity set. Splitting into two entities, similar to Capital Group’s model, allows each side to adhere to its own company ownership limits and provides more bandwidth for portfolio managers to claim bigger stakes in companies than they would be able to under the current setup.

The six strategies moving to the new entity will benefit from increased capacity. T. Rowe Price Mid-Cap Growth RPMGX, under steady hand Brian Berghuis, closed to new investors in 2010; T. Rowe Price Capital Appreciation PRWCX, led by David Giroux, limited access in 2014; and Frank Alonso’s T. Rowe Price Small-Cap Stock OTCFX closed in 2013. There are no current plans to immediately reopen those strategies upon the transition’s completion. While open to investors, David Wagner’s T. Rowe Price Small-Cap Value PRSVX and Curt Organt’s T. Rowe Price US Smaller Companies Equity strategy (sold to investors outside the United States), must also be mindful of capacity and gain some breathing room. T. Rowe Price US High Yield TUHIX, the lesser-known high-yield offering that T. Rowe acquired from Henderson in 2017, is also making the move. Run by T. Rowe alum Kevin Loome, it has operated autonomously since the acquisition. While its asset base is manageable, housing it separately from the closed T. Rowe Price High Yield PRHYX makes sense. Remaining with T. Rowe Price Associates are capacity-constrained strategies such as T. Rowe Price New Horizons PRNHX and T. Rowe Price Mid-Cap Value TRMCX.

The mix of strategies on each side is well-reasoned, though it means the elimination of long-standing collaboration between certain portfolio managers and analysts. T. Rowe Price Mid-Cap Growth, for instance, will need to make sure it’s properly keeping tabs on promising small-growth companies that it might have formerly learned about via T. Rowe Price New Horizons. T. Rowe Price Mid-Cap Value, on the Associates side of the house, will no longer have the pipeline of ideas that came from T. Rowe Price Small-Cap Value. That might not be an immediate problem given T. Rowe Price Mid-Cap Value manager David Wallack’s high level of independent thinking, but it could prove more challenging for an eventual successor. On the plus side, some freed-up capacity means large-cap strategies within T. Rowe Price Associates may be better positioned to selectively invest down the market-cap ladder if the managers so choose, specifically on the growth side where T. Rowe Price New Horizons has long kept a pulse on the market’s up-and-coming disruptive forces.

In typical fashion, T. Rowe has approached this massive undertaking with proper planning. It has hired several experienced analysts in key sectors such as healthcare, technology, consumer, and business services the past couple of years in anticipation of a division of resources and will continue hiring in 2021, with about 25 net additions to the headcount overall. While analyst teams are not yet public, the firm says each side’s bench will sport similar average industry tenure. Divvying up analysts into each entity was a collaborative effort involving portfolio managers, analysts, and equity leaders, and performance incentives are consistent across the two groups. What remains to be seen is whether changing teams will upset anyone enough to leave the firm and how the two sides will compete for future investment talent following the official split.

Other trade-offs loom. The new entity will lose access to T. Rowe’s broad, well-respected global analyst team and the information sharing that comes with a wide-ranging and geographically diverse fund lineup. Arguably, global stock coverage is less pertinent for the six strategies moving, which traffic mostly in U.S. equities. However, being informed of global viewpoints and the competitive landscape isn’t irrelevant. Over time, it’s possible other existing or brand-new strategies could join T. Rowe Price Investment Management--T. Rowe Price Emerging Markets Stock PRMSX is currently capacity-constrained and closed, for instance--but building up a second global team would require significant resources, focused effort, and time.

Meanwhile, T. Rowe Price Associates will lose Giroux’s firmwide thought leadership efforts as equity and multi-asset CIO. He was the key driver of important research projects that helped influence investment opinions and results across the platform, ranging from tax reform to merger arbitrage to navigating the early 2020 coronavirus-induced market sell-off. He has also served as a key bridge between asset classes at T. Rowe Price Associates given his experience and success running an asset-allocation portfolio. His leadership qualities will help the new entity get off the ground, but his stellar T. Rowe Price Capital Appreciation strategy will no longer have access to T. Rowe’s broad resources across asset classes. Giroux is likely up for this new challenge; he’s one of the industry’s most talented managers who’s known for developing unique investment views, and he already works with a handful of dedicated analysts who would presumably move with him, providing some stability.

The firm has laid the groundwork for this significant change. T. Rowe’s track record of putting its clients and fundholders first, which supports its High Parent rating, gives confidence in this decision. Now it must prove it can execute.