UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-CSR
CERTIFIED SHAREHOLDER REPORT OF REGISTERED
MANAGEMENT INVESTMENT COMPANIES
Investment Company Act File Number: 811-07173
T. Rowe Price Personal Strategy Funds, Inc. |
(Exact name of registrant as specified in charter) |
100 East Pratt Street, Baltimore, MD 21202 |
(Address of principal executive offices) |
David Oestreicher |
100 East Pratt Street, Baltimore, MD 21202 |
(Name and address of agent for service) |
Registrant’s telephone number, including area code: (410) 345-2000
Date of fiscal year end: May 31
Date of reporting period: May 31, 2013
Item 1. Report to Shareholders
Personal Strategy Balanced Fund | May 31, 2013 |
The views and opinions in this report were current as of May 31, 2013. They are not guarantees of performance or investment results and should not be taken as investment advice. Investment decisions reflect a variety of factors, and the managers reserve the right to change their views about individual stocks, sectors, and the markets at any time. As a result, the views expressed should not be relied upon as a forecast of the fund’s future investment intent. The report is certified under the Sarbanes-Oxley Act, which requires mutual funds and other public companies to affirm that, to the best of their knowledge, the information in their financial reports is fairly and accurately stated in all material respects.
UPCOMING SHAREHOLDER MEETING
The T. Rowe Price Funds will be holding a shareholder meeting on October 22, 2013. Shareholders will be asked to elect directors and consider changes to certain fundamental policies to permit the funds greater flexibility in managing their investment strategies.
REPORTS ON THE WEB
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Manager’s Letter
Fellow Shareholders
U.S. and international stocks generated robust gains in the 12 months ended May 31, 2013, against a backdrop of accommodative central bank actions, signs of stabilization in the eurozone, and an ongoing, if modest, U.S. economic recovery. Developed equity markets significantly outpaced emerging markets over the period, with Europe posting some of the strongest gains. U.S. bond markets managed a modest overall gain, with high yield securities outperforming higher-quality debt by a wide margin. The Personal Strategy Funds posted strong results and outpaced their benchmarks over the 6- and 12-month periods.
MARKET ENVIRONMENT
Central banks around the world continued to maintain highly accommodative monetary policies over the past 12 months in efforts to spur economic growth. The U.S. Federal Reserve remained committed to keeping interest rates low until the unemployment rate, which currently hovers around 7.6%, falls below its 6.5% target. With gradually improving employment, a strengthening housing market, and benign inflation, the Fed has signaled that it could begin to reduce the size and pace of Treasury and mortgage-backed securities purchases in the months ahead.
Outside the U.S., the European Central Bank’s bond-purchase program (Outright Monetary Transactions, or OMT) has resulted in reduced borrowing costs for the most distressed eurozone countries and eased concerns about the currency union’s future. Widespread austerity measures helped many governments achieve a better balance between revenues and spending, but they were politically contentious and arguably contributed to the ongoing economic recession in many countries. Japanese Prime Minister Shinzo Abe announced a wide-ranging set of reforms designed to wrest the country from the deflationary trap of falling prices and wages that has hampered the economy for most of the past two decades. The Bank of Japan said it would increase the amount of its annual purchases of government bonds by ¥50 trillion (approximately $492 billion) to fight deflation and stimulate growth.
While China’s economy appeared to stabilize at a lower growth level toward the end of 2012, lower first-quarter economic data and other indicators this spring renewed questions about further slowing. However, China has telegraphed for many months that it wants to transition to slower and more sustainable growth after double-digit annual gains in gross domestic product over most of the last decade. In March, China completed a once-in-a-decade leadership transition, and its new president has signaled a willingness to implement significant economic reforms.
Major U.S. stock market indexes produced strong returns in the past year, with many reaching new highs during our reporting cycle. Mid- and small-cap stocks marginally outperformed large-caps for the period, and value shares fared better than growth across all market capitalizations. Non-U.S. developed market stocks also generated strong results over the period, led by developed Europe, Asia, and Japan. Emerging markets trailed developed markets with comparatively modest double-digit gains. Emerging Europe posted the strongest results, followed by Asia and Latin America.
U.S. bond markets managed a modest overall gain, with the Barclays U.S. Aggregate Bond Index rising 0.91% for the one-year period. High yield securities outperformed their higher-quality counterparts. Investment-grade corporate and municipal bonds performed well. Asset-backed and agency securities trailed with slim gains, while mortgage-backed securities declined slightly. Treasuries declined modestly as long-term yields rose during the period.
PORTFOLIO REVIEW AND POSITIONING
Stocks
An overweight to stocks versus bonds helped performance over the 12-month reporting period. The domestic large-cap value stock portfolio was among the funds’ best absolute performers and outpaced its style-specific benchmark. Financials stocks were particularly strong. Diversified financial services companies JPMorgan Chase and Bank of America were two of our best stocks in the sector, with capital markets firm Morgan Stanley also posting solid gains. The health care sector also generated strong results, with Pfizer and Johnson & Johnson among the biggest contributors. The funds’ U.S. large-cap growth stock portfolio posted solid gains but lagged the broader equities markets. Google, the world’s leading Web search engine, Internet shopping giant Amazon.com, and travel website priceline.com were standouts. Apple shares tumbled as investors grew increasingly concerned about the company’s competitive position in smartphones and other products. Our non-U.S. developed markets stocks posted double-digit gains and kept pace with the broader equities markets, but our portfolio lagged its underlying benchmark. Emerging markets equities returns were positive, but the asset class notably trailed the broader equities markets. (Please refer to the portfolio of investments for a complete list of holdings and the amount each represents in the portfolio.)
We continue to favor stocks versus bonds but reduced our overweight during the reporting period. Despite their recent strength, stocks remain reasonably valued and still appear attractive relative to historical valuations. Continued monetary easing from central banks around the world has helped to reduce some of the downside risk, but the uncertain impact of U.S. fiscal policy and austerity measures in Europe are constraining upside potential. More recently, the prospects of potentially less accommodative U.S. monetary policy have contributed to uncertainty in global stock and bonds markets. U.S. corporate balance sheets and profit margins still appear healthy, while earnings and revenue growth appear consistent with modest economic growth. Stocks offer dividend yields that, in many cases, are competitive with bond yields, which remain at historically low levels.
We favor domestic growth stocks over value stocks. A low-growth economy often benefits growth stocks more than value as growth companies tend to rely less on a strong economy to increase corporate earnings. A modest improvement in global economic growth is unlikely to provide a sufficient catalyst for value stocks to outperform. Outside the U.S., we transitioned to a slight overweight to value stocks. Although challenged by muted economic growth, non-U.S. value stocks benefit from attractive valuations and the potential for improvement as systemic risks recede. Valuations currently favor domestic large-cap stocks over small-caps given the latter’s strong performance in recent years.
We recently moved to a modest overweight in non-U.S. equities over domestic stocks as underperformance by non-U.S. equities in 2013 has increased the attractiveness of relative valuations. We are overweight emerging markets equities relative to developed equity markets. However, we trimmed the size of our overweight in light of slower global economic growth, which could constrain growth in export-oriented economies over the short term. We like the prospects for emerging markets over the intermediate term given the potential for stronger economic growth than developed markets, although the sector is likely to see greater differentiation among countries and markets than over the last several years. Weaker global growth and an associated reduction in commodity demand may challenge those economies that are dependent on commodity exports, but other countries that are commodity consumers stand to benefit from lower prices and a potential lessening of inflationary pressures.
We are underweight real assets stocks versus global equities as the prospects for modest global economic growth may weigh on commodity prices. We expect commodities demand to remain subdued as China shifts its growth model away from investments and exports and toward domestic consumption. Although gradual economic improvement supports real estate fundamentals, current valuations appear rich. Over the long term, we believe that exposure to real assets equities, which include sectors such as energy and natural resources, basic materials, real estate, as well as utilities and infrastructure, should expand the funds’ broad diversification and position them to perform well under a variety of market conditions, particularly in periods of rising inflation.
Bonds
Our fixed income allocation generated positive overall returns for the past 12 months and outperformed its benchmark, the Barclays U.S. Aggregate Bond Index. Diversifying sectors such as high yield and emerging markets debt, which are not included in the Barclays benchmark, were strong contributors. Our portfolio of international developed market debt managed a modest gain. An allocation to U.S. investment-grade bonds also generated decent gains, and security selection helped our underlying portfolio outperform its benchmark.
We have an overweight allocation to high yield versus investment-grade bonds. High yield debt remains attractive relative to other fixed income sectors in this low-yield environment, particularly in light of our expectations for gradual economic improvement. In addition, many high yield issuers have improved their financial condition significantly since the 2008 global financial crisis, taking advantage of low interest rates to refinance debt and extend maturities. The tendency for high yield debt to be less sensitive to changes in interest rates is appealing given that interest rates are generally near historical lows and are likely to rise.
We trimmed our allocation to emerging markets debt during the fiscal year but remain modestly overweight versus U.S. investment-grade bonds. The favorable fiscal positioning of many emerging markets sovereign issuers stands in stark contrast to the budget and funding challenges faced by many developed markets. Yield-hungry investors continue to support strong inflows to emerging markets debt although relatively limited liquidity means that emerging markets debt is susceptible to shifts in investor inflows. We are underweight non-U.S. developed market debt relative to U.S. investment-grade bonds based largely on currency expectations, particularly the potential for a weaker Japanese yen. Recent European Central Bank actions have enhanced financial stability in the eurozone and, as a result, reduced the perceived safe-haven appeal of the U.S. dollar. However, the dollar should continue to benefit from improving economic growth and the potential for higher interest rates.
PERFORMANCE COMPARISON
Personal Strategy Income Fund
As shown in the Performance Comparison table, the Personal Strategy Income Fund gained 6.04% and 14.21% for the 6- and 12-month periods ended May 31, 2013, respectively. The fund outpaced its combined index portfolio, Morningstar benchmark, and Lipper peer group index for both periods.
Security selection was the primary contributor to the fund’s outperformance versus its combined index portfolio over the past 12 months. Most of our underlying portfolios outperformed their respective style-specific benchmarks, led by domestic large-cap value stocks. U.S. large-cap growth stocks and emerging markets stocks also contributed to relative performance, while our non-U.S. developed markets stock portfolio detracted from relative results. The fund’s domestic investment-grade bond portfolio and its non-U.S. bonds from developed and emerging markets were also solid contributors. Diversifying allocations to sectors not included in the fund’s broad fixed income benchmark (the Barclays U.S. Aggregate Bond Index) were positive for the 12-month period. Our exposure to emerging markets debt and high yield bonds was particularly helpful. Our portfolio of real assets stocks provided solid absolute returns and outperformed its style benchmark, but it weighed on results versus our blended equity benchmark as the sector generally underperformed the broader equities markets. Our decision to overweight stocks versus bonds helped relative results because, on the whole, equity markets significantly outperformed fixed income markets. Please see the Portfolio Review and Positioning section for more information.
At the end of the reporting period, the fund’s target allocations were 44.0% equities and 56.0% bonds and cash. Both targets were unchanged from our last report on November 30, 2012. The actual allocations may differ from the target allocations due to investment time horizon, market conditions, trading environment, and other factors.
Personal Strategy Balanced Fund
As shown in the Performance Comparison table on page 8, the Personal Strategy Balanced Fund gained 8.83% and 19.13% for the 6- and 12-month periods ended May 31, 2013, respectively. The fund outpaced its combined index portfolio, Morningstar benchmark, and Lipper peer group index for both periods.
Security selection was the primary contributor to the fund’s outperformance versus its combined index portfolio over the past 12 months. Most of our underlying portfolios outperformed their respective style-specific benchmarks, led by domestic large-cap value stocks. U.S. large-cap growth stocks and emerging markets stocks also contributed to relative performance, while our non-U.S. developed markets stock portfolio detracted from relative results. The fund’s domestic investment-grade bond portfolio and its non-U.S. bonds from developed and emerging markets were also solid contributors. Our decision to overweight stocks versus bonds helped relative results because, on the whole, equity markets significantly outperformed fixed income markets. Diversifying allocations to sectors not included in the fund’s broad fixed income benchmark (the Barclays U.S. Aggregate Bond Index) were positive for the 12-month period. Among these, our exposure to emerging markets debt and high yield bonds were particularly helpful. Our portfolio of real assets stocks provided solid absolute returns and outperformed its style benchmark, but it weighed on results versus our blended equity benchmark as the sector generally underperformed the broader equity markets. Please see the Portfolio Review and Positioning section for more information.
At the end of the reporting period, the fund’s target allocations were 64.0% equities and 36.0% bonds and cash. Both targets were unchanged from our last report on November 30, 2012. The actual allocations may differ from the target allocations due to investment time horizon, market conditions, trading environment, and other factors.
Personal Strategy Growth Fund
As shown in the Performance Comparison table on page 9, the Personal Strategy Growth Fund gained 11.86% and 24.17% for the 6- and 12-month periods ended May 31, 2013, respectively. The fund outpaced its combined index portfolio, Morningstar benchmark, and Lipper peer group index for both periods.
Security selection was the primary contributor to the fund’s outperformance versus its combined index portfolio over the past 12 months. Most of our underlying portfolios outperformed their respective sector- and style-specific benchmarks, led by domestic large-cap value stocks. U.S. large-cap growth stocks and emerging markets stocks also contributed to relative performance, while our non-U.S. developed markets stock portfolio detracted from relative results. The fund’s domestic investment-grade bond portfolio and its non-U.S. bonds from developed and emerging markets were also solid contributors. Our decision to overweight stocks versus bonds helped relative results because, on the whole, equity markets significantly outperformed fixed income markets. Diversifying allocations to sectors not included in the fund’s broad fixed income benchmark (the Barclays U.S. Aggregate Bond Index) were positive for the 12-month period. Among these, our exposure to emerging markets debt and high yield bonds were particularly helpful. Our portfolio of real assets stocks provided solid absolute returns and outperformed its style benchmark, but it weighed on results versus our blended equity benchmark as the sector generally underperformed the broader equity markets. Please see the Portfolio Review and Positioning section for more information.
At the end of the current reporting period, the fund’s target allocations were 84.0% equities and 16.0% bonds and cash. Both targets were unchanged from our last report on November 30, 2012. The actual allocations may differ from the target allocations due to investment time horizon, market conditions, trading environment, and other factors.
OUTLOOK
We expect modest global economic growth over the next several quarters. In the U.S., fiscal policy has helped moderate the deficit as a divided Congress debates a longer-term solution. While the Federal Reserve is maintaining interest rates at current low levels, it may start to wind down its quantitative easing program sooner than expected. The domestic housing market continues to recover as household finances improve and builders respond to pent-up demand. Moderate employment growth and an uptick in personal income further support gradual economic improvement. Healthy balance sheets and good cash flow offer corporations some flexibility in the deployment of capital, which could contribute to increased hiring or capital spending, as well as activities such as stock buybacks or acquisitions.
Outside the U.S., the macroeconomic environment in Europe remains challenging. Resolving the European debt crisis will be a slow process. While fiscal austerity is likely to remain a headwind, eurozone economies may benefit from a shift in policy to ease back on austerity in response to high unemployment and sluggish growth. Japan is taking steps to revive its moribund economy through aggressive, growth-oriented monetary policies and other economic stimulus. However, we await signs that policymakers are politically willing and able to address important structural reforms to labor markets, tax and regulatory regimes, and social spending. Although economic growth in emerging markets appears to be slowing, it remains robust. Over the long term, we believe that China’s growth rates will decline gradually as the economy, in keeping with government policy objectives, shifts to a more sustainable focus on domestic consumption. However, we expect the transition will take several years and produce periods of uneven economic growth and stock market performance.
Markets are likely to be somewhat choppy against a backdrop of modest global economic growth. However, we believe that a highly diversified portfolio and a careful focus on fundamental research can improve our ability to identify investment opportunities on behalf of our shareholders.
Respectfully submitted,
Charles Shriver
Portfolio manager and chairman of the funds’ Investment Advisory Committees
June 19, 2013
The committees’ chairman has day-to-day responsibility for managing the portfolios and works with committees’ members in developing and executing the funds’ investment programs.
RISKS OF INVESTING
As with all stock and bond mutual funds, each fund’s share price can fall because of weakness in the stock or bond markets, a particular industry, or specific holdings. Stock markets can decline for many reasons, including adverse political or economic developments, changes in investor psychology, or heavy institutional selling. The prospects for an industry or company may deteriorate because of a variety of factors, including disappointing earnings or changes in the competitive environment. In addition, the investment manager’s assessment of companies held in a fund may prove incorrect, resulting in losses or poor performance even in rising markets.
Bonds are subject to interest rate risk, the decline in bond prices that usually accompanies a rise in interest rates, and credit risk, the chance that any fund holding could have its credit rating downgraded or that a bond issuer will default (fail to make timely payments of interest or principal), potentially reducing the fund’s income level and share price. High yield corporate bonds could have greater price declines than funds that invest primarily in high-quality bonds. Companies issuing high yield bonds are not as strong financially as those with higher credit ratings, so the bonds are usually considered speculative investments.
Funds that invest overseas may carry more risk than funds that invest strictly in U.S. assets. Risks can result from varying stages of economic and political development; differing regulatory environments, trading days, and accounting standards; and higher transaction costs of non-U.S. markets. Non-U.S. investments are also subject to currency risk, or a decline in the value of a foreign currency versus the U.S. dollar, which reduces the dollar value of securities denominated in that currency.
GLOSSARY
Barclays Global Aggregate ex USD Bond Index: Tracks the performance of government, corporate, agency, and mortgage-related bonds in Europe, the Asia-Pacific region, and Canada.
Barclays U.S. Aggregate Bond Index: An unmanaged index that tracks investment-grade bonds, including corporate, government, and mortgage-backed securities.
Citigroup 3-Month Treasury Bill Index: An unmanaged index that tracks short-term U.S. government debt instruments.
Combined index portfolios: Unmanaged portfolios composed of the following underlying indexes as of May 31, 2013:
- Personal Strategy Income—40% stocks (28% Russell 3000 Index, 12% MSCI All Country World Index ex USA), 40% bonds (Barclays U.S. Aggregate Bond Index), and 20% money market securities (Citigroup 3-Month Treasury Bill Index).
- Personal Strategy Balanced—60% stocks (42% Russell 3000 Index, 18% MSCI All Country World Index ex USA), 30% bonds (Barclays U.S. Aggregate Bond Index), and 10% money market securities (Citigroup 3-Month Treasury Bill Index).
- Personal Strategy Growth—80% stocks (56% Russell 3000 Index, 24% MSCI All Country World Index ex USA) and 20% bonds (Barclays U.S. Aggregate Bond Index).
Credit Suisse High Yield Index: Tracks the performance of domestic noninvestment-grade corporate bonds.
Lipper Mixed-Asset Target Allocation Conservative Funds Index: A peer group benchmark that measures the performance of similar funds with a mix of between 20% and 40% equities, with the remainder invested in bonds and short-term investments.
Lipper Mixed-Asset Target Allocation Growth Funds Index: A peer group benchmark that measures the performance of similar funds with a mix of between 60% and 80% equities, with the remainder invested in bonds and short-term investments.
Lipper Mixed-Asset Target Allocation Moderate Funds Index: A peer group benchmark that measures the performance of similar funds with a mix of between 40% and 60% equities, with the remainder invested in bonds and short-term investments.
Morningstar Moderate Target Risk Index: Represents a portfolio of global equities (fixed at 60%), bonds, and other asset classes.
Morningstar Moderately Aggressive Target Risk Index: Represents a portfolio of global equities (fixed at 80%), bonds, and other asset classes.
Morningstar Moderately Conservative Target Risk Index: Represents a portfolio of global equities (fixed at 40%), bonds, and other asset classes.
MSCI All Country World Index ex USA: An index that measures equity market performance of developed and emerging countries, excluding the U.S.
MSCI Emerging Markets Index: A capitalization-weighted index of stocks from emerging market countries that only includes securities that may be traded by foreign investors.
Russell 3000 Index: An index that tracks the performance of the 3,000 largest U.S. companies, representing approximately 98% of the investable U.S. equity market.
S&P 500 Index: An index that tracks the stocks of 500 primarily large-cap U.S. companies.
Note: Russell Investment Group is the source and owner of the trademarks, service marks, and copyrights related to the Russell indexes. Russell® is a trademark of Russell Investment Group.
Performance and Expenses
Growth of $10,000 |
This chart shows the value of a hypothetical $10,000 investment in the fund over the past 10 fiscal year periods or since inception (for funds lacking 10-year records). The result is compared with benchmarks, which may include a broad-based market index and a peer group average or index. Market indexes do not include expenses, which are deducted from fund returns as well as mutual fund averages and indexes.
Growth of $10,000 |
This chart shows the value of a hypothetical $10,000 investment in the fund over the past 10 fiscal year periods or since inception (for funds lacking 10-year records). The result is compared with benchmarks, which may include a broad-based market index and a peer group average or index. Market indexes do not include expenses, which are deducted from fund returns as well as mutual fund averages and indexes.
Growth of $10,000 |
This chart shows the value of a hypothetical $10,000 investment in the fund over the past 10 fiscal year periods or since inception (for funds lacking 10-year records). The result is compared with benchmarks, which may include a broad-based market index and a peer group average or index. Market indexes do not include expenses, which are deducted from fund returns as well as mutual fund averages and indexes.
Fund Expense Example |
As a mutual fund shareholder, you may incur two types of costs: (1) transaction costs, such as redemption fees or sales loads, and (2) ongoing costs, including management fees, distribution and service (12b-1) fees, and other fund expenses. The following example is intended to help you understand your ongoing costs (in dollars) of investing in the fund and to compare these costs with the ongoing costs of investing in other mutual funds. The example is based on an investment of $1,000 invested at the beginning of the most recent six-month period and held for the entire period.
Actual Expenses
The first line of the following table (Actual) provides information about actual account values and expenses based on the fund’s actual returns. You may use the information on this line, together with your account balance, to estimate the expenses that you paid over the period. Simply divide your account value by $1,000 (for example, an $8,600 account value divided by $1,000 = 8.6), then multiply the result by the number on the first line under the heading “Expenses Paid During Period” to estimate the expenses you paid on your account during this period.
Hypothetical Example for Comparison Purposes
The information on the second line of the table (Hypothetical) is based on hypothetical account values and expenses derived from the fund’s actual expense ratio and an assumed 5% per year rate of return before expenses (not the fund’s actual return). You may compare the ongoing costs of investing in the fund with other funds by contrasting this 5% hypothetical example and the 5% hypothetical examples that appear in the shareholder reports of the other funds. The hypothetical account values and expenses may not be used to estimate the actual ending account balance or expenses you paid for the period.
Note: T. Rowe Price charges an annual account service fee of $20, generally for accounts with less than $10,000. The fee is waived for any investor whose T. Rowe Price mutual fund accounts total $50,000 or more; accounts electing to receive electronic delivery of account statements, transaction confirmations, prospectuses, and shareholder reports; or accounts of an investor who is a T. Rowe Price Preferred Services, Personal Services, or Enhanced Personal Services client (enrollment in these programs generally requires T. Rowe Price assets of at least $100,000). This fee is not included in the accompanying table. If you are subject to the fee, keep it in mind when you are estimating the ongoing expenses of investing in the fund and when comparing the expenses of this fund with other funds.
You should also be aware that the expenses shown in the table highlight only your ongoing costs and do not reflect any transaction costs, such as redemption fees or sales loads. Therefore, the second line of the table is useful in comparing ongoing costs only and will not help you determine the relative total costs of owning different funds. To the extent a fund charges transaction costs, however, the total cost of owning that fund is higher.
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
The accompanying notes are an integral part of these financial statements.
Notes to Financial Statements |
T. Rowe Price Personal Strategy Funds, Inc. (the corporation), is registered under the Investment Company Act of 1940 (the 1940 Act). The Personal Strategy Balanced Fund (the fund) is a diversified, open-end management investment company established by the corporation. The fund commenced operations on July 29, 1994. The fund seeks the highest total return over time consistent with an emphasis on both capital growth and income. The fund pursues this objective by investing in a diversified portfolio typically consisting of approximately 60% stocks, 30% bonds, and 10% money market securities.
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES
Basis of Preparation The accompanying financial statements were prepared in accordance with accounting principles generally accepted in the United States of America (GAAP), which require the use of estimates made by management. Management believes that estimates and valuations are appropriate; however, actual results may differ from those estimates, and the valuations reflected in the accompanying financial statements may differ from the value ultimately realized upon sale or maturity.
Investment Transactions, Investment Income, and Distributions Income and expenses are recorded on the accrual basis. Premiums and discounts on debt securities are amortized for financial reporting purposes. Paydown gains and losses are recorded as an adjustment to interest income. Inflation adjustments to the principal amount of inflation-indexed bonds are reflected as interest income. Dividends received from mutual fund investments are reflected as dividend income; capital gain distributions are reflected as realized gain/loss. Earnings on investments recognized as partnerships for federal income tax purposes reflect the tax character of such earnings. Dividend income and capital gain distributions are recorded on the ex-dividend date. Income tax-related interest and penalties, if incurred, would be recorded as income tax expense. Investment transactions are accounted for on the trade date. Realized gains and losses are reported on the identified cost basis. Distributions to shareholders are recorded on the ex-dividend date. Income distributions are declared and paid quarterly. Capital gain distributions, if any, are generally declared and paid by the fund annually.
Currency Translation Assets, including investments, and liabilities denominated in foreign currencies are translated into U.S. dollar values each day at the prevailing exchange rate, using the mean of the bid and asked prices of such currencies against U.S. dollars as quoted by a major bank. Purchases and sales of securities, income, and expenses are translated into U.S. dollars at the prevailing exchange rate on the date of the transaction. The effect of changes in foreign currency exchange rates on realized and unrealized security gains and losses is reflected as a component of security gains and losses.
Rebates and Credits Subject to best execution, the fund may direct certain security trades to brokers who have agreed to rebate a portion of the related brokerage commission to the fund in cash. Commission rebates are reflected as realized gain on securities in the accompanying financial statements and totaled $15,000 for the year ended May 31, 2013. Additionally, the fund earns credits on temporarily uninvested cash balances held at the custodian, which reduce the fund’s custody charges. Custody expense in the accompanying financial statements is presented before reduction for credits.
New Accounting Guidance In December 2011, the Financial Accounting Standards Board issued amended guidance requiring an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. The guidance is effective for fiscal years and interim periods beginning on or after January 1, 2013. Adoption will have no effect on the fund’s net assets or results of operations.
NOTE 2 - VALUATION
The fund’s financial instruments are valued and its net asset value (NAV) per share is computed at the close of the New York Stock Exchange (NYSE), normally 4 p.m. ET, each day the NYSE is open for business.
Fair Value The fund’s financial instruments are reported at fair value, which GAAP defines as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The T. Rowe Price Valuation Committee (the Valuation Committee) has been established by the fund’s Board of Directors (the Board) to ensure that financial instruments are appropriately priced at fair value in accordance with GAAP and the 1940 Act. Subject to oversight by the Board, the Valuation Committee develops and oversees pricing-related policies and procedures and approves all fair value determinations. Specifically, the Valuation Committee establishes procedures to value securities; determines pricing techniques, sources, and persons eligible to effect fair value pricing actions; oversees the selection, services, and performance of pricing vendors; oversees valuation-related business continuity practices; and provides guidance on internal controls and valuation-related matters. The Valuation Committee reports to the fund’s Board; is chaired by the fund’s treasurer; and has representation from legal, portfolio management and trading, operations, and risk management.
Various valuation techniques and inputs are used to determine the fair value of financial instruments. GAAP establishes the following fair value hierarchy that categorizes the inputs used to measure fair value:
Level 1 – quoted prices (unadjusted) in active markets for identical financial instruments that the fund can access at the reporting date
Level 2 – inputs other than Level 1 quoted prices that are observable, either directly or indirectly (including, but not limited to, quoted prices for similar financial instruments in active markets, quoted prices for identical or similar financial instruments in inactive markets, interest rates and yield curves, implied volatilities, and credit spreads)
Level 3 – unobservable inputs
Observable inputs are developed using market data, such as publicly available information about actual events or transactions, and reflect the assumptions that market participants would use to price the financial instrument. Unobservable inputs are those for which market data are not available and are developed using the best information available about the assumptions that market participants would use to price the financial instrument. GAAP requires valuation techniques to maximize the use of relevant observable inputs and minimize the use of unobservable inputs. When multiple inputs are used to derive fair value, the financial instrument is assigned to the level within the fair value hierarchy based on the lowest-level input that is significant to the fair value of the financial instrument. Input levels are not necessarily an indication of the risk or liquidity associated with financial instruments at that level but rather the degree of judgment used in determining those values.
Valuation Techniques Equity securities listed or regularly traded on a securities exchange or in the over-the-counter (OTC) market are valued at the last quoted sale price or, for certain markets, the official closing price at the time the valuations are made. OTC Bulletin Board securities are valued at the mean of the closing bid and asked prices. A security that is listed or traded on more than one exchange is valued at the quotation on the exchange determined to be the primary market for such security. Listed securities not traded on a particular day are valued at the mean of the closing bid and asked prices for domestic securities and the last quoted sale or closing price for international securities.
For valuation purposes, the last quoted prices of non-U.S. equity securities may be adjusted to reflect the fair value of such securities at the close of the NYSE. If the fund determines that developments between the close of a foreign market and the close of the NYSE will, in its judgment, materially affect the value of some or all of its portfolio securities, the fund will adjust the previous quoted prices to reflect what it believes to be the fair value of the securities as of the close of the NYSE. In deciding whether it is necessary to adjust quoted prices to reflect fair value, the fund reviews a variety of factors, including developments in foreign markets, the performance of U.S. securities markets, and the performance of instruments trading in U.S. markets that represent foreign securities and baskets of foreign securities. The fund may also fair value securities in other situations, such as when a particular foreign market is closed but the fund is open. The fund uses outside pricing services to provide it with quoted prices and information to evaluate and/or adjust those prices. The fund cannot predict how often it will use quoted prices and how often it will determine it necessary to adjust those prices to reflect fair value. As a means of evaluating its security valuation process, the fund routinely compares quoted prices, the next day’s opening prices in the same markets, and adjusted prices.
Actively traded domestic equity securities generally are categorized in Level 1 of the fair value hierarchy. Non-U.S. equity securities generally are categorized in Level 2 of the fair value hierarchy despite the availability of quoted prices because, as described above, the fund evaluates and determines whether those quoted prices reflect fair value at the close of the NYSE or require adjustment. OTC Bulletin Board securities, certain preferred securities, and equity securities traded in inactive markets generally are categorized in Level 2 of the fair value hierarchy.
Debt securities generally are traded in the OTC market. Securities with remaining maturities of one year or more at the time of acquisition are valued at prices furnished by dealers who make markets in such securities or by an independent pricing service, which considers the yield or price of bonds of comparable quality, coupon, maturity, and type, as well as prices quoted by dealers who make markets in such securities. Generally, debt securities are categorized in Level 2 of the fair value hierarchy; however, to the extent the valuations include significant unobservable inputs, the securities would be categorized in Level 3.
Investments in mutual funds are valued at the mutual fund’s closing net asset value per share on the day of valuation and are categorized in Level 1 of the fair value hierarchy. Financial futures contracts are valued at closing settlement prices and are categorized in Level 1 of the fair value hierarchy. Swaps are valued at prices furnished by independent swap dealers or by an independent pricing service and generally are categorized in Level 2 of the fair value hierarchy; however, if unobservable inputs are significant to the valuation, the swap would be categorized in Level 3. Assets and liabilities other than financial instruments, including short-term receivables and payables, are carried at cost, or estimated realizable value, if less, which approximates fair value.
Thinly traded financial instruments and those for which the above valuation procedures are inappropriate or are deemed not to reflect fair value are stated at fair value as determined in good faith by the Valuation Committee. The objective of any fair value pricing determination is to arrive at a price that could reasonably be expected from a current sale. Financial instruments fair valued by the Valuation Committee are primarily private placements, restricted securities, warrants, rights, and other securities that are not publicly traded.
Subject to oversight by the Board, the Valuation Committee regularly makes good faith judgments to establish and adjust the fair valuations of certain securities as events occur and circumstances warrant. For instance, in determining the fair value of an equity investment with limited market activity, such as a private placement or a thinly traded public company stock, the Valuation Committee considers a variety of factors, which may include, but are not limited to, the issuer’s business prospects, its financial standing and performance, recent investment transactions in the issuer, new rounds of financing, negotiated transactions of significant size between other investors in the company, relevant market valuations of peer companies, strategic events affecting the company, market liquidity for the issuer, and general economic conditions and events. In consultation with the investment and pricing teams, the Valuation Committee will determine an appropriate valuation technique based on available information, which may include both observable and unobservable inputs. The Valuation Committee typically will afford greatest weight to actual prices in arm’s length transactions, to the extent they represent orderly transactions between market participants; transaction information can be reliably obtained; and prices are deemed representative of fair value. However, the Valuation Committee may also consider other valuation methods such as market-based valuation multiples; a discount or premium from market value of a similar, freely traded security of the same issuer; or some combination. Fair value determinations are reviewed on a regular basis and updated as information becomes available, including actual purchase and sale transactions of the issue. Because any fair value determination involves a significant amount of judgment, there is a degree of subjectivity inherent in such pricing decisions and fair value prices determined by the Valuation Committee could differ from those of other market participants. Depending on the relative significance of unobservable inputs, including the valuation technique(s) used, fair valued securities may be categorized in Level 2 or 3 of the fair value hierarchy.
Valuation Inputs The following table summarizes the fund’s financial instruments, based on the inputs used to determine their fair values on May 31, 2013:
There were no material transfers between Levels 1 and 2 during the period.
Following is a reconciliation of the fund’s Level 3 holdings for the year ended May 31, 2013. Gain (loss) reflects both realized and change in unrealized gain/loss on Level 3 holdings during the period, if any, and is included on the accompanying Statement of Operations. The change in unrealized gain/loss on Level 3 instruments held at May 31, 2013, totaled $(69,000) for the year ended May 31, 2013. Transfers into and out of Level 3 are reflected at the value of the financial instrument at the beginning of the period. During the year, transfers out of Level 3 were because observable market data became available for the security.
NOTE 3 - DERIVATIVE INSTRUMENTS
During the year ended May 31, 2013, the fund invested in derivative instruments. As defined by GAAP, a derivative is a financial instrument whose value is derived from an underlying security price, foreign exchange rate, interest rate, index of prices or rates, or other variable; it requires little or no initial investment and permits or requires net settlement. The fund invests in derivatives only if the expected risks and rewards are consistent with its investment objectives, policies, and overall risk profile, as described in its prospectus and Statement of Additional Information. The fund may use derivatives for a variety of purposes, such as seeking to hedge against declines in principal value, increase yield, invest in an asset with greater efficiency and at a lower cost than is possible through direct investment, or to adjust credit exposure. The risks associated with the use of derivatives are different from, and potentially much greater than, the risks associated with investing directly in the instruments on which the derivatives are based. Investments in derivatives can magnify returns positively or negatively; however, the fund at all times maintains sufficient cash reserves, liquid assets, or other SEC-permitted asset types to cover the settlement obligations under its open derivative contracts.
The fund values its derivatives at fair value, as described below and in Note 2, and recognizes changes in fair value currently in its results of operations. Accordingly, the fund does not follow hedge accounting, even for derivatives employed as economic hedges. The fund does not offset the fair value of derivative instruments against the right to reclaim or obligation to return collateral.
The following table summarizes the fair value of the fund’s derivative instruments held as of May 31, 2013, and the related location on the accompanying Statement of Assets and Liabilities, presented by primary underlying risk exposure:
Additionally, the amount of gains and losses on derivative instruments recognized in fund earnings during the year ended May 31, 2013, and the related location on the accompanying Statement of Operations is summarized in the following table by primary underlying risk exposure:
Futures Contracts The fund is subject to interest rate risk in the normal course of pursuing its investment objectives and uses futures contracts to help manage such risk. The fund may enter into futures contracts to manage exposure to interest rates, security prices, foreign currencies, and credit quality; as an efficient means of adjusting exposure to all or part of a target market; to enhance income; as a cash management tool; and/or to adjust credit exposure. A futures contract provides for the future sale by one party and purchase by another of a specified amount of a particular underlying financial instrument at an agreed-upon price, date, time, and place. The fund currently invests only in exchange-traded futures, which generally are standardized as to maturity date, underlying financial instrument, and other contract terms. Upon entering into a futures contract, the fund is required to deposit collateral with the broker in the form of cash or securities in an amount equal to a certain percentage of the contract value (margin requirement); the margin requirement must then be maintained at the established level over the life of the contract. Subsequent payments are made or received by the fund each day to settle daily fluctuations in the value of the contract (variation margin), which reflect changes in the value of the underlying financial instrument. Variation margin is recorded as unrealized gain or loss until the contract is closed. The value of a futures contract included in net assets is the amount of unsettled variation margin; net variation margin receivable is reflected as an asset, and net variation margin payable is reflected as a liability on the accompanying Statement of Assets and Liabilities. Risks related to the use of futures contracts include possible illiquidity of the futures markets, contract prices that can be highly volatile and imperfectly correlated to movements in hedged security values interest rates, and potential losses in excess of the fund’s initial investment. During the year ended May 31, 2013, the fund’s exposure to futures, based on underlying notional amounts, was generally between 0% and 2% of net assets.
Credit Default Swaps The fund is subject to credit risk in the normal course of pursuing its investment objectives and uses swap contracts to help manage such risk. The fund may use swaps in an effort to manage exposure to changes in interest rates, inflation rates, and credit quality; to adjust overall exposure to certain markets; to enhance total return or protect the value of portfolio securities; to serve as a cash management tool; and/or to adjust portfolio duration or credit exposure. Credit default swaps are agreements where one party (the protection buyer) agrees to make periodic payments to another party (the protection seller) in exchange for protection against specified credit events, such as certain defaults and bankruptcies related to an underlying credit instrument, or issuer or index of such instruments. Upon occurrence of a specified credit event, the protection seller is required to pay the buyer the difference between the notional amount of the swap and the value of the underlying credit, either in the form of a net cash settlement or by paying the gross notional amount and accepting delivery of the relevant underlying credit. For credit default swaps where the underlying credit is an index, a specified credit event may affect all or individual underlying securities included in the index and will be settled based upon the relative weighting of the affected underlying security(s) within the index. Generally, the payment risk for the seller of protection is inversely related to the current market price and/or credit rating of the underlying credit, both of which are indicators of market valuations of credit quality. Therefore, payment risk increases as the price of the relevant underlying credit and/or credit rating declines. Generally payment risk increases as the market value of a swap contract declines in relation to the notional amount. As of May 31, 2013, the notional amount of protection sold by the fund totaled $920,000 (0.1% of net assets), which reflects the maximum potential amount the fund could be required to pay under such contracts. The value of a swap included in net assets is the unrealized gain or loss on the contract plus or minus any unamortized premiums paid or received, respectively. Appreciated swaps and premiums paid are reflected as assets, and depreciated swaps and premiums received are reflected as liabilities on the accompanying Statement of Assets and Liabilities. Net periodic receipts or payments required by swaps are accrued daily and are recorded as realized gain or loss for financial reporting purposes when settled; fluctuations in the fair value of swaps are reflected in the change in net unrealized gain or loss and are reclassified to realized gain or loss upon termination prior to maturity or cash settlement. Risks related to the use of credit default swaps include the possible inability of the fund to accurately assess the current and future creditworthiness of underlying issuers, the possible failure of a counterparty to perform in accordance with the terms of the swap agreements, potential government regulation that could adversely affect the fund’s swap investments, and potential losses in excess of the fund’s initial investment. During the year ended May 31, 2013, the fund’s exposure to swaps, based on underlying notional amounts, was generally less than 1% of net assets.
NOTE 4 - OTHER INVESTMENT TRANSACTIONS
Consistent with its investment objective, the fund engages in the following practices to manage exposure to certain risks and/or to enhance performance. The investment objective, policies, program, and risk factors of the fund are described more fully in the fund’s prospectus and Statement of Additional Information.
Noninvestment-Grade Debt Securities At May 31, 2013, approximately 10% of the fund’s net assets were invested, either directly or through its investment in T. Rowe Price institutional funds, in noninvestment-grade debt securities, commonly referred to as “high yield” or “junk” bonds. The noninvestment-grade bond market may experience sudden and sharp price swings due to a variety of factors, including changes in economic forecasts, stock market activity, large sustained sales by major investors, a high-profile default, or a change in market psychology. These events may decrease the ability of issuers to make principal and interest payments and adversely affect the liquidity or value, or both, of such securities.
Restricted Securities The fund may invest in securities that are subject to legal or contractual restrictions on resale. Prompt sale of such securities at an acceptable price may be difficult and may involve substantial delays and additional costs.
TBA Purchase and Sale Commitments During the year ended May 31, 2013, the fund entered into to be announced (TBA) purchase and/or sale commitments, pursuant to which it agrees to purchase or sell, respectively, mortgage-backed securities for a fixed unit price, with payment and delivery at a scheduled future date beyond the customary settlement period for such mortgage-backed securities. With TBA transactions, the particular securities to be delivered are not identified at the trade date; however, delivered securities must meet specified terms, including issuer, rate, and mortgage term, and be within industry-accepted “good delivery” standards. The fund generally enters into TBA purchase transactions with the intention of taking possession of the underlying mortgage securities; however, for either purchase or sale transactions, the fund also may extend the settlement by “rolling” the transaction. Until settlement, the fund maintains cash reserves and liquid assets sufficient to settle its TBA commitments.
Securities Lending The fund lends its securities to approved brokers to earn additional income. It receives as collateral cash and U.S. government securities valued at 102% to 105% of the value of the securities on loan. Collateral is maintained over the life of the loan in an amount not less than the value of loaned securities; any additional collateral required due to changes in security values is delivered to the fund the next business day. Cash collateral is invested by the fund’s lending agent(s) in accordance with investment guidelines approved by management. Although risk is mitigated by the collateral, the fund could experience a delay in recovering its securities and a possible loss of income or value if the borrower fails to return the securities or if collateral investments decline in value. Securities lending revenue recognized by the fund consists of earnings on invested collateral and borrowing fees, net of any rebates to the borrower, compensation to the lending agent and other administrative costs. In accordance with GAAP, investments made with cash collateral are reflected in the accompanying financial statements, but collateral received in the form of securities is not. At May 31, 2013, the value of loaned securities was $4,293,000; the value of cash collateral and related investments was $4,675,000.
Counterparty Risk and Collateral The fund has entered into collateral agreements with certain counterparties to mitigate counterparty risk associated with certain over-the-counter (OTC) financial instruments, including swaps, forward currency exchange contracts, TBA purchase commitments, and OTC options (collectively, covered OTC instruments). Subject to certain minimum exposure requirements (which typically range from $100,000 to $500,000), collateral requirements generally are determined and transfers made based on the net aggregate unrealized gain or loss on all OTC instruments covered by a particular collateral agreement with a specified counterparty. At any point in time, the fund’s risk of loss from counterparty credit risk on covered OTC instruments is the aggregate unrealized gain on appreciated covered OTC instruments in excess of collateral, if any, pledged by the counterparty to the fund. Further, in accordance with the terms of the relevant agreements, counterparties to certain OTC instruments may be able to terminate the contracts prior to maturity upon the occurrence of certain stated events, such as a decline in net assets above a certain percentage or a failure by the fund to perform its obligations under the contract. Upon termination, all transactions would typically be liquidated and a net amount would be owed by or payable to the fund.
Counterparty risk related to exchange-traded futures and options contracts is minimal because the exchange’s clearinghouse provides protection against counterparty defaults. Generally, for exchange-traded derivatives such as futures and options, each broker, in its sole discretion, may change margin requirements applicable to the fund.
Collateral can be in the form of cash or debt securities issued by the U.S. government or related agencies. For OTC instruments, collateral both pledged by the fund to a counterparty and pledged by a counterparty to the fund, is held in a segregated account by a third-party agent. For exchange-traded instruments, margin posted by the fund is held by the broker. Cash posted by the fund as collateral or to meet margin requirements is reflected as restricted cash in the accompanying financial statements and securities posted by the fund are so noted in the accompanying Portfolio of Investments; both remain in the fund’s assets. Collateral pledged by counterparties is not included in the fund’s assets because the fund does not obtain effective control over those assets. As of May 31, 2013, securities valued at $365,000 had been posted by the fund to counterparties for covered OTC instruments. As of May 31, 2013, no collateral was pledged by counterparties to the fund for covered OTC instruments. As of May 31, 2013, Securities valued at $375,000 had been posted by the fund to the broker for exchange-traded derivatives.
Other Purchases and sales of portfolio securities other than short-term and U.S. government securities aggregated $527,799,000 and $551,219,000, respectively, for the year ended May 31, 2013. Purchases and sales of U.S. government securities aggregated $473,505,000 and $418,228,000, respectively, for the year ended May 31, 2013.
NOTE 5 - FEDERAL INCOME TAXES
No provision for federal income taxes is required since the fund intends to continue to qualify as a regulated investment company under Subchapter M of the Internal Revenue Code and distribute to shareholders all of its taxable income and gains. Distributions determined in accordance with federal income tax regulations may differ in amount or character from net investment income and realized gains for financial reporting purposes. Financial reporting records are adjusted for permanent book/tax differences to reflect tax character but are not adjusted for temporary differences.
The fund files U.S. federal, state, and local tax returns as required. The fund’s tax returns are subject to examination by the relevant tax authorities until expiration of the applicable statute of limitations, which is generally three years after the filing of the tax return but which can be extended to six years in certain circumstances. Tax returns for open years have incorporated no uncertain tax positions that require a provision for income taxes.
Reclassifications to paid-in capital relate primarily to a tax practice that treats a portion of the proceeds from each redemption of capital shares as a distribution of taxable net investment income. Reclassifications between income and gain relate primarily to the character of paydown gains and losses on asset-backed securities. For the year ended May 31, 2013, the following reclassifications were recorded to reflect tax character (there was no impact on results of operations or net assets):
Distributions during the years ended May 31, 2013 and May 31, 2012, were characterized for tax purposes as follows:
At May 31, 2013, the tax-basis cost of investments and components of net assets were as follows:
The difference between book-basis and tax-basis net unrealized appreciation (depreciation) is attributable to the deferral of losses from wash sales for tax purposes.
NOTE 6 - RELATED PARTY TRANSACTIONS
The fund is managed by T. Rowe Price Associates, Inc. (Price Associates), a wholly owned subsidiary of T. Rowe Price Group, Inc. (Price Group). The investment management agreement between the fund and Price Associates provides for an annual investment management fee, which is computed daily and paid monthly. The fee consists of an individual fund fee, equal to 0.25% of the fund’s average daily net assets, and a group fee. The group fee rate is calculated based on the combined net assets of certain mutual funds sponsored by Price Associates (the group) applied to a graduated fee schedule, with rates ranging from 0.48% for the first $1 billion of assets to 0.275% for assets in excess of $400 billion. The fund’s group fee is determined by applying the group fee rate to the fund’s average daily net assets. At May 31, 2013, the effective annual group fee rate was 0.30%.
In addition, the fund has entered into service agreements with Price Associates and two wholly owned subsidiaries of Price Associates (collectively, Price). Price Associates computes the daily share price and provides certain other administrative services to the fund. T. Rowe Price Services, Inc., provides shareholder and administrative services in its capacity as the fund’s transfer and dividend disbursing agent. T. Rowe Price Retirement Plan Services, Inc., provides subaccounting and recordkeeping services for certain retirement accounts invested in the fund. For the year ended May 31, 2013, expenses incurred pursuant to these service agreements were $184,000 for Price Associates; $403,000 for T. Rowe Price Services, Inc.; and $787,000 for T. Rowe Price Retirement Plan Services, Inc. The total amount payable at period-end pursuant to these service agreements is reflected as Due to Affiliates in the accompanying financial statements.
The fund may invest in the T. Rowe Price Reserve Investment Fund and the T. Rowe Price Government Reserve Investment Fund (collectively, the T. Rowe Price Reserve Investment Funds), open-end management investment companies managed by Price Associates and considered affiliates of the fund. The T. Rowe Price Reserve Investment Funds are offered as cash management options to mutual funds, trusts, and other accounts managed by Price Associates and/or its affiliates and are not available for direct purchase by members of the public. The T. Rowe Price Reserve Investment Funds pay no investment management fees.
The fund may also invest in certain T. Rowe Price institutional funds and/or the T. Rowe Price Real Assets Fund (collectively, the underlying institutional funds) as a means of gaining efficient and cost-effective exposure to certain markets. The underlying institutional funds are open-end management investment companies managed by Price Associates and are considered affiliates of the fund. Each institutional fund pays an all-inclusive management and administrative fee to Price Associates; Real Assets Fund pays a management fee to Price Associates as well as operating expenses. To ensure that the fund does not incur duplicate management fees, Price Associates has agreed to permanently waive a portion of its management fee charged to the fund in an amount sufficient to fully offset the management fees paid by the underlying institutional funds related to fund assets invested therein. Accordingly, the accompanying Statement of Operations includes management fees permanently waived pursuant to this agreement. Annual fee rates and amounts waived within the accompanying Statement of Operations related to shares of the underlying institutional funds for the year ended May 31, 2013, are as follows:
Report of Independent Registered Public Accounting Firm |
To the Board of Directors of T. Rowe Price Personal Strategy Funds, Inc. and
Shareholders of T. Rowe Price Personal Strategy Balanced Fund
In our opinion, the accompanying statement of assets and liabilities, including the portfolio of investments, and the related statements of operations and of changes in net assets and the financial highlights present fairly, in all material respects, the financial position of T. Rowe Price Personal Strategy Balanced Fund (one of the portfolios comprising T. Rowe Price Personal Strategy Funds, Inc., hereafter referred to as the “Fund”) at May 31, 2013, and the results of its operations, the changes in its net assets and the financial highlights for each of the periods indicated therein, in conformity with accounting principles generally accepted in the United States of America. These financial statements and financial highlights (hereafter referred to as “financial statements”) are the responsibility of the Fund’s management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of securities at May 31, 2013 by correspondence with the custodian and brokers, and confirmation of the underlying funds by correspondence with the transfer agent, provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Baltimore, Maryland
July 16, 2013
Tax Information (Unaudited) for the Tax Year Ended 5/31/13 |
We are providing this information as required by the Internal Revenue Code. The amounts shown may differ from those elsewhere in this report because of differences between tax and financial reporting requirements.
The fund’s distributions to shareholders included:
- $8,571,000 from short-term capital gains
- $23,434,000 from long-term capital gains, subject to the 15% rate gains category.
For taxable non-corporate shareholders, $18,946,000 of the fund’s income represents qualified dividend income subject to the 15% rate category.
For corporate shareholders, $11,519,000 of the fund’s income qualifies for the dividends-received deduction.
Information on Proxy Voting Policies, Procedures, and Records |
A description of the policies and procedures used by T. Rowe Price funds and portfolios to determine how to vote proxies relating to portfolio securities is available in each fund’s Statement of Additional Information. You may request this document by calling 1-800-225-5132 or by accessing the SEC’s website, sec.gov.
The description of our proxy voting policies and procedures is also available on our website, troweprice.com. To access it, click on the words “Social Responsibility” at the top of our corporate homepage. Next, click on the words “Conducting Business Responsibly” on the left side of the page that appears. Finally, click on the words “Proxy Voting Policies” on the left side of the page that appears.
Each fund’s most recent annual proxy voting record is available on our website and through the SEC’s website. To access it through our website, follow the above directions to reach the “Conducting Business Responsibly” page. Click on the words “Proxy Voting Records” on the left side of that page, and then click on the “View Proxy Voting Records” link at the bottom of the page that appears.
How to Obtain Quarterly Portfolio Holdings |
The fund files a complete schedule of portfolio holdings with the Securities and Exchange Commission for the first and third quarters of each fiscal year on Form N-Q. The fund’s Form N-Q is available electronically on the SEC’s website (sec.gov); hard copies may be reviewed and copied at the SEC’s Public Reference Room, 100 F St. N.E., Washington, DC 20549. For more information on the Public Reference Room, call 1-800-SEC-0330.
Approval of Investment Management Agreement |
On March 5, 2013, the fund’s Board of Directors (Board), including a majority of the fund’s independent directors, approved the continuation of the investment management agreement (Advisory Contract) between the fund and its investment advisor, T. Rowe Price Associates, Inc. (Advisor). In connection with their deliberations, the Board requested, and the Advisor provided, such information as the Board (with advice from independent legal counsel) deemed reasonably necessary. The Board considered a variety of factors in connection with its review of the Advisory Contract, also taking into account information provided by the Advisor during the course of the year, as discussed below:
Services Provided by the Advisor
The Board considered the nature, quality, and extent of the services provided to the fund by the Advisor. These services included, but were not limited to, directing the fund’s investments in accordance with its investment program and the overall management of the fund’s portfolio, as well as a variety of related activities, such as financial, investment operations, and administrative services; compliance; maintaining the fund’s records and registrations; and shareholder communications. The Board also reviewed the background and experience of the Advisor’s senior management team and investment personnel involved in the management of the fund, as well as the Advisor’s compliance record. The Board concluded that it was satisfied with the nature, quality, and extent of the services provided by the Advisor.
Investment Performance of the Fund
The Board reviewed the fund’s three-month, one-year, and year-by-year returns, as well as the fund’s average annualized total returns over the 3-, 5-, and 10-year periods, and compared these returns with a wide variety of previously agreed upon comparable performance measures and market data, including those supplied by Lipper and Morningstar, which are independent providers of mutual fund data.
On the basis of this evaluation and the Board’s ongoing review of investment results, and factoring in the relative market conditions during certain of the performance periods, the Board concluded that the fund’s performance was satisfactory.
Costs, Benefits, Profits, and Economies of Scale
The Board reviewed detailed information regarding the revenues received by the Advisor under the Advisory Contract and other benefits that the Advisor (and its affiliates) may have realized from its relationship with the fund, including any research received under “soft dollar” agreements and commission-sharing arrangements with broker-dealers. The Board considered that the Advisor may receive some benefit from soft-dollar arrangements pursuant to which research is received from broker-dealers that execute the applicable fund’s portfolio transactions. The Board received information on the estimated costs incurred and profits realized by the Advisor from managing T. Rowe Price mutual funds. The Board also reviewed estimates of the profits realized from managing the fund in particular, and the Board concluded that the Advisor’s profits were reasonable in light of the services provided to the fund.
The Board also considered whether the fund benefits under the fee levels set forth in the Advisory Contract from any economies of scale realized by the Advisor. Under the Advisory Contract, the fund pays a fee to the Advisor for investment management services composed of two components—a group fee rate based on the combined average net assets of most of the T. Rowe Price mutual funds (including the fund) that declines at certain asset levels and an individual fund fee rate based on the fund’s average daily net assets—and the fund pays its own expenses of operations. The Board concluded that the advisory fee structure for the fund continued to provide for a reasonable sharing of benefits from any economies of scale with the fund’s investors.
Fees
The Board was provided with information regarding industry trends in management fees and expenses, and the Board reviewed the fund’s management fee rate, operating expenses, and total expense ratio in comparison with fees and expenses of other comparable funds based on information and data supplied by Lipper. After including reductions of the management fee that resulted from the fund’s investments in T. Rowe Price Institutional Funds, the information provided to the Board indicated that the fund’s management fee rate was at or below the median for comparable funds and the fund’s total expense ratio was below the median for comparable funds.
The Board also reviewed the fee schedules for institutional accounts and private accounts with similar mandates that are advised or subadvised by the Advisor and its affiliates. Management provided the Board with information about the Advisor’s responsibilities and services provided to institutional account clients, including information about how the requirements and economics of the institutional business are fundamentally different from those of the mutual fund business. The Board considered information showing that the mutual fund business is generally more complex from a business and compliance perspective than the institutional business and that the Advisor generally performs significant additional services and assumes greater risk in managing the fund and other T. Rowe Price mutual funds than it does for institutional account clients.
On the basis of the information provided and the factors considered, the Board concluded that the fees paid by the fund under the Advisory Contract are reasonable.
Approval of the Advisory Contract
As noted, the Board approved the continuation of the Advisory Contract. No single factor was considered in isolation or to be determinative to the decision. Rather, the Board concluded, in light of a weighting and balancing of all factors considered, that it was in the best interests of the fund and its shareholders for the Board to approve the continuation of the Advisory Contract (including the fees to be charged for services thereunder). The independent directors were advised throughout the process by independent legal counsel.
About the Fund’s Directors and Officers |
Your fund is overseen by a Board of Directors (Board) that meets regularly to review a wide variety of matters affecting the fund, including performance, investment programs, compliance matters, advisory fees and expenses, service providers, and other business affairs. The Board elects the fund’s officers, who are listed in the final table. At least 75% of the Board’s members are independent of T. Rowe Price Associates, Inc. (T. Rowe Price), and its affiliates; “inside” or “interested” directors are employees or officers of T. Rowe Price. The business address of each director and officer is 100 East Pratt Street, Baltimore, Maryland 21202. The Statement of Additional Information includes additional information about the fund directors and is available without charge by calling a T. Rowe Price representative at 1-800-638-5660.
Independent Directors | ||
Name | ||
(Year of Birth) | ||
Year Elected* | ||
[Number of T. Rowe Price | Principal Occupation(s) and Directorships of Public Companies and | |
Portfolios Overseen] | Other Investment Companies During the Past Five Years | |
William R. Brody | President and Trustee, Salk Institute for Biological Studies (2009 | |
(1944) | to present); Director, Novartis, Inc. (2009 to present); Director, IBM | |
2009 | (2007 to present); President and Trustee, Johns Hopkins University | |
[143] | (1996 to 2009); Chairman of Executive Committee and Trustee, | |
Johns Hopkins Health System (1996 to 2009) | ||
Anthony W. Deering | Chairman, Exeter Capital, LLC, a private investment firm (2004 to | |
(1945) | present); Director and Member of the Advisory Board, Deutsche | |
2001 | Bank North America (2004 to present); Director, Under Armour | |
[143] | (2008 to present); Director, Vornado Real Estate Investment Trust | |
(2004 to 2012) | ||
Donald W. Dick, Jr. | Principal, EuroCapital Partners, LLC, an acquisition and management | |
(1943) | advisory firm (1995 to present) | |
1994 | ||
[143] | ||
Robert J. Gerrard, Jr. | Advisory Board Member, Pipeline Crisis/Winning Strategies (1997 | |
(1952) | to present); Chairman of Compensation Committee and Director, | |
2012 | Syniverse Holdings, Inc. (2008 to 2011); Executive Vice President | |
[91] | and General Counsel, Scripps Networks, LLC (1997 to 2009) | |
Karen N. Horn | Senior Managing Director, Brock Capital Group, an advisory and | |
(1943) | investment banking firm (2004 to present); Director, Eli Lilly and | |
2003 | Company (1987 to present); Director, Simon Property Group (2004 | |
[143] | to present); Director, Norfolk Southern (2008 to present); Director, | |
Fannie Mae (2006 to 2008) | ||
Theo C. Rodgers | President, A&R Development Corporation (1977 to present) | |
(1941) | ||
2005 | ||
[143] | ||
Cecilia E. Rouse, Ph.D. | Dean, Woodrow Wilson School (2012 to present); Professor and | |
(1963) | Researcher, Princeton University (1992 to present); Director, MDRC | |
2012 | (2011 to present); Member, National Academy of Education (2010 | |
[91] | to present); Research Associate, National Bureau of Economic | |
Research’s Labor Studies Program (1998 to 2009 and 2011 to | ||
present); Member, President’s Council of Economic Advisors | ||
(2009 to 2011); Member, The MacArthur Foundation Network on | ||
the Transition to Adulthood and Public Policy (2000 to 2008); | ||
Member, National Advisory Committee for the Robert Wood | ||
Johnson Foundation’s Scholars in Health Policy Research Program | ||
(2008); Director and Member, National Economic Association | ||
(2006 to 2008); Member, Association of Public Policy Analysis and | ||
Management Policy Council (2006 to 2008); Member, Hamilton | ||
Project’s Advisory Board at The Brookings Institute (2006 to 2008); | ||
Chair of Committee on the Status of Minority Groups in the Economic | ||
Profession, American Economic Association (2006 to 2008 and | ||
2012 to present) | ||
John G. Schreiber | Owner/President, Centaur Capital Partners, Inc., a real estate | |
(1946) | investment company (1991 to present); Cofounder and Partner, | |
2001 | Blackstone Real Estate Advisors, L.P. (1992 to present); Director, | |
[143] | General Growth Properties, Inc. (2010 to present); Director, Capital | |
Trust, Inc., a real estate investment company (2012 to present) | ||
Mark R. Tercek | President and Chief Executive Officer, The Nature Conservancy (2008 | |
(1957) | to present); Managing Director, The Goldman Sachs Group, Inc. | |
2009 | (1984 to 2008) | |
[143] | ||
*Each independent director serves until retirement, resignation, or election of a successor. |
Inside Directors | ||
Name | ||
(Year of Birth) | ||
Year Elected* | ||
[Number of T. Rowe Price | Principal Occupation(s) and Directorships of Public Companies and | |
Portfolios Overseen] | Other Investment Companies During the Past Five Years | |
Edward C. Bernard | Director and Vice President, T. Rowe Price; Vice Chairman of the | |
(1956) | Board, Director, and Vice President, T. Rowe Price Group, Inc.; | |
2006 | Chairman of the Board, Director, and President, T. Rowe Price | |
[143] | Investment Services, Inc.; Chairman of the Board and Director, | |
T. Rowe Price Retirement Plan Services, Inc., T. Rowe Price Savings | ||
Bank, and T. Rowe Price Services, Inc.; Chairman of the Board, Chief | ||
Executive Officer, and Director, T. Rowe Price International; Chairman | ||
of the Board, Chief Executive Officer, Director, and President, | ||
T. Rowe Price Trust Company; Chairman of the Board, all funds | ||
Brian C. Rogers, CFA, CIC | Chief Investment Officer, Director, and Vice President, T. Rowe Price; | |
(1955) | Chairman of the Board, Chief Investment Officer, Director, and Vice | |
2006 | President, T. Rowe Price Group, Inc.; Vice President, T. Rowe Price | |
[76] | Trust Company; Vice President, Personal Strategy Funds | |
*Each inside director serves until retirement, resignation, or election of a successor. |
Officers | ||
Name (Year of Birth) | ||
Position Held With Personal Strategy Funds | Principal Occupation(s) | |
Christopher D. Alderson (1962) | Director and President-International Equity, | |
Vice President | T. Rowe Price International; Company’s | |
Representative, Director, and Vice President, | ||
Price Hong Kong; Director and Vice President, | ||
Price Singapore; Vice President, T. Rowe Price | ||
Group, Inc. | ||
E. Frederick Bair, CFA, CPA (1969) | Vice President, T. Rowe Price, T. Rowe Price | |
Vice President | Group, Inc., and T. Rowe Price Trust Company | |
Jerome A. Clark, CFA (1961) | Vice President, T. Rowe Price, T. Rowe Price | |
Vice President | Group, Inc., T. Rowe Price Investment Services, | |
Inc., and T. Rowe Price Trust Company | ||
Kimberly E. DeDominicis (1976) | Vice President, T. Rowe Price, T. Rowe Price | |
Vice President | Group, Inc., and T. Rowe Price International | |
Roger L. Fiery III, CPA (1959) | Vice President, Price Hong Kong, Price | |
Vice President | Singapore, T. Rowe Price, T. Rowe Price Group, | |
Inc., T. Rowe Price International, and T. Rowe | ||
Price Trust Company | ||
Mark S. Finn, CFA, CPA (1963) | Vice President, T. Rowe Price, T. Rowe Price | |
Vice President | Group, Inc., and T. Rowe Price Trust Company | |
John R. Gilner (1961) | Chief Compliance Officer and Vice President, | |
Chief Compliance Officer | T. Rowe Price; Vice President, T. Rowe Price | |
Group, Inc., and T. Rowe Price Investment | ||
Services, Inc. | ||
Gregory S. Golczewski (1966) | Vice President, T. Rowe Price and T. Rowe Price | |
Vice President | Trust Company | |
Gregory K. Hinkle, CPA (1958) | Vice President, T. Rowe Price, T. Rowe Price | |
Treasurer | Group, Inc., and T. Rowe Price Trust Company | |
Ian D. Kelson (1956) | President-International Fixed Income, T. Rowe | |
Vice President | Price International; Vice President, T. Rowe | |
Price and T. Rowe Price Group, Inc. | ||
Wyatt A. Lee, CFA (1971) | Vice President, T. Rowe Price, T. Rowe Price | |
Vice President | Group, Inc., and T. Rowe Price Trust Company | |
Patricia B. Lippert (1953) | Assistant Vice President, T. Rowe Price and | |
Secretary | T. Rowe Price Investment Services, Inc. | |
Raymond A. Mills, Ph.D., CFA (1960) | Vice President, T. Rowe Price, T. Rowe Price | |
Vice President | Group, Inc., T. Rowe Price International, and | |
T. Rowe Price Trust Company | ||
David Oestreicher (1967) | Director, Vice President, and Secretary, T. Rowe | |
Vice President | Price Investment Services, Inc., T. Rowe | |
Price Retirement Plan Services, Inc., T. Rowe | ||
Price Services, Inc., and T. Rowe Price Trust | ||
Company; Chief Legal Officer, Vice President, | ||
and Secretary, T. Rowe Price Group, Inc.; Vice | ||
President and Secretary, T. Rowe Price and | ||
T. Rowe Price International; Vice President, | ||
Price Hong Kong and Price Singapore; | ||
Secretary, T. Rowe Price Savings Bank | ||
Larry J. Puglia, CFA, CPA (1960) | Vice President, T. Rowe Price, T. Rowe Price | |
Vice President | Group, Inc., and T. Rowe Price Trust Company | |
Deborah D. Seidel (1962) | Vice President, T. Rowe Price, T. Rowe Price | |
Vice President | Group, Inc., T. Rowe Price Investment Services, | |
Inc., and T. Rowe Price Services, Inc. | ||
Charles M. Shriver, CFA (1967) | Vice President, T. Rowe Price, T. Rowe Price | |
President | Group, Inc., and T. Rowe Price Trust Company | |
Robert W. Smith (1961) | Vice President, T. Rowe Price, T. Rowe Price | |
Vice President | Group, Inc., and T. Rowe Price Trust Company | |
Guido F. Stubenrauch (1970) | Vice President, T. Rowe Price | |
Vice President | ||
Mark J. Vaselkiv (1958) | Vice President, T. Rowe Price, T. Rowe Price | |
Vice President | Group, Inc., and T. Rowe Price Trust Company | |
Julie L. Waples (1970) | Vice President, T. Rowe Price | |
Vice President | ||
Richard T. Whitney, CFA (1958) | Vice President, T. Rowe Price, T. Rowe Price | |
Vice President | Group, Inc., T. Rowe Price International, and | |
T. Rowe Price Trust Company | ||
Unless otherwise noted, officers have been employees of T. Rowe Price or T. Rowe Price International for at least 5 years. |
Item 2. Code of Ethics.
The registrant has adopted a code of ethics, as defined in Item 2 of Form N-CSR, applicable to its principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. A copy of this code of ethics is filed as an exhibit to this Form N-CSR. No substantive amendments were approved or waivers were granted to this code of ethics during the period covered by this report.
Item 3. Audit Committee Financial Expert.
The registrant’s Board of Directors/Trustees has determined that Mr. Anthony W. Deering qualifies as an audit committee financial expert, as defined in Item 3 of Form N-CSR. Mr. Deering is considered independent for purposes of Item 3 of Form N-CSR.
Item 4. Principal Accountant Fees and Services.
(a) – (d) Aggregate fees billed for the last two fiscal years for professional services rendered to, or on behalf of, the registrant by the registrant’s principal accountant were as follows:
Audit fees include amounts related to the audit of the registrant’s annual financial statements and services normally provided by the accountant in connection with statutory and regulatory filings. Audit-related fees include amounts reasonably related to the performance of the audit of the registrant’s financial statements and specifically include the issuance of a report on internal controls and, if applicable, agreed-upon procedures related to fund acquisitions. Tax fees include amounts related to services for tax compliance, tax planning, and tax advice. The nature of these services specifically includes the review of distribution calculations and the preparation of Federal, state, and excise tax returns. All other fees include the registrant’s pro-rata share of amounts for agreed-upon procedures in conjunction with service contract approvals by the registrant’s Board of Directors/Trustees.
(e)(1) The registrant’s audit committee has adopted a policy whereby audit and non-audit services performed by the registrant’s principal accountant for the registrant, its investment adviser, and any entity controlling, controlled by, or under common control with the investment adviser that provides ongoing services to the registrant require pre-approval in advance at regularly scheduled audit committee meetings. If such a service is required between regularly scheduled audit committee meetings, pre-approval may be authorized by one audit committee member with ratification at the next scheduled audit committee meeting. Waiver of pre-approval for audit or non-audit services requiring fees of a de minimis amount is not permitted.
(2) No services included in (b) – (d) above were approved pursuant to paragraph (c)(7)(i)(C) of Rule 2-01 of Regulation S-X.
(f) Less than 50 percent of the hours expended on the principal accountant’s engagement to audit the registrant’s financial statements for the most recent fiscal year were attributed to work performed by persons other than the principal accountant’s full-time, permanent employees.
(g) The aggregate fees billed for the most recent fiscal year and the preceding fiscal year by the registrant’s principal accountant for non-audit services rendered to the registrant, its investment adviser, and any entity controlling, controlled by, or under common control with the investment adviser that provides ongoing services to the registrant were $1,794,000 and $1,375,000, respectively.
(h) All non-audit services rendered in (g) above were pre-approved by the registrant’s audit committee. Accordingly, these services were considered by the registrant’s audit committee in maintaining the principal accountant’s independence.
Item 5. Audit Committee of Listed Registrants.
Not applicable.
Item 6. Investments.
(a) Not applicable. The complete schedule of investments is included in Item 1 of this Form N-CSR.
(b) Not applicable.
Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End Management Investment Companies.
Not applicable.
Item 8. Portfolio Managers of Closed-End Management Investment Companies.
Not applicable.
Item 9. Purchases of Equity Securities by Closed-End Management Investment Company and Affiliated Purchasers.
Not applicable.
Item 10. Submission of Matters to a Vote of Security Holders.
Not applicable.
Item 11. Controls and Procedures.
(a) The registrant’s principal executive officer and principal financial officer have evaluated the registrant’s disclosure controls and procedures within 90 days of this filing and have concluded that the registrant’s disclosure controls and procedures were effective, as of that date, in ensuring that information required to be disclosed by the registrant in this Form N-CSR was recorded, processed, summarized, and reported timely.
(b) The registrant’s principal executive officer and principal financial officer are aware of no change in the registrant’s internal control over financial reporting that occurred during the registrant’s second fiscal quarter covered by this report that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting.
Item 12. Exhibits.
(a)(1) The registrant’s code of ethics pursuant to Item 2 of Form N-CSR is attached.
(b) A certification by the registrant's principal executive officer and principal financial officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and required by Rule 30a-2(b) under the Investment Company Act of 1940, is attached.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
T. Rowe Price Personal Strategy Funds, Inc.
By | /s/ Edward C. Bernard | |
Edward C. Bernard | ||
Principal Executive Officer | ||
Date July 16, 2013 |
Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
By | /s/ Edward C. Bernard | |
Edward C. Bernard | ||
Principal Executive Officer | ||
Date July 16, 2013 | ||
By | /s/ Gregory K. Hinkle | |
Gregory K. Hinkle | ||
Principal Financial Officer | ||
Date July 16, 2013 |