How T. Rowe Price rows its boat

Kiplinger's Personal Finance Magazine, Feb, 1998 by Robert Frick

In Baltimore's Inner Harbor, across the street from T. Rowe Price headquarters, sits an empty pier where the U.S.S. Constellation usually floats. The 19th-century sloop, described as 1,400 tons of "rotting vegetable matter," is in dry dock now, stripped to the waterline as it is rebuilt, plank by plank. T. Rowe Price is helping to pay for the restoration -- and it can easily afford to because its own plank-by-plank reconstruction has made it arguably the most successful mutual fund company of the past several years.

The engine driving T. Rowe Price's growth is stock-fund performance. Every actively managed domestic equity fund but two has beat the average returns of its peers in the most recent five-year period. Half are in the top 30% of their investment categories, and almost an produced those superior returns with below-average risk.

Fund investors have rewarded T. Rowe Price for its solid numbers. Since 1990 assets managed have risen from $29 billion to more than $125 billion, and the company's stock price has rocketed almost tenfold. To underscore the key role of the stock funds' performance: The amount invested in T. Rowe Price stock funds in 1990 was less than half that in bond and money-market funds. Now it's three times as much.

While the Constellation's rehab will take three years, the makeover of T. Rowe Price consumed a decade, dating back to the early 1980s, when meetings with investors were reminiscent of Mutiny on the Bounty. But instead of raiding other fund companies for top people to turn the ship around, the company set out to develop its own talent, and in the process junked old habits and created new traditions to give its analysts and fund managers a water-tight culture built on teamwork and individual accountability.

The low turnover of fund managers and analysts, and the consistently good performance at T. Rowe Price, tell a lot about how well the system works, says Russel Kinnel, equity editor at Morningstar Mutual Funds, the fund-analysis publication: "They get people who aren't the type to sell themselves to the highest bidder -- fidelity and Putnam get those types. I think both cultures work, but at T. Rowe you get a lot more stability."

This one-for-all-and-all-for-one environment has meant that its funds tend to rise and sink together. Unfortunately for investors, 1997 was a year when T. Rowe Price took on water -- almost 60% of the company's stock funds were in the bottom half of their categories, only three managed to reach the top one-third. You're entitled to ask: Has success spoiled yet another mutual fund company?

A "GROWTH SHOP" LEARNS NEW TRICKS

From the time Thomas Rowe Price Started the firm in 1937, his company was known as a growth-stock shop. That tradition continued until the 1970s, when the company was caught with its financial pants around its ankles: It held many grossly overpriced issues trading for 40 times earnings just as the 1973-74 bear market struck. Those stocks plummeted, in many cases to fractions of their precrash price's, and along with them went some of the firm's luster.

By the end of the 1970s, when energy stocks were soaring, the company became enamored of oil stocks; at one point, it had five analysts covering the sector, while other broad segments of the economy were ignored. The present director of research (and spiritual guru), James Kennedy, remembers volunteering to cover railroads as a junior analyst because he thought they were about to surge. He was told, "We're a growth-stock shop. We've never owned a steel company; we've never owned a railroad."

Getting any new idea into the pipeline wax a chore. Analysts had to write elaborate reports to be reviewed by the investment committee. By the time an idea was approved -- and only stocks on the approved list could be used by fund managers -- several weeks and a boat-load of opportunity might have passed.

Clearly changes needed to be made, and as luck would have it, a wave of new managers rose to the top ranks just as the great bull market of the 1980s began to roll. M. David Testa (now a T. Rowe Price managing director and head of stock investing) became chairman of the investment policy committee in 1982 and made his first official act his last -- he disbanded it. Also gone were many of the portfolio managers whose talent lay in entertaining clients, not in picking stocks. You schmooze, you lose. The number of managers plummeted as the number of analysts rose, reflecting a stronger emphasis on research.

Other fundamental changes followed. Analysts and portfolio managers, who used to be on separate floors, were brought together; satellite offices in New York City and Washington, D.C., were closed and consolidated in Baltimore; and bright young analysts and managers who liked investing in undervalued stocks got the go-ahead to do just that. The value philosophy gradually suffused the entire company, until today good returns with low volatility are part and parcel of all the T. Rowe Price funds. "Even our aggressive funds are in at the value end," says James Riepe, who oversees all of the mutual funds.