By Dean Biggins, U.S. Fish and Wildlife Service [Public domain], via Wikimedia Commons
Warren Buffett / Charlie Munger’s Four Filters + Risk Factors
- Understand the Business
- Enduring Competitive Advantages
- Able and Trustworthy Managers
- Risk Factors
- Bargain Price = Margin of Safety (I will not explore this as everyone should devise their own fair value)
1. Understand the Business [Updated Oct 17th 2015]
T.Rowe Price is an asset management firm that serves individual and institutional clients mainly in the form of US mutual funds and other investment portfolios (separately managed accounts, subadvised funds, collective investment trusts, target-date retirement trusts, Luxembourg-based funds for non-US investors, variable annuity life insurance plans etc.). Of the 746.8 billion USD assets under management (AUM) as of 2014 Dec 31, Mutual funds currently occupy 63.95% while other investment portfolios occupy 36.05%.
In terms of investment strategies, T.Rowe Price only focuses on equities and fixed income, providing options that range from purely equity or fixed income to a mix between both. Of the 746.8 billion USD AUM as of 2014 Dec 31, stock and blended asset occupy 77.65% while fixed income portfolios occupy 22.35%.
2. Enduring Competitive Advantages [Updated Oct 21st 2o15]
T.Rowe Price’s biggest competitive advantage is its Reputation, with most of its related competitive advantage derived from its Reputation. The other significant competitive advantage T.Rowe Price has is its Disciplined capital allocation.
One competitive advantage that derives from T.Rowe Price’s Reputation is an extremely happy customer base (National Association of Retirement Plan Participants ranked T.Rowe Price as “most trusted” retirement plan provider in 2014, and 86% of customers would recommend T.Rowe Price to friend / relative for one to one consultation), which helps with customer stickiness through thick and thin as clients stay put with a brand they are familiar with during times of uncertainty.
T.Rowe Price’s Reputation also helps it grow its AUM, which helps gives it scale for cost efficiency as the 26th largest asset management firm globally. Its AUM growth rate (using Dec 31 2014 as cut off date) is 7.89% (1 year), 15.13% (3 year CAGR), 13.81% (5 year CAGR) and 12.25% (10 year CAGR).
This Reputation also helps T.Rowe Price attract and retain a fund management team that have an average of 19 years of investment experience and 13 years’ tenure with T.Rowe Price and contributed to 74% of its mutual funds outperforming comparable Lipper average on total return for a 3 year period and have 82% of assets given a four to five star rating from Morningstar.
All three of these Reputation related competitive advantages creates a virtuous cycle that continually feeds each others’ increasing strength.
Another competitive advantage that cannot be ignored is T.Rowe Price’s Disciplined capital allocation. T.Rowe Price has rarely engaged in acquisition activities, and has a shareholder friendly dividend policy that has seen its dividend grown year on year for 29 consecutive years.
3. Able and Trustworthy Managers [Updated Oct 1st 2015]
One aspect of T.Rowe Price’s management was explored in the aforementioned “Disciplined capital allocation” section below “2. Enduring Competitive Advantages”.
The other aspect of T.Rowe Price’s management is Financial prudence, which is different to disciplined capital allocation in a sense that I view capital allocation as offensive (deploying capital to generate more capital) while I view financial prudence as defensive. As of 2014 Dec, T.Rowe Price’s zero debt and dividend payout ratio of 38.20% provides huge margin of safety for T.Rowe Price to navigate unforeseen negative circumstances.
4. Risk Factors [Updated Oct 19th 2015]
The biggest risk to T.Rowe Price is purely on its ability to recruit and retain talents that can continuously succeed in the world of investing.
Making matters more difficult, T.Rowe Price is heavily exposure to US Equities, which accounts for 69.40% of its total assets under management (685.18 billion USD in US Equity and 61.62 billion USD in int’l Equity), arguably the “most transparent, efficient and competitive (stock market)… in the world“. The implication is that T.Rowe Price needs to recruit and retain the absolutely best talents available in order to outperform not only its competitors, but also the extremely efficient US stock market.
And as of Oct 19th 2015, there is concern about T.Rowe Price’s ability to differentiate itself admist competitors in the war for talent.
Compared to its direct competitors as listed in Yahoo Finance and top 3 biggest competitors as listed in Morningstar (namely Fidelity Investments, The Vanguard Group and American Century Companies and BlackRock, Bank of New York Mellon, and Blackstone Group), T.Rowe Price’s Glassdoor score is 3.5 versus Fidelity’s 3.7, Vanguard 3.3, American Century’s 4.0, BlackRock’s 3.6, BNY Mellon’s 2.8, Blackstone Group’s 4.0 (Competitor average score of 3.57).
Another significant risk to T.Rowe Price is that most of its business is done in the form of mutual funds. Actively managed mutual funds are structurally designed to have a hard time beating the market due to over-diversification, high fees vs passive funds, mandatory cash on hand, closet indexing, and high taxes due to turnover rate. It’s a reason why 86% of actively managed mutual funds fail to beat the market.
If T.Rowe Price fails to keep beating the market and peers due to limitations of the mutual fund structure, it would seriously deteriorate its reputation and any competitive advantages that come with it (customer attraction, customer stickiness, talent recruitment, talent stickiness and scale).