T. Rowe Price Remains on Top

Morningstar recently 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. 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 a long history of putting investors' interests first. It offers a reasonably priced lineup of sensible funds. The funds employ a risk-conscious investment process driven by fundamental research, which has led to good outcomes for fund shareholders across asset classes. Indeed, 88% of all of T. Rowe's funds landed in the top half of their respective Morningstar Categories for the 10-year period through November (79% and 82% of the funds did the same for the three- and five-year periods, respectively.) The funds have performed well on a risk-adjusted basis, too, typically exhibiting less volatility than peers and making them easy for investors to own. 

Investors have come to appreciate that steady performance. The firm has experienced net inflows to its mutual funds in every calendar year since 2000, even recently as investors have increasingly turned toward passive funds. In 2014, T. Rowe became the fourth biggest manager of open-end mutual fund assets with more than $450 billion in open-end fund assets, moving up from sixth place in 2013. Overall, the company manages more than $700 billion globally.

T. Rowe hasn't been without its challenges, though. The investment team has seen more turnover than normal over the past two years, particularly on the domestic-equity side. Long known for its well-planned manager transitions, T. Rowe experienced a rash of unexpected departures in 2013 and 2014. Kris Jenner of T. Rowe Price Health Sciences (PRHSX) exited to start his own hedge fund in early 2013, taking two health-care analysts with him. The loss of experience in the sector was concerning, particularly on the biotech side, though the team has since stabilized and the fund's performance hasn't suffered. Joe Milano also left in May 2013 to start a hedge fund after leading  T. Rowe Price New America Growth (PRWAX) to a strong 10-year record. He was one of the firm's more independent-minded managers who really shone, both through his research contributions and by mentoring and developing analysts. A domestic stock analyst later left T. Rowe to join Milano. Rob Bartolo of  T. Rowe Price Growth Stock (PRGFX) abruptly exited in early 2014. Those roles were filled by analysts and sector managers, though all three funds received downgrades in their Morningstar Analyst Ratings because of the successors' lack of management experience. 

Other departures have been more orderly. Preston Athey at  T. Rowe Price Small-Cap Value (PRSVX) retired in 2014, and Brian Rogers at  T. Rowe Price Equity Income (PRFDX) plans to step back in late 2015 after 30 years at the fund. Both departures were announced over a year in advance, allowing a long transition process for the incoming manager and minimizing disruption to the end investor--continuing an industry best practice long demonstrated by T. Rowe Price. Those funds' Analyst Ratings were downgraded, reflecting the loss of top managers, but they still remain Morningstar Medalists. The previous experience of Rogers' replacement at another value fund and the fact that Athey's successor had worked with him as associate portfolio manager are encouraging signs. 

More retirements are likely to happen in the coming years, both within the manager and executive management ranks. It's rare for people to stick around T. Rowe in a full-time role well past age 65, and some key people are approaching that age. Rogers, who will retain his role as chairman of  T. Rowe Price Group (TROW) and CIO after stepping down from T. Rowe Price Equity Income in 2015, is 59; CEO James Kennedy is 60; Ed Bernard, T. Rowe's head of distribution and chairman of the fund board, is 58; and several prominent portfolio managers are in their mid-50s. The next generation is promising, and T. Rowe will likely telegraph succession plans well in advance, but it's worth closely watching future developments. 

Turnover on the analyst team also deserves attention. The domestic-equity team had six analyst departures in 2013 and six in 2014's first half, about twice as many as normally would be expected at T. Rowe in a given year. The numbers look particularly stark because there have been some years without any departures. Beyond typical attrition due to performance, some analysts joined competitors or left to work with the ex-T. Rowe managers at their new hedge funds. 

Retaining a top analyst team is critical, and the flux that turnover can create in the short term can be disruptive. For instance, there have been more uncovered domestic-equity stocks over the past couple of years, though that number has trended down as the firm has filled open roles and rotated coverage. So far, performance across the fund lineup hasn't suffered following the departures. 

T. Rowe has ramped up its recruiting efforts at a greater number of business schools to keep a strong pipeline of MBA summer interns, who are typically among its more successful full-time analyst hires. These positions are key to strengthening the analyst bench and keeping stock coverage at an acceptable rate. T. Rowe could also stand to make sure it is casting a wide-enough net in its analyst search to support all investment styles used at the firm. T. Rowe's analyst team has broadly done a good job serving both growth and value managers using a relative-value, growth-at-a-reasonable-price approach. There may be room for a few analysts who think outside that box and bring a slightly different analytical framework, such as an absolute value approach. 

On the plus side, in 2014 T. Rowe tweaked its analyst compensation plan to encourage longer-term thinking and incorporate portfolio impact of the analysts' picks. The one-year period for analysts' ratings was deemphasized, with more consideration of longer periods, up to 10 years if the analyst has been in the role that long. How much impact the analysts' picks have on each fund's performance is now incorporated, versus merely considering whether they got the ratings right. (Qualitative feedback remains an input, too.) The downside is that analysts can't always control how much managers actually act on their recommendations, even if they're right. However, these changes, which are in effect for equity analysts globally, overall provide a better framework that should encourage the analysts to show more conviction in their stock picks, helping get their best ideas into the portfolios and ultimately benefiting the end fund investor. 

Meanwhile, the firm's international equity team has steadily improved. It dates back to 2000, when T. Rowe's joint venture with Robert Fleming Holdings ended and the firm began building out its own analyst team. There were some growing pains to getting the right hires in place, but the team has stabilized under former portfolio manager Chris Alderson's oversight and has actually had fewer departures than its domestic-equity counterpart the past two years. Performance has been decent, too. In aggregate, the funds' median category ranks for the five- and 10-year periods through November were 40 and 35, respectively. Five of the eight funds covered by Morningstar analysts are Morningstar Medalists. The international funds still lag T. Rowe's domestic-equity funds in terms of performance and manager tenure. They also haven't been immune to changes: Bob Smith of  T. Rowe Price International Stock (PRITX) will retire in 2015, and  T. Rowe Price Latin America (PRLAX) also experienced a manager change in early 2014. Even so, the international team has trended upward, which is especially important because those funds have accounted for a good portion of T. Rowe's recent mutual fund inflows. 

Fixed-income has also played a bigger role as T. Rowe tries to better balance out its domestic-equity-heavy fund lineup. That's meant additional head count and several new funds. The fixed-income analyst team grew from 33 in 2007 to 76 in 2014. Part of that jump stems from the addition of 20 quantitative analysts, but other areas saw significant increases as well. The firm started an emerging-markets corporate team from scratch in 2009, anticipating the asset class will become increasingly important. (It launched T. Rowe Price Emerging Markets Corporate Bond (TRECX) in 2012.) The number of sovereign analysts more than doubled in the wake a shaky macro environment. These increased resources will help support T. Rowe Price Global Unconstrained Bond, expected to launch in 2015. Nine high-yield analysts were added as the new issue market expanded, even though  T. Rowe Price High-Yield (PRHYX) closed to new investors in 2012. The firm is gearing up to add T. Rowe Price Global High Income Bond in 2015 and launched T. Rowe Price Credit Opportunities (PRCPX) in 2014. 

That's a lot of new funds, but T. Rowe has taken a measured approach. For instance, management already has capacity limits in mind for T. Rowe Price Global High Income and T. Rowe Price Credit Opportunities given liquidity constraints. T. Rowe has a good record of closing funds, including its prominent small- and mid-cap equity funds,  T. Rowe Price Capital Appreciation (PRWCX), and its existing high-yield bond fund, so there's precedent. It's also encouraging that fixed-income resources were added well in advance of these launches. More broadly, the fixed-income team has experienced low turnover in the analyst and manager ranks. Head of fixed income Mike Gitlin has worked to increase career path opportunities for analysts, such as associate manager and team leader, to keep people motivated and retain talent. Team members have also traveled to overseas offices to improve collaboration globally. 

Target-date funds remain a strong suit of the firm. Performance relative to peers is unmatched, and steady inflows have followed. Some of the manager changes at the underlying equity funds featured in the series bear watching, as do inflows affecting capacity at the underlying funds (some of which are already closed to new investors outside of the target-date series). In 2013 the firm launched a second series with a more conservative glide path for investors worried about market volatility. 

Meanwhile, the firm continues to have strong shareholder communications, and the fund lineup is reasonably priced overall. T. Rowe has taken a careful approach to distribution, too, preferring to roll out new funds that make sense and grow at a reasonable pace. In recent years T. Rowe has hired outside the United States to expand the firm's overseas presence. While this expansion will likely fuel T. Rowe's next wave of growth, the firm's distribution efforts overall remain responsible. Further impact from the equity manager and analyst departures bear watching, but overall T. Rowe remains a cut above the rest and retains its A Corporate Culture grade. 

This article is the Corporate Culture portion of the Morningstar Stewardship Grade for T. Rowe Price. See Morningstar's Stewardship Grade methodology on our corporate website.