Wide-Ranging Success for T. Rowe Price Capital Appreciation

Jason Stipp: I'm Jason Stipp for Morningstar. It's Beat the Market Week on Morningstar.com and one of the managers we are profiling is David Giroux, the manager of T. Rowe Price Capital Appreciation. That's a Gold-rated fund by Morningstar analysts. We are checking in with Greg Carlson, the analyst on that fund, to understand why it's been so successful over time.

Greg, thanks for joining me.

Greg Carlson: Absolutely, Jason.

Stipp: This fund has had remarkable longer-term performance in its category. It's a moderate-allocation fund. That means it owns stocks and bonds. What do you think is the secret to the success that this fund has had over the years?

Carlson: It's interesting. I think it's a mixture of strategy and execution. The fund has had great success under several different managers. David Giroux took over in 2006. He's done a bang-up job, probably a little better [than his predecessors], and improved the record, which was already fantastic.

The fund has long been very well diversified, which kind of plays to T. Rowe Price's strengths because they have expertise across a broad range of asset classes, and types of stocks and bonds.

The fund does own stocks and bonds, but it's not really a traditional balanced fund so much. It's a little more wide ranging. It will own equities. It will own traditional bonds. But it will also own bonds that are called leveraged loans. It will own convertible bonds, preferred bonds. It will do a little bit of option writing at times, covered calls. And it will own a significant cash stake at times.

Stipp: What does that mean for how this fund might perform versus other funds in that category, given that it is a little bit more wide-ranging?

Carlson: Under David Giroux, it's had a little more equity exposure, both through a bigger equity stake and the equity sensitivity of some of the bonds it owns. So it's been a little more volatile, but it's been very rewarding.

Stipp: And a good time to have that kind of exposure over the last several years, obviously.

This fund has, probably because of its long-term record, become quite popular with investors. It's gained a lot of assets. What do you think about the level of assets now and the ability of the manager to be able to continue to execute? Do you think assets at that level could start to become a problem?

Carlson: If flows continue to pour in, I think it could be an issue. But they are keeping a close eye on capacity.

Flows, I should point out, have been significant but not huge. Some of the fund's growth has been obviously through stock market appreciation. The fund took in $1 billion in 2012, $2.2 billion last year, about $600 million in the first quarter of this year. So it's on a pace for $2 billion to $3 billion a year, and the fund has got about $20 billion in assets. And David Giroux runs another close to $10 billion in the strategy.

He has addressed capacity to some degree by adding resources. He's got an assistant portfolio manager. He's got two dedicated research assistants, who help him spot stocks more quickly. He is also looking to hold stocks for a longer period. He sold some stocks too early, and he started extending his time horizon a bit.

Stipp: So you would say right now, the asset level is something to keep an eye on, but it's not really a worry sign yet, given that they've added some research capacity and they are still continuing to execute well?

Carlson: Yes. And they haven't really [had to] alter the portfolio to accommodate that size. They want to add Treasuries, which is something they have avoided because of the low yields, but they really haven't. They are just now dipping their toe in. But I expect if Treasury yields rise, they will own more of those, and obviously that's a very liquid asset.

Stipp: What kind of investor do you think a fund like this is good for? What sort of profile might this be a good option?

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Carlson: Someone who's looking for equity-like exposure with a bit less volatility. The fund's real aim is to beat the S&P 500 with less volatility, and it's done that.

Stipp: We know that by looking at investor returns, investors sometimes will buy great funds, but they will buy them at the wrong time, or they won't sit through some tougher times, when a fund doesn't look as good.

So what should you know if you're an investor buying this moderate allocation fund? When might it not look so great and you maybe just need to ride it out? What do you need to know going in?

Carlson: If there's a sharp downturn, it might not look so great, because of its increased equity exposure. At the end of 2013, it had 66% in stocks, and some of its bonds were a little more equity sensitive. A typical moderate allocation fund is more around 60%. But I should point out, even with that kind of profile, if you go back to 2008, the fund landed in the middle of its category. It didn't really underperform.

Stipp: So it's been pretty smooth sailing for investors in this option.

Just to get a little bit of a broader view, what other funds do you think investors might want to consider if they're looking for a really good moderate allocation or balanced fund?

Carlson: I think FPA Crescent is a great option, run by Steve Romick. That fund won the Allocation Manager of the Year Award for 2013. T. Rowe Price Capital Appreciation won for 2012. FPA Crescent tends to hold a big cash stake, and sometimes it's about 50-50 equities and cash. But other times he will add to equities and also own some unusual debt instruments as well. It's a little bit of a nontraditional moderate allocation fund, too.

If you are looking for a more traditional balanced fund, I'd say Vanguard Wellington is a fabulous choice. A little more equity exposure, similar to T. Rowe Capital Appreciation, but they're more willing to own high-quality bonds. So, volatility has been moderate there.

Stipp: Greg, excellent insights on these great funds. Thanks for joining me today.

Carlson: Absolutely. Thanks, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.