Global Allocation Fund Global Allocation Fund

128 Pages·2017·2.25 MB·English

ANNUAL REPORT
October 31, 2018
T. ROWE PRICE
RPGAX Global Allocation Fund
PAFGX Global Allocation Fund–
Advisor Class
TGAFX Global Allocation Fund–
I Class
The fund invests in a broadly diversified
portfolio of stocks, bonds, and alternative
investments issued throughout the world.
For more insights from T. Rowe Price
investment professionals, go to
troweprice.com.
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T. Rowe PRICe GlobAl AlloCATIon Fund T. Rowe PRICe GlobAl AlloCATIon Fund
CIo Market Commentary
HIGHLIGHTS
n The Global Allocation Fund returned -2.31% in the 12 months ended
October 31, 2018, and underperformed the Morningstar Global
Allocation Index.
n Global equity markets were mixed, with U.S. stocks posting gains while
international and emerging markets equities declined. Rising interest
rates hampered returns in U.S. fixed income markets, and local currency
weakness hurt performance in international bond markets.
n We moderated our underweight to global equities after the market sell-off
late in the period resulted in more reasonable valuations. Bond yields in
the U.S. have risen from low levels, and bonds may also offer diversification
and downside protection, particularly against an increase in equity
market volatility.
n We believe that broad diversification across asset classes, regions, and
sectors, as well as our ability to actively adjust allocations to enhance the
portfolio’s risk/reward profile, should benefit the Global Allocation Fund
across a range of market environments.
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T. Rowe PRICe GlobAl AlloCATIon Fund T. Rowe PRICe GlobAl AlloCATIon Fund
CIo Market Commentary
Dear Shareholder
Global financial markets generated widely divergent returns in your fund’s
fiscal year ended October 31, 2018. International equities declined during a
volatile period marked by slowing growth in Europe, a growing trade conflict
between the U.S. and China, and struggling currencies versus the U.S. dollar.
Relatively high interest rates and the stronger U.S. economy resulted in asset
flows to the U.S., where equities moved higher, particularly large-cap growth
stocks. Both taxable and tax-exempt domestic bonds recorded losses, and
non-U.S. bond prices declined considerably.
Several factors contributed to the significant performance gap between
U.S. stocks and other assets. U.S. equities benefited from the strong domestic
economy and the tax cuts passed in late 2017, which helped corporate earnings
expand at their fastest pace since the recovery from the financial crisis nearly a
decade ago. Less welcome was a sharp rise in long-term interest rates, a result
of improved economic conditions and early signs of higher inflation. Bond
prices fell as yields rose, leaving only the riskier high yield and asset-backed
sectors—which are typically more resilient when rates increase—with gains for
the period.
In Europe, slowing growth buffeted equities, while interest rates remained
low due to continued monetary accommodation by the European Central
Bank. Bank stocks, which make up a significant portion of major indexes,
were particularly weak in this environment. Stocks slipped in Japan, but
exceptionally aggressive monetary stimulus from the Bank of Japan failed to
spark inflation or a convincing rebound in the country’s sluggish growth rate.
Higher rates and the strengthening U.S. economy bolstered the U.S. dollar
versus other currencies but reduced returns of non-U.S. assets in dollar terms.
The strong dollar also weighed heavily on emerging market countries with
large current account deficits and external financing needs. A broad crisis in
emerging markets debt has yet to materialize, however.
Chinese stocks dropped sharply, reflecting a manufacturing sector slowdown
brought about by efforts to reduce pollution and the government’s continued
clampdown on financial excesses. New regulations on gaming and online
activities also weighed on the widely traded shares of the country’s Internet
giants. Heightened trade tensions with the U.S. took a further toll on investor
sentiment toward China and other markets and may well have drained
enthusiasm about healthy corporate profits and economic growth.
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The actual impact of trade tensions on the U.S. economy appears muted to
date, although the reprieve may prove temporary. The Chinese yuan has
cheapened considerably, largely offsetting the 10% U.S. tariff on many Chinese
imports by making them less expensive in dollar terms. If the yuan stabilizes
and the Trump administration increases the tariff rate to 25% in 2019, as it has
threatened, the U.S. could face meaningfully higher import costs. A continued
decline in the yuan, on the other hand, would likely draw the ire of U.S. trade
negotiators and further heighten tensions.
Other uncertainties await investors in 2019. In the U.S., our investment
professionals will be assessing the impact of a new era of divided government
and keeping a close eye on earnings growth, which will most certainly slow
in the coming year as the effect of the corporate tax cut on year-over-year
earnings comparisons fades. By late in the year, the impact of fiscal stimulus
will have peaked, while the U.S. economy will be without easy money for the
first time in this economic cycle—assuming the Fed stays on its current path
of raising short-term rates gradually. In Europe, the Brexit deadline looms in
March, and investors are keeping a close eye on whether populist movements in
Italy and elsewhere will challenge the stability of the European Union.
Nonetheless, our investment professionals continue to see opportunities
for careful and patient investors. For example, sharp declines have created
attractive valuations in some emerging markets, and corporate fundamentals
in the U.S. generally remain excellent. Many innovative companies around the
globe are using technology to seize market share from others, allowing them to
continue growing at a healthy pace even if economic growth slows.
In the search for these opportunities, your portfolio manager is drawing on
the extensive resources of T. Rowe Price’s global research platform, and I am
confident that our uniquely collaborative culture will continue to serve our
shareholders well.
Thank you for your continued confidence in T. Rowe Price.
Sincerely,
Robert Sharps
Group Chief Investment Officer
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Management’s discussion of Fund Performance
INVESTMENT OBJECTIVE
The fund seeks long-term capital appreciation and income.
FUND COMMENTARY
How did the fund perform in the past 12 months?
The Global Allocation Fund returned -2.31% in the 12 months ended
October 31, 2018. The fund underperformed the Morningstar Global Allocation
Index. (Returns for the Advisor and I Class shares varied slightly, reflecting
their different fee structures.
PERFORMANCE COMPARISON Past performance cannot
guarantee future results.)
Total Return
Periods ended 10/31/18 6 Months 12 Months What factors influenced the
Global Allocation Fund -4.32% -2.31% fund’s performance?
Global Allocation Fund– For the year, security selection
Advisor Class -4.42 -2.56 within several underlying
Global Allocation Fund– strategies detracted, led by
I Class -4.24 -2.23 underperformance in the
U.S. large-cap value and
Morningstar Global
Allocation Index -2.88 -0.38 international value equity
portfolios. An underweight
allocation to U.S. equities
relative to international equities also hurt returns. U.S. equities rallied for
much of the period, as tax reform legislation passed in late 2017 translated
into strong U.S. earnings growth, whereas escalating trade tensions, a stronger
U.S. dollar, political risk, and slowing economic growth dragged down
international equities.
Exposure to international small-cap equities weighed on performance. Small-cap
stocks outside the U.S. lagged broader equity markets as international small-caps
have been more vulnerable to moderating global growth and tightening liquidity.
The inclusion of emerging markets debt was unfavorable as those markets
sold off broadly over the period, driven in part by economic woes in Turkey
and Argentina.
On the positive side, our diversifying allocation to a conservative hedge fund
of funds boosted relative returns. The strategy’s diversifying properties proved
beneficial in an environment characterized by low returns and periods of
elevated volatility, as the hedge fund of funds outperformed both cash and
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its benchmark (the HFRI Conservative Fund of Funds Index). Our exposure
to currency-hedged international equities also added value, moderating
the adverse impact of a stronger U.S. dollar on the performance of our
international holdings.
The fund uses derivatives such as forward currency exchange contracts to
reduce the exposure to movements in foreign currencies. During the reporting
period, these derivative holdings contributed to performance.
How is the fund positioned?
We have moderated our underweight to global equities following a meaningful
correction late in the period, as valuations appear more reasonable and better
reflect building risks from higher interest rates and elevated trade tensions.
Bond yields in the U.S. have risen in concert with a determined Federal Reserve
and an increasing Treasury supply. In addition to more competitive yields, we
have maintained an overweight to bonds as they also offer diversification and a
buffer against adverse equity markets.
Stocks
On a regional basis, we favor international equities over U.S. equities as
recent underperformance has reinforced more attractive relative valuations.
International markets are earlier in the economic cycle and are, in many cases,
supported by more accommodative monetary policy relative to the U.S., where
the Federal Reserve is further along the path of raising interest rates. Strong
earnings growth in the U.S. is still supportive but has likely peaked. Within
international equities, the broad sell-off in emerging markets has resulted in
cheaper valuations, and we took advantage of the opportunity to add to select
equities in these markets.
In the U.S., we are neutral between value and growth stocks. Growth stock
valuations remain elevated, and trade tensions could impact the supply chains
of some leading global technology companies. Fiscal stimulus provided
near-term support for some cyclical value stocks, but moderating global growth
and a waning credit cycle pose headwinds. We are overweight U.S. small-caps
relative to U.S. large-caps. Valuations for small-cap stocks are supportive
on a number of metrics, and the sector could benefit from increased capital
expenditure activity as well as potential mergers and acquisitions.
Among international equities, we prefer value over growth stocks. Valuations
for growth stocks are above historical averages, particularly within cyclically
sensitive areas such as the industrials and business services sector. Value stocks
are more attractively priced, although we have seen fundamentals weaken
within European financials, a key barometer of the value sector. We are
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underweight to international small-cap stocks relative to international large-cap
stocks as riskier assets (such as small-cap stocks outside the U.S.) may be more
susceptible in an environment of tighter liquidity. Additionally, small-cap
valuations have been trending more expensive relative to large-cap, although
valuation differentials have moderated in the recent market sell-off.
We remain underweight to inflation-sensitive real assets equities given the
potential for persistent supply/demand imbalances from continued advances
in oil and gas production—particularly in U.S. shale—and moderating Chinese
growth, which make the long-term prospects for energy and commodity
prices challenging. Valuations for real estate investment trusts have become
less appealing, but their
SECURITY DIVERSIFICATION fundamentals remain broadly
positive, supported by
Other Reserves*
11% 6% limited supply and healthy
occupancy rate. However,
rising interest rates could
Foreign Domestic
Bonds Equities continue to be a headwind.
14% 24%
Bonds
Domestic Foreign
Bonds Equities Yields for U.S. investment-
18% 27% grade bonds have risen
year-to-date, making them
Based on net assets as of 10/31/18.
more attractive, and they
*Includes the cash underlying futures positions, such as
also provide ballast in the
the Russell 2000 futures.
portfolio in an environment
of equity market uncertainty.
Within fixed income, we are underweight high yield bonds. Despite the
late stage of the credit cycle, near-term default expectations remain low;
however, high yield bonds offer a limited buffer against a more challenging
credit environment. We favor floating rate bank loans as their supportive
fundamentals and rate reset feature may offer some defense against rising
rates, although we have recently reduced our overweight as we have seen
opportunities in other fixed income sectors.
Low yields and long durations create a less attractive outlook for international
investment-grade debt. European bonds are particularly at risk from rising
interest rates as the European Central Bank tapers its stimulus policies.
We initiated an opportunistic allocation to currency-hedged international
bonds during the period, as the expanding short-term interest rate
differential between U.S. and international bonds made hedged yields more
attractive for U.S. dollar-based investors. We increased our exposure to
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BOND PORTFOLIO PROFILE U.S. dollar-denominated
emerging markets sovereign
Periods ended 4/30/18 10/31/18 debt after the recent
weighted Average effective sell-off made valuations
duration (years) 6.1 6.0 more appealing. We have
maintained an overweight
weighted Average
Maturity (years) 9.3 9.1 to emerging market local
currency bonds. Many
Credit Quality diversification*
emerging markets currencies
u.S. Government Agencies** 0.5% 1.2%
have been unduly punished
u.S. Treasuries*** 30.9 27.3
amid fears of contagion,
AAA 5.2 4.2
creating compelling oppor-
AA 5.2 4.4
tunities in select areas.
A 11.4 13.7
Still, U.S. dollar strength
bbb 18.7 21.4 represents a headwind for
bb and below 24.3 25.0 most emerging markets.
not Rated 2.0 1.5
What is the portfolio
Reserves 1.8 1.3
management’s outlook?
Total 100.0% 100.0%
Global growth trajectories
*Sources: Moody’s Investors Service; if Moody’s
does not rate a security, then Standard & Poor’s have diverged in 2018 as the
(S&P) is used as a secondary source. when U.S. economy has benefited
available, T. Rowe Price will use Fitch for securities from late-cycle fiscal stimulus
that are not rated by Moody’s or S&P.
and corporate tax reform,
**u.S. government agency securities are issued or
while some economies
guaranteed by a u.S. government agency and
outside the U.S. have lagged
may include conventional pass-through securities
and collateralized mortgage obligations; unlike despite support from accom-
Treasuries, government agency securities are not modative monetary policies.
issued directly by the u.S. government and are We expect global growth to
generally unrated but may have credit support from
stabilize at more sustainable
the u.S. Treasury (e.g., FHlMC and FnMA issues)
levels and for the growth
or a direct government guarantee (e.g., GnMA
issues). Therefore, this category may include differential between the U.S.
rated and unrated securities. and the rest of the world
***u.S. Treasury securities are issued by the u.S. to narrow as the tailwind
Treasury and are backed by the full faith and credit from fiscal stimulus in the
of the u.S. government. The ratings of u.S. Treasury
U.S. begins to abate next
securities are derived from the ratings on the
year. Growth in Europe has
u.S. government.
moderated, but we expect it
to stabilize and remain above
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potential. In Japan, monetary and fiscal policies remain tailwinds, but slowing
global growth and escalating trade tensions could weigh on the country’s
trade-driven economy. U.S. dollar strength and trade risks have exacerbated
economic imbalances in some emerging markets; however, many developing
countries are less reliant on U.S. dollar funding than they were in the past,
lessening the potential for systemic risk.
We have a cautious view on risk-taking within our portfolios given the
backdrop of an extended economic cycle, but we continue to look for
opportunities particularly where fundamental value may not be fully reflected
in market prices. Global central banks are in varying stages of winding down
accommodative monetary policies, leading to a decrease in liquidity and
potential for upward pressure on yields. Fundamentals for corporate earnings
remain broadly supportive, and while we expect slowing global growth, we do
not anticipate a recession over the next year. Key risks to global markets include
negative impacts from potential monetary policy missteps and protectionist
trade policies.
Given the many crosscurrents that can influence global financial markets, we
believe that the Global Allocation Fund’s broad diversification, combined with
strengths in our strategic investing approach, can add value over the long term
and help mitigate downside risk in an uncertain market environment.
The views expressed reflect the opinions of T. Rowe Price as of the date of this report and are subject
to change based on changes in market, economic, or other conditions. These views are not intended
to be a forecast of future events and are no guarantee of future results.
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RISKS OF INVESTING IN STOCKS
As with all stock and bond mutual funds, the 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. A sizable cash or fixed income position
may hinder the fund from participating fully in a strong, rapidly rising bull
market. In addition, significant exposure to bonds increases the risk that the
fund’s share value could be hurt by rising interest rates or credit downgrades
or defaults. Convertible securities are also exposed to price fluctuations of the
company’s stock.
RISKS OF INTERNATIONAL INVESTING
Funds that invest overseas generally carry more risk than funds that invest
strictly in U.S. assets. Funds investing in a single country or in a limited
geographic region tend to be riskier than more diversified funds. 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.
The risks of international investing are heightened for securities of issuers
in emerging market countries. Emerging market countries tend to have
economic structures that are less diverse and mature, and political systems
that are less stable, than those of developed countries. In addition to all of the
risks of investing in international developed markets, emerging markets are
more susceptible to governmental interference, local taxes being imposed on
international investments, restrictions on gaining access to sales proceeds, and
less liquid and less efficient trading markets.
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