Objective and Strategy
The fund tries to protect investors against the effects of inflation by investing in stocks which give you direct or indirect exposure to “real assets.” Real assets include “any assets that have physical properties.” Their understandably vague investment parameters include “energy and natural resources, real estate, basic materials, equipment, utilities and infrastructure, and commodities.” A stock is eligible for inclusion in the fund so long as at least 50% of company revenues or assets are linked to real assets. The portfolio is global and sprawling.
T. Rowe Price. Price was founded in 1937 by Thomas Rowe Price, widely acknowledged as “the father of growth investing.” The firm now serves retail and institutional clients through more than 450 separate and commingled institutional accounts and more than 90 stock, bond, and money market funds. As of December 31, 2011, the Firm managed approximately $489 billion for more than 11 million individual and institutional investor accounts.
Wyatt Lee handles day-to-day management of the fund and chairs the fund’s Investment Advisory Committee. The IAC is comprised of other Price managers whose expertise and experience might be relevant to this portfolio. Mr. Lee joined Price in 1999. Before joining this fund he “assisted other T. Rowe Price portfolio managers in managing and executing the Firm’s asset allocation strategies.”
Management’s Stake in the Fund
As of December 31, 2011, Mr. Lee has under $10,000 invested in the fund but over $1 million invested in Price funds as a whole. None of the fund’s eight trustees had chosen to invest in it.
From July 28, 2010 to May 1, 2011, PRAFX was managed by Edmund M. Notzon and available only for use in other T. Rowe Price mutual funds, mostly the Retirement Date series. It became available to the public and Mr. Lee became the manager on May 1, 2011.
$2,500 for regular accounts, $1000 for IRAs.
0.85% on assets of $2.5 billion. There’s a 2% redemption fee for sales of shares held fewer than 90 days and a $20 service fee on accounts under $10,000.
PRAFX was created to respond to a compelling problem. The problem was the return of inflation and, in particular, the return of inflation driven by commodity prices. Three things are true about inflation:
- It’s tremendously corrosive.
- It might rise substantially.
- Neither stocks nor bonds cope well with rising inflation.
While inflation is pretty benign for now (in 2011 it was 3.2%), In the ten year period beginning in 1973 (and encompassing the two great oil price shocks), the annual rate of inflation was 8.75%. Over that decade, the S&P500 lost money in four years and returned 6.7% annually. In “real” terms, that is, factoring in the effects of inflation, your investment lost 18% of its buying power over the decade.
Price, which consistently does some of the industry’s best and most forward-thinking work on asset classes and asset allocation, began several decades ago to prepare its shareholders’ portfolios for the challenge of rising inflation. Their first venture in this direction was T. Rowe Price New Era (PRNEX), designed to cope with a new era of rising natural resource prices. The fund was launched in 1969, ahead of the inflation that dogged the 70s, and it performed excellently. Its 1973-1882 returns were about 50% higher than those produced by a globally diversified stock portfolio. As of September 2012, about 60% of its portfolio is linked to energy stocks and the remainder to other hard commodities.
In the course of designing and refining their asset allocation funds (the Spectrum, Personal Strategy and Retirement date funds), Price’s strategists concluded that they needed to build in inflation buffers. They tested a series of asset classes, alone and in combination. They concluded that some reputed inflation hedges worked poorly and a handful worked well, but differently from one another.
- TIPs had low volatility, reacted somewhat slowly to rising inflation and had limited upside.
- Commodities were much more volatile, reacted very quickly to inflation (indeed, likely drove the inflation) and performed well.
- Equities were also volatile, reacted a bit more slowly to inflation than did commodities but performed better than commodities over longer time periods
- Futures contracts and other derivatives sometimes worked well, but there was concern about their reliability. Small changes in the futures curve could trigger losses in the contracts. The returns on the collateral (usually government bonds) used with the contracts is very low and Price was concerned about the implications of the “financialization” of the derivatives market.
Since the purpose of the inflation funds was to provide a specific hedge inside Price’s asset allocation funds, they decided that they shouldn’t try an “one size fits all” approach that included both TIPs and equities. In consequence, they launched two separate funds for their managers’ use: Real Assets and Inflation-Focused Bond (no symbol). Both funds were originally available only for use in other Price funds, Inflation-Focused Bond (as distinct from the public Inflation-Protected Bond PRIPX) remains available only to Price managers.
How might you use PRAFX? A lot depends on your expectations for inflation. PRAFX is a global stock fund whose portfolio has two huge sector biases: 38% of the portfolio is invested in real estate and 35% in basic materials stocks. In the “normal” world stock fund, those numbers would be 2% and 5%, respectively. Another 16% is in energy stocks, twice the group norm. The relative performance of that portfolio varies according to your inflation assumption. The manager writes that “real assets stocks typically lag other equities during periods of low or falling inflation.” In periods of moderate inflation, “it’s a crap shoot.” He suggested that at 2-3% inflation, a firm’s underlying fundamentals would have a greater effect on its stock price than would inflation sensitivity. But if inflation tops 5%, if the rate is rising and, especially, if the rise was unexpected, the portfolio should perform markedly better than other equity portfolios.
Price’s own asset allocation decisions might give you some sense of how much exposure to PRAFX might be sensible.
|%age of the portfolio in PRAFX, 9/2012|
|Retirement 2055 (TRRNX)||
|Price Personal Strategy Growth (TRSGX)||
|T. Rowe Price Spectrum Growth (PRSGX)||
|Retirement 2020 (TRRBX)||
|Retirement Income (TRRIX)||
If you have a portfolio of $50,000, the minimum investment in PRAFX would be more (5%) than Price currently devotes in any of its funds.
Mr. Lee is a bright and articulate guy. He has a lot of experience in asset allocation products. Price trusts him enough to build his work into all of their asset allocation funds. And he’s supported by the same analyst pool that all of the Price’s managers draw from. That said, he doesn’t have a public record, he suspects that asset allocation changes (his strength) will drive returns less than will security selection, and his portfolio (315 stocks) is sprawling. All of those point toward “steady and solid” rather than “spectacular.” Which is to say, it’s a Price fund.
Mr. Lee believes that over longer periods, even without sustained bursts of inflation, the portfolio should have returns competitive with the world stock group as a whole. New Era’s performance seems to bear that out: it’s lagged over the past 5 – 10 years (which have been marked by low and falling inflation), it’s been a perfectly middling fund over the past 15 years but brilliant over the past 40. The fund’s expenses are reasonable and Price is always a responsible, cautious steward. For folks with larger portfolios or premonitions of spiking resource prices, a modest position here might be a sensible option.
I own shares of PRAFX in my retirement portfolio. Along with Fidelity Strategic Real Return (FSRRX) inflation-sensitive funds comprise about 4% of my portfolio.© Mutual Fund Observer, 2012. All rights reserved. The information here reflects publicly available information current at the time of publication. For reprint/e-rights contact us.