A Fine Choice for Small-Value Believers

The following is our latest Fund Analyst Report for T. Rowe Price Small-Cap Value PRSVX.

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A capable manager's steady stock-picking and strong supporting cast earn T. Rowe Price Small-Cap Value a Morningstar Analyst Rating of Silver.

Manager David Wagner's disciplined approach has rewarded investors since he took the helm in June 2014. Wagner works closely with T. Rowe Price's talented analyst bench to identify high-quality businesses. The team looks for companies with sound fundamentals, sustainable competitive advantages, and strong management teams. It also looks for stocks trading at attractive relative valuations, but Wagner is willing to pay a higher multiple for higher-quality businesses and holds on to stocks that have appreciated but remain attractive, thus pushing the strategy toward core in the Morningstar Style Box. By hewing close to the sector weightings of the Russell 2000 Value Index benchmark, Wagner lets stock-picking drive results.

Despite upcoming organizational changes, Wagner will retain access to key personnel, and the timeline affords ample time to fill any gaps. T. Rowe Price Group TROW announced in November 2020 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. Wagner will be part of the new entity. While a few analysts and some sector portfolio managers won't be making the move, Wagner will retain access to most analysts and key collaborators such as Frank Alonso of T. Rowe Price Small-Cap Stock OTCFX. As such, the strategy remains in capable hands.

Wagner's record is a testament to his stock-picking abilities. From his June 2014 start through December 2020, the oldest share class' 8.6% annualized return outpaced both its Russell 2000 Value Index benchmark and average small-cap blend Morningstar Category peer. It trailed the Russell 2000 Index by 1.0 percentage point, but this was driven by sector allocations; stock-picking relative to the blend bogy was positive. All told, a solid relative value approach and strong execution make this strategy a compelling small-cap option.

Process | Above Average Manager David Wagner applies a disciplined, relative value approach that earns an Above Average Process rating.

He works closely with T. Rowe Price's analysts to identify high-quality businesses. Valuation is a secondary consideration; in fact, Wagner's willingness to pay a higher multiple for higher-quality businesses and holding on to stocks that have appreciated contribute to the strategy’s placement in the small-blend category. Specifically, the team looks for companies with sound fundamentals, sustainable competitive advantages, and strong management teams. To emphasize his stock-picking, Wagner keeps the portfolio's sector weightings close to those of the Russell 2000 Value Index benchmark. However, even in traditional value sectors like financials, he opts for higher-quality fare with more-attractive growth prospects, and names such as PennyMac Financial Services PFSI have contributed much to performance on his watch.

Wagner and his team focus on the long term. Portfolio turnover has averaged just 22% under Wagner, less than half the rate of its typical peer. Wagner's patience and large portfolio of roughly 300 stocks help him handle the strategy's hefty $13 billion in total assets. T. Rowe Price's planned reorganization in 2022 should also afford the strategy some additional capacity because Wagner will have less in-house competition.

This portfolio's sector weightings hew close to those of its Russell 2000 Value Index benchmark, but bottom-up security selection determines positioning in this diversified portfolio. The team hunts for stocks with market caps below $5 billion at the time of purchase, but it will hold on to names that have run up. As of September 2020, a handful of stocks, including Afterpay AFTPY and Pool Corp POOL, had increased to over $10 billion in market cap. As a result, the portfolio's average market cap of $2.1 billion was above the bogy's $1.4 billion.

Wagner's focus on company quality before valuation results in the portfolio looking mixed on valuation characteristics. For example, its average price/sales and price/book ratios land below the typical small-blend category peer's, while its average price/earnings ratio ranks above its average rival's. The portfolio also looks more expensive when compared with the benchmark, but it's higher quality. It boasts higher returns on invested capital, returns on assets, and returns on equity and a lower debt/capital ratio.

Finally, a long holding period and a sprawling portfolio of roughly 300 stocks help Wagner navigate the strategy's growing asset base, but flexibility is still limited. For example, Wagner's investments in tiny companies can amount to sizable ownership stakes of 5% or more and could prove tough to liquidate if needed.

People | Above Average Capable manager David Wagner helms the strategy and draws upon T. Rowe Price's talented analyst bench. Despite upcoming organizational changes, Wagner will retain access to key personnel, and the timeline affords him ample time to fill any gaps. As such, the strategy retains an Above Average People rating.

Wagner has led this strategy since June 2014 but has been involved for longer. He served as the strategy's associate portfolio manager starting in 2005 under longtime manager Preston Athey until his retirement in 2014. That gave Wagner ample time to familiarize himself with the portfolio's holdings and the strategy's approach. Further, he boasts more than 20 years of industry experience.

Wagner leans heavily on T. Rowe's well-regarded analyst team for insights, but with an upcoming organizational change he will lose access to some resources. T. Rowe Price Group announced in November 2020 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. Wagner will be part of the new entity, but he thinks its positives outweigh the negatives. He will retain access to most of the analysts on whom he has relied.

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 the firm'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 Price 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 Price is evolving from a business standpoint. It's broadening distribution outside the United States, expanding its environmental, social, and governance 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.

Performance The strategy boasts a decent track record under manager David Wagner. From his June 2014 start through December 2020, the 8.6% annualized return of the fund's oldest share class outpaced both its Russell 2000 Value Index benchmark and average small-cap blend category peer by 2.5 and 1.8 percentage points, respectively. It trailed the Russell 2000 Index by 1.0 percentage point, though, as value stocks have trailed growth stocks in recent years and the portfolio's underweightings to growthier segments like healthcare and technology have hurt.

Because Wagner keeps the portfolio's sector weightings close to those of the Russell 2000 Value Index, stock selection drives performance, and that's true versus the core benchmark as well. Morningstar's attribution suggests that picks such as Quidel QDEL and Cable One CABO have added value.

Wagner's emphasis on identifying high-quality companies with strong fundamentals has helped in downdrafts. Under his watch, the fund's downside-capture ratio relative to the Russell 2000 Value Index was an impressive 84% while still managing to catch 95% of its upside. Its diversified approach also results in less volatility, as shown in the modest standard deviation of the fund's returns relative to its bogies.

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 Silver.