PRSGX RPSIX PSILX. Spectrum Growth Fund Spectrum Income Fund Spectrum International Fund. annual REPORT - PDF

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annual REPORT December 31, 2016 PRSGX RPSIX PSILX T. Rowe Price Spectrum Growth Fund Spectrum Income Fund Spectrum International Fund The funds invest in T. Rowe Price funds focused on growth, income,
annual REPORT December 31, 2016 PRSGX RPSIX PSILX T. Rowe Price Spectrum Growth Fund Spectrum Income Fund Spectrum International Fund The funds invest in T. Rowe Price funds focused on growth, income, and international investments. T. Rowe Price Spectrum Funds HIGHLIGHTS Many U.S. stock indexes reached record highs near the end of Equities in international developed markets were modestly positive, while emerging markets stocks generated strong gains. U.S. investment-grade bonds advanced in 2016, while international developed markets debt was slightly positive. Emerging markets debt generated strong gains. The Spectrum Growth Fund returned 7.22% and 7.84% for the semiannual and annual reporting periods, respectively, and trailed its benchmarks. The Spectrum Income Fund returned 1.15% and 8.18% for the semiannual and annual reporting periods, respectively. Performance versus its benchmarks was mixed. The Spectrum International Fund returned 1.78% and 0.39% for the semiannual and annual reporting periods, respectively, and trailed its benchmarks. Key risks to global markets include the potential for protectionist policies to weigh on global trade, the sustainability of energy prices, and global monetary policies. We believe that the diversification of our portfolios combined with the benefits of active management in security selection and our ability to make tactical changes in the fund s allocations will help us generate attractive risk-adjusted returns in an uncertain market environment. The views and opinions in this report were current as of December 31, 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. REPORTS ON THE WEB Sign up for our Program, and you can begin to receive updated fund reports and prospectuses online rather than through the mail. Log in to your account at for more information. T. Rowe Price Spectrum Funds Manager s Letter Fellow Shareholders Several major U.S. stock indexes reached record highs near the end of 2016 in a turbulent year marked by rebounding commodity prices, Brexit-related concerns, and uncertainties about interest rate policy and elections. Emerging markets stocks generated strong gains, while equities in international developed markets trailed with modest gains. In the fixed income universe, U.S. investment-grade bonds were positive overall as losses in the latter half of 2016 were offset by strong gains in the first half of the year. High yield bonds advanced as prices for oil and other commodities rebounded to higher levels. Bonds in developed non-u.s. markets were modestly positive in U.S. dollar terms, while emerging markets debt advanced solidly. The Spectrum Income Fund and Spectrum Growth Fund posted good gains against this backdrop, while the Spectrum International Fund was slightly positive. MARKET ENVIRONMENT U.S. stocks rose in 2016, with major indexes repeatedly reaching record highs in the final weeks of the year. The year began on a sour note, as fears of a global economic slowdown and a collapse in oil prices to 13-year lows weighed on markets. Equities gradually worked their way higher through late June as commodity prices recovered and the U.S. dollar weakened due to diminishing expectations for Federal Reserve (Fed) interest rate increases in The UK s decision to leave the European Union (EU) disrupted markets for a short time, but equities soon recovered the lost ground. Shares were largely flat in the months prior to the November 8 U.S. elections. Uncertainty about a possible interest rate increase also held equities back, as Federal Reserve officials were cautioning that the case for raising short-term interest rates had strengthened. Donald Trump s election victory sparked a sharp rally due to the potential for a friendlier regulatory 1 environment and stimulative fiscal policies, including tax cuts and increased infrastructure spending. Small- and mid-cap stocks, which stand to benefit relatively more from Mr. Trump s proposed policies given their characteristically greater focus on the domestic economy, significantly outperformed Global Equity Returns Total Return Periods Ended 12/31/16 6 Months 12 Months S&P 500 Index 7.82% 11.96% Russell 2000 Index large-caps. As measured by various Russell indexes, more cyclically sensitive value stocks outpaced growth stocks across all market capitalizations. Russell 3000 Index International developed MSCI All Country markets stocks edged World Index ex USA slightly higher in U.S. MSCI Emerging dollar terms. Equities Markets Index in Japan rose modestly. Sluggish economic growth and doubts about the efficacy of stimulative policies weighed on Japanese stocks in the first half of the year, but they saw strong gains in the second half of the year as a weakening currency supported prospects for the country s exporters. European equity markets were widely mixed. Brexit concerns weighed on several markets, particularly in the UK, and economic growth remained muted. At the same time, a stronger dollar versus many European currencies further eroded returns for U.S. investors. Equities in Norway benefited from a rebound in oil prices and performed very well, while stocks in Italy fell more than 9% amid troubles in the country s banking sector. Emerging markets stocks produced strong returns in dollar terms and outperformed developed international markets. Several Latin American markets produced excellent returns, helped by rebounding commodity prices and a more stable political environment. In emerging Europe, Russian shares advanced 56%, helped by firming oil prices, a stronger ruble, and hopes for better relations with the U.S. following the election of Donald Trump. Emerging Asian markets were widely mixed. Shares in Thailand, Taiwan, and Indonesia performed well, but Indian stocks fell slightly, and the Chinese A shares market fell almost 19%. U.S. investment-grade bonds produced positive returns in 2016, with substantial gains in the first half of the year offsetting losses in the second half. In the Treasury market, yields rose across all maturities. Intermediate- and long-term yields dipped to four-year lows around Interest Rate Levels 4.0% 10-Year Treasury Note 5-Year Treasury Note Day Treasury Bill /31/15 3/16 6/16 9/16 12/31/16 Source: Federal Reserve Board. midyear, then rebounded in the second half and finished the year above their year-end 2015 levels. Treasury bill yields remained low throughout the year, but they increased in the fourth quarter in anticipation of a Fed rate hike in December and more rate increases in Corporate bonds were among the best performers among investment-grade securities. Treasury inflation protected securities (TIPS) fared well due to expectations for stronger economic growth and rising inflation in High yield bonds strongly outperformed investment-grade issues, helped by their lower sensitivity to interest rates, attractive yields, and a rebound in oil prices. Bonds in developed non-u.s. markets produced modestly positive returns in U.S. dollar terms, as significant first-half gains driven by dollar weakness and falling sovereign debt yields were largely offset by a reversal of both trends in the latter half of the year. Emerging markets bonds also produced strong returns, due largely to strength in the first half of the period. Dollar-denominated emerging markets debt outpaced local currency debt by a slim margin. SPECTRUM GROWTH FUND Performance Comparison Total Return Periods Ended 12/31/16 6 Months 12 Months Spectrum Growth Fund 7.22% 7.84% Russell 3000 Index Combined Index Portfolio Lipper Multi-Cap Core Funds Index As shown in the Performance Comparison table, the Spectrum Growth Fund returned 7.22% and 7.84% for the six and 12 months ended December 31, 2016, respectively. The fund trailed the Russell 3000 Index and the Lipper Multi-Cap Core Funds Index for both periods. 3 Portfolio Performance Security selection among the underlying funds weighed on results versus the Russell 3000 Index over the reporting period. Results were particularly weak in our U.S. large-cap portfolios, including the Blue Chip Growth Fund, Growth Stock Fund, and Value Fund. Selection in the International Growth & Income Fund, which invests in largecap dividend-paying stocks outside the U.S., also weighed on results. (Please note: Effective January 1, 2017, the International Growth & Income Fund was renamed the International Value Equity Fund. We believe the fund s new name better aligns it with similarly managed funds at T. Rowe Price. Its investment objective and approach remain unchanged.) The negative impact from these funds was only partially offset by positive security selection in the growth-oriented International Stock Fund and the Equity Income Fund, which invests primarily in large-cap dividend-paying U.S. stocks. Tactical decisions to overweight/underweight asset classes were a modest drag on results. An overweight to international developed markets equities for much of the period weighed on relative performance, as did an underweight to real assets equities, which performed well against a backdrop of higher commodities prices. These negative impacts Security Diversification Spectrum Growth Fund Small-Cap Stocks 5% Mid-Cap Stocks 14% International Stocks 33% Other and Reserves 3% Large-Cap Stocks 45% were somewhat offset by positive contributions from an underweight position in the New Horizons Fund, which invests in U.S. small-cap growth stocks, and a resultant overweight to the Small-Cap Value Fund. Strategic allocations to diversifying asset classes helped the fund s relative results, primarily due to our inclusion of the Real Assets Fund, which gained as prices for oil and other commodities rallied from a prolonged downturn. Based on net assets as of 12/31/16. 4 Portfolio Positioning The Spectrum Growth Fund invests in several underlying funds that focus on U.S. equities across the full range of market capitalizations and international stocks in both developing and emerging markets. We started the reporting period with an overweight position in international equities versus U.S. stocks but gradually moved to a neutral position. International developed markets remain supported by aggressive quantitative easing measures, and valuations appear attractive in many countries and sectors. However, the prospects for improved earnings growth overseas have moderated amid increased risks to global economic growth and trade. In Europe, uncertainty resulting from Brexit and upcoming elections and referendums in several countries are likely to weigh on business capital spending for an extended period. The potential for Among U.S. significant fiscal stimulus in Europe is challenged by equities, we moved the willingness and ability of many highly indebted countries to pursue such measures. from a neutral Among U.S. equities, we moved from a neutral position position in growth in growth stocks versus value stocks to a modest stocks versus overweight to growth. The strong postelection rally in many U.S. value sectors appears to be pricing in value stocks the most optimistic of pro-growth scenarios. Growth to a modest stocks feature more attractive valuations and also should benefit if growth proves more moderate than overweight postelection expectations. Although increased spending, to growth. lower taxes, and deregulation are likely to support cyclical sectors such as financials and energy, the ultimate scope of such measures and their prospects for congressional approval remain uncertain. We favor large-cap stocks over small-caps, but we moderated our underweight to small-caps as relative valuations moved closer to their historical averages. We note that higher U.S. fiscal spending and lower corporate taxes could benefit small-caps more than large-caps, given the greater domestic focus of small-cap stocks. Additionally, a stronger U.S. dollar could weigh more heavily on large-caps due to their larger exposure to foreign trade. Within international equities, we were modestly overweight emerging markets stocks versus developed markets shares for much of the period but moved to an underweight in emerging markets at the end of the period. Relative valuations in emerging markets appear broadly attractive but look expensive versus historical averages in absolute terms. Additionally, emerging economies and capital 5 flows are vulnerable to higher interest rates in developed markets, a stronger U.S. dollar, and the potential for protectionist policies in key markets to disrupt global trade. We favor international value over growth stocks as certain growth sectors appear increasingly expensive. Valuations for value sectors are broadly attractive, but sectors such as financials and energy continue to face headwinds. We maintained a modest overweight to international small-cap stocks versus international large-caps throughout the period. International small-caps offer selective opportunities in domestic economies that are in earlier stages of recovery than the U.S. While growth in Europe may be tempered over the near term by the impact of Brexit, growth has stabilized at modest levels, borrowing costs are low, credit is expanding, and employment is rising. Accommodative monetary policy continues to support growth in Europe and Japan in contrast to the U.S., where the Fed has started to tighten its policy. We increased the size of our underweight to real assets stocks relative to global equities. We remain cautious about the longer-term prospects for energy and commodity prices due to concerns about a secular global supply/demand imbalance. While the potential for infrastructure renewal spending has increased, its ultimate form, timing, and scope remain largely unknown. Recent stability in energy prices may be temporary as U.S. suppliers raise production in response, reigniting oversupply and pricing pressures. Fundamentals for developed markets real estate investment trusts (REITs) appear generally solid, supported by modest economic growth and limited supply. Inflation expectations and interest rates have risen since the U.S. election, and markets anticipate a reflationary impact from pro-growth economic policies. However, we note that a stronger U.S. dollar could dampen inflationary pressures as import prices fall and exports are pressured. SPECTRUM INCOME FUND Performance Comparison Total Return Periods Ended 12/31/16 6 Months 12 Months Spectrum Income Fund 1.15% 8.18% Bloomberg Barclays U.S. Aggregate Bond Index Lipper Multi-Sector Income Funds Average As shown in the Performance Comparison table, the Spectrum Income Fund returned 1.15% and 8.18% for the six and 12 months ended December 31, 2016, respectively. The fund outperformed the Bloomberg Barclays U.S. Aggregate Bond Index over the six-month period but trailed its Lipper peer group average. The fund outperformed the Bloomberg Barclays index and its Lipper peer group average for the annual reporting period. Portfolio Performance Strategic allocations to diversifying asset classes provided a significant boost to the fund s relative performance for the 12-month period, as top-performing sectors such as high yield bonds and emerging market debt are not included in the fund s benchmark, the Bloomberg Barclays U.S. Aggregate Bond Index, an investment-grade U.S. bond index. The High Yield Bond Fund provided the biggest benefit as the rebound in commodities prices helped the high yield sector, which has a significant number of energy- and materials-related issuers. Higher commodity prices also helped our dollar-denominated emerging markets holdings in the Emerging Markets Bond Fund, which also saw strong gains. Our allocation to the Equity Income Fund, which invests in large-cap dividend-paying U.S. stocks, also offered significant relative return benefits. Tactical decisions to overweight/underweight underlying asset classes were modestly helpful over the period. Underweight positions in international nondollar bonds and long-term U.S. Treasury bonds boosted results, as did our positioning in high yield bonds versus U.S. Security Diversification Spectrum Income Fund U.S. Treasuries 5% Government- Related Bonds 8% Equity and Other 12% Non-U.S. Dollar- Denominated Bonds 12% Based on net assets as of 12/31/16. Other and Reserves 10% High Yield Bonds 23% Mortgages 17% Corporate Bonds 13% investment-grade debt. This was partially offset by a negative contribution from an overweight to emerging markets debt denominated in local currencies. Security selection among the underlying funds had a minimal net impact on results. Selection was positive in the Emerging Markets Bond Fund, International Bond Fund, and Equity Income Fund. This was offset by negative impacts from the 7 High Yield Bond Fund and the Floating Rate Fund as our bias toward higher-quality issuers hurt during a period when lower-quality issues saw the largest gains. Portfolio Positioning The Spectrum Income Fund invests primarily in fixed income securities through a diversified mix of U.S.-focused and international T. Rowe Price mutual funds. The fund also has an allocation to a fund focusing on dividend-paying U.S. large-cap stocks. We made a number of tactical adjustments to our high yield bond allocation during We started the annual reporting period with an underweight position in high yield bonds versus U.S. investmentgrade debt but ended with an overweight. High yield bonds rebounded from lows seen earlier in the year, supported by increased prices for oil and other commodities. High yield bonds offer an attractive risk/return alternative to investment-grade bonds, given their yield advantage, as well as less sensitivity to rising interest rates. The current credit cycle is showing signs of aging with increased leverage and weak corporate profitability, but default expectations We made a number remain low and have been largely contained to energyrelated companies. Stable economic growth and the of tactical potential for pro-growth economic policies, including adjustments to infrastructure renewal spending, should be supportive. our high yield We also made a number of changes to our position in bond allocation emerging markets bonds over the period, moving from a neutral stance in January 2016 to an overweight in during emerging markets at the end of the reporting period. Emerging markets bonds weakened after the U.S. elections as a number of currencies fell sharply versus the U.S. dollar. However, yields on emerging markets bonds are relatively attractive, and economic fundamentals have improved in a number of countries. Emerging markets have benefited from higher commodity prices, but there are concerns about the potential impact of protectionist trade policies and a stronger U.S. dollar, particularly as the U.S. Federal Reserve is expected to increase interest rates in We note the considerable disparity between emerging markets countries in their fiscal positions, political flexibility, and progress toward reforms, highlighting the importance of careful research and a selective approach. 8 We moved from a neutral position in nondollar bonds to an underweight position. The U.S. dollar is supported by the prospects for improving growth and higher interest rates. Aggressive quantitative easing in Europe and Japan has resulted in negative yields extending out bond maturities and produced an unfavo
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