T. Rowe Price Thrives Despite a Tumultuous 2013

On Dec. 31, 2013, Morningstar issued a new Stewardship Grade for T. Rowe Price. The firm's overall grade--which considers corporate culture, fund board quality, fund manager incentives, fees, and regulatory history--is an A. What follows is Morningstar's analysis of the firm's corporate culture, for which T. Rowe Price receives an A. This text, as well as analytical text on the other four Stewardship Grade criteria, is available to subscribers of Morningstar's software for advisors and institutions: Morningstar Advisor Workstation(SM), Morningstar Office(SM), and Morningstar Direct(SM).

T. Rowe Price has long provided a good experience for mutual fund investors. Its reasonably priced lineup includes many appealing funds that have experienced relatively little churn in investment strategy and management through the years. T. Rowe's disciplined and risk-aware investment process, which relies on in-house fundamental research, has consistently turned in peer-beating performances across the board. Of the 54 funds Morningstar's analysts rated as of December 2013 (which totaled roughly 82% of the firm's mutual fund assets), 47, or 87%, were Morningstar Medalists, and no fund received a Negative rating. The firm has historically been a model for how a large, publicly traded fund company can successfully operate without jeopardizing fund investors' interests.

Considering those high standards then, 2013 looks like a tumultuous year for T. Rowe, at least in one area. Not much went wrong on the performance side: Two thirds of its funds outperformed their respective categories, and long-term results remain stellar. However, the firm, known for its organizational stability, saw more departures than usual in 2013, including two highly regarded managers and five domestic-equity analysts.*

That most of the departures happened suddenly did not help matters; the firm has historically given fundholders ample notice of upcoming changes and has had the luxury of long transition periods. In February, 13-year manager Kris Jenner of  T. Rowe Price Health Sciences (PRHSX) announced he was leaving to start his own venture. And he took two of the firm's more-experienced health-care analysts with him, striking an even bigger blow to the team. Because he is a doctor by training, Jenner's background helped in analyzing complex biotechnology and pharmaceutical companies, which fed into T. Rowe Price Health Sciences and others across the complex, often with successful results. In fact, health-care picks such as  Regeneron Pharmaceuticals (REGN) have been big contributors to many diversified funds in recent years, meaning the departures were felt well beyond the shareholders of T. Rowe Price Health Sciences.  

Three months later, Joe Milano of  T. Rowe Price New America Growth (PRWAX) announced his resignation. Milano produced a strong record during nearly 11 years at the large-growth fund but wanted to strike out on his own to start a mid-cap hedge fund, a market-cap range that played a limited role at T. Rowe Price New America Growth. While he didn't run one of the firm's biggest funds assetwise, his thoughtful nature, hands-on approach to research, and interest in instilling T. Rowe's investment process in analysts made his presence at the firm invaluable. 

The departures were unusual given that most manager changes at T. Rowe are driven by retirements and are well telegraphed in advance. (For instance, longtime manager Preston Athey of  T. Rowe Price Small-Cap Value (PRSVX) announced his June 2014 retirement in August 2012.) That Jenner and Milano both left to start up their own shops also raises the question of whether T. Rowe has become too big and bureaucratic, getting away from the small-company mentality that prevailed years ago when it was smaller. The firm has added management layers over time, perhaps necessary given its tremendous growth. Indeed, in the past 20 years the firm has had net outflows in only one year calendar year--2000--and it's now the industry's sixth-biggest fund manager.

Still, there's not necessarily reason to think the firm's culture is deteriorating or that there's significant flight risk for other managers (besides retirements). Many of the firm's longest-tenured managers are likely to stick around given that they've produced strong long-term records, are well compensated, and work at a stable and collegial organization. Branching out and starting a new venture--particularly for managers closer to the end of their careers than the beginning--is not extremely likely, and it's hard to imagine them fleeing for another large competitor. The fact that the firm is in a strong financial position and that  T. Rowe Price Group's (TROW) stock--a part of portfolio managers' compensation--has performed well doesn't hurt, either.

Flight risk may be more of a concern on the analyst team, which, given the firm's history of promoting from within, presumably includes the next generation of managers. Occasional turnover is expected for the roughly 200-member global analyst team, but experiencing five departures on the domestic-equity side in 2013 was unusual. A weak intern class in 2012 meant the firm didn't have the back-fill it normally does, which particularly hurt after Jenner and two health-care analysts exited. T. Rowe has since filled those slots by promoting the most experienced team member to manage T. Rowe Price Health Sciences, moving a technology analyst over, hiring externally, and adding an extra "team analyst" for general support. While the health-care team is fully staffed, the members are still ramping up and adjusting to coverage changes, so it's not as strong as before.

T. Rowe recognizes that most analysts don't want to be in that role forever, but portfolio manager opportunities can be scarce: Managers tend to stick around (42 funds have managers with 10-plus years' tenure), and the firm doesn't launch a lot of new funds. Analysts are well compensated and can pursue other career paths, including associate portfolio managers, who are highly involved in the investment process, and directors of research, who oversee analysts. However, analysts waiting in the wings could still jump ship if they're passed over when opportunities do come up, a problem that is not necessarily unique to T. Rowe. It begs the question of whether recently launched  T. Rowe Price Global Industrials (RPGIX), run by an analyst and the firm's first sector fund in several years, was an attempt to retain talent. However, it's unlikely to see a slew of niche funds rolled out for this reason. T. Rowe has a good record of sensible fund launches, which in 2013 included  T. Rowe Price Global Allocation (RPGAX) and a second target-date series, and it's generally avoided flavor-of-the-moment strategies that investors may not use well.

In other ways, the firm has looked out for fund investors' interests. In August it banned participants in American Airlines' 401(k) plan who were making frequent short-term trades, which can prove disruptive to fund managers and long-term shareholders. The firm has closed funds with growing asset bases, including  T. Rowe Price Small-Cap Stock  (OTCFX) and  T. Rowe Price New Horizons (PRNHX) in 2013. Shareholder letters are thoughtful, and T. Rowe's website is easy to use.

The firm's strong financial health has allowed it to add resources where needed. On the fixed-income side, that's meant upping the analyst headcount to 74 in 2013 from 33 in 2007. The greatest increase came on the quantitative side as the firm built out its risk and attribution technology platform starting in 2008. Five emerging-markets corporate analysts were hired in the past few years, which the firm views as an increasingly important asset class. (It's since launched two related bond funds.) Additional sovereign and high-yield analysts joined, too. Meanwhile, technology improvements across the organization have helped the investment staff globally share information more easily.

T. Rowe remains in a position to succeed. Its funds have excelled through a diversified, risk-conscious approach, benefiting from strong security-specific research. The average T. Rowe fund lands in its category's top third or better for the trailing three-, five-, and 10-year periods through December, a remarkable sign of consistency for a lineup of more than 100 funds. Experienced leaders remain on board, many of whom have spent their careers at the firm. T. Rowe's long-term success relies on its veterans institutionalizing T. Rowe's process in newer hires and strengthening the firm's research by traveling and interacting with the analysts. That's how many of T. Rowe's best managers learned, and it remains integral to the firm's future success, especially as the old guard retires.

More than anything, T. Rowe does not want to become average, a legitimate concern for an organization that's experienced such robust growth over the past few decades and that's done so on the back of strong risk-adjusted performance from a variety of strategies and managers. That's why the firm has stuck to its knitting with fund launches and handles planned manager departures with care. Retaining analyst and manager talent is critical as well. Unexpected departures cannot be guarded against completely, and as 2013 proved, they can occur more than usual. But T. Rowe's reputation and strong fund performance help in this respect, as managers and analysts might not be as willing to flee as they would at a firm on a downward spiral. Overall, T. Rowe's corporate culture remains in top shape.

*On Jan. 16, 2014,  T. Rowe Price Growth Stock (PRGFX) manager Rob Bartolo resigned from the firm. Manager departures were considered in the December 2013 review but were not material enough to affect the firm's stewardship grade. However, stewardship is reviewed annually, and Morningstar will continue to monitor T. Rowe Price's manager and analyst retention. 

This article is the corporate culture portion of the Morningstar Stewardship Grade for T. Rowe Price. Click here to see Morningstar's Stewardship Grade for funds methodology.