The mutual-fund giant plans to launch a new investment advisor platform called T. Rowe Price Investment Management in 2022.
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T. Rowe Price Group, one of the largest U.S. fund companies, will split itself into two independent entities in the next two years. The move is somewhat unusual, but not unexpected. When it happens, investors might have a chance to access some of the firm’s long-closed funds.
The mutual-fund giant, which has more than $1 trillion assets under management, announced last week that it plans to launch a new investment advisor platform called T. Rowe Price Investment Management in the second quarter of 2022. The company will move six existing investment strategies to the new entity, including three small-cap, one midcap, one high-yield bond, and one cross-asset fund, representing a combined $167 billion in assets.
The new platform will still be wholly owned by T. Rowe Price (ticker: TROW), but stay entirely independent from the legacy T. Rowe Price Associates. Once divided, the two platforms will have separate leadership, research, and trading teams, and will no longer share resources with each other.
According to the company, the day-to-day management of the transferred funds shouldn’t be affected by the split. Although some supporting analysts might be different than before, there are no planned changes for current portfolio managers. Still, investors should know why T. Rowe Price is making the move and how this could affect them down the road.
More Isn’t Always Merrier
The rationale behind T. Rowe Price’s split is a well-known challenge among active asset managers—capacity constraint. While it’s generally a good thing when a fund is successful in growing assets, a unique challenge can occur if a fund becomes too big in size.
“The actively managed strategies can sometimes have a pretty tight universe of holdings. When new money comes into the door, it needs to be put to work,” Todd Rosenbluth, director of exchange-traded fund and mutual fund research at CFRA Research tells Barron’s. “If the product is successful, a concentrated portfolio can relatively quickly bump up its stakes in certain stocks, especially the smaller-size companies.”
This can be trouble for a fund when its favored positions stop being favored. “If they want to exit the position or scale back, they’re constrained because it takes time to take action on such a large holding,” says Rosenbluth. “Especially for small stocks with less liquidity, it can be costly and cumbersome to sell the position. Other investors might also take notice and short the stock. The fund company might end up getting a much lower price than it might have otherwise.”
Capping the Stakes
That’s why many active managers have self-imposed rules to limit their footprint in a particular stock. As the fund grows in assets, they can avoid oversize holdings by diversifying the portfolio. But that often means managers won’t be able to buy as much of their favored companies as they would like to. That can be a drag on performance.
“If a fund gets too big, it can really disrupt the investment process,” Katie Rushkewicz Reichart, director of equity strategies at Morningstar, tells Barron’s. “Sometimes the portfolio changes a lot, where they’ll have to double the number of holdings just to accommodate the asset growth.”
For small-cap fund managers, the task has become especially difficult over the past decade due to a shrinking universe of smaller companies. Since 2006, the number of companies under $9 billion market cap in the Wilshire 5000 index decreased by 36%, from 4,581 to 2,942. This has left stock pickers with fewer options to choose from, while having to keep the size of individual holdings under limits.
Instead of being forced to diversify the portfolio, capping the funds’ size might be a more responsible way to protect performance and the interest of existing investors. That’s what many active fund managers have been doing for years.
T. Rowe Price currently has 10 strategies—representing 30% of the total assets under its U.S. equity division—either closed to new investors or with a constrained ability to take in new assets, despite their strong performance record. “That’s a lot of investors that have not been able to participate,” says Rosenbluth.
The T. Rowe Price Mid-Cap Growth fund (RPMGX), which is being moved to the newly created entity, has been closed since 2010. In addition, two other funds set to be transferred— T. Rowe Price Capital Appreciation (PRWCX) and T. Rowe Price Small-Cap Stock (OTCFX)—are also closed or have limited access to investors.
Breaking the Constraints
Keeping these strategies closed, however, can cut into the potential revenue stream of fund companies, which charge a certain percentage fee of the total assets being managed. T. Rowe Price has been trying to find a way to free itself from this capacity constraint.
Simply launching a new fund isn’t enough. Within large asset managers like T. Rowe Price, portfolio managers—despite managing different funds—typically rely on the same research insight from the company’s centralized team of analysts and strategists, and therefore tend to move in coordination.
“You can open up a second small growth fund, but analysts are presenting the same ideas to both of the managers and they are going to want to buy the same stock,” says Reichart, “It would still be difficult for T. Rowe Price to stick to the ownership limits as an entire entity.”
That’s why T. Rowe Price is now launching a completely separate entity that—in theory—could come up with different opinions on the market and new investment ideas. Some stocks might be more popular on one side than the other, mitigating the worries about uniform and oversize positions across the firm. Most important, by having two independent entities, the company is now able to have separate stock-ownership limits on each side of the business. “They’ll have a little more breathing room,” says Reichart.
In an analyst call following last week’s announcement, Eric Veiel, co-head of global equity and head of U.S. equity at T. Rowe Price Associates, described the firm’s pending move as “a natural next step” in its long history of managing investment capacity. “More capacity will give our portfolio managers the opportunity to continue to select the right securities in the right amount at the right time, while adhering to proper management and regulatory rules,” he says.
What It Means for Investors
Investors in T. Rowe Price funds shouldn’t expect to see drastic portfolio changes, though, says Rosenbluth. While fund managers now have more bandwidth to claim bigger stakes in companies they like, he doesn’t think they’ll be taking on much additional risk given the unchanged investment philosophy and other limitations in place.
Instead, the split likely means T. Rowe Price—both T. Rowe Price Investment Management and T. Rowe Price Associates—will be able to reopen some of its closed strategies and grow assets again, although the firm says it doesn’t have immediate plans to do so just yet. The company is still in the process of building up the new entity and hiring additional analysts.
“I think it’s smart for T. Rowe to be cautious about such announcements. They’d want to make sure everything with the new entity is functioning well before trying to get a bunch of new assets at the door,” says Reichart, “Although with this new system—the whole point being to have more capacity to take in new assets—I would imagine to see some reopenings down the line.”
“It’s hard to see the words ‘capacity constraints relieved’ and not thinking that they are going to reopen these closed funds,” says Rosenbluth, “Investors should keep these funds on their radar to see if the performance record can be maintained following the structural change.”
While well-planned and executed, T. Rowe Price’s move isn’t without risks, says Reichart, as some longstanding collaborations will be eliminated. Insight on promising small-cap companies, for example, is often helpful for large-cap managers as well. The new entity will also lose access to the company’s broad global research team.
“Even if a strategy isn’t global in nature, it’s nice to stay informed of global viewpoints and the competitive landscape,” she says, “Building up a second global team would require significant resources, focused effort, and time.”
T. Rowe Price isn’t the first or only fund company that has tried to solve capacity problems through a split. In 1998, Capital Group, the parent company of American Funds, broke into three different equity investment divisions and one fixed-income division to reduce the risk of their respective management and analyst teams focusing on a narrow set of opportunities.
Still, Rosenbluth thinks a spate of similar moves across the industry is unlikely. Actively managed funds in general have been losing assets to index-based ETFs over the past decade, and many of the former are underperforming. In fact, some funds that were previously closed to new investors are now reopened because their assets have shrunk, says Rosenbluth.
That means most smaller active managers likely won’t have to worry about capacity constraints soon. Instead, they should focus on growth and performance first. Closing funds or limiting flows, after all, is a bittersweet problem that comes only after a certain level of success.
Write to Evie Liu at [email protected]
