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Manager’s Letter
Fellow Shareholders
Several African and Middle Eastern
markets produced excellent returns and outperformed other emerging regions in
the six-month period ended April 30, 2013. In sub-Saharan Africa, the Nigerian
and Kenyan equity markets surged more than 27%; Ghana outperformed with a
remarkable 63% gain. South African shares edged lower in dollar terms as a 3%
decline in the rand offset the market’s modest 2% gain in local currency terms.
Most Gulf Cooperation Council (GCC) markets advanced at least 7%, but the United
Arab Emirates (UAE) surged 40% amid increasing trade and tourism and a rapidly
improving property sector. Egyptian stocks tumbled 18% on continued political
turmoil and economic uncertainty.
Your fund returned 11.34% in the
first half of its fiscal year. As shown in the Performance Comparison table, the
fund strongly outperformed its benchmark. Relative performance was driven by
our overweights in Nigeria and the UAE, a
significant underweight in South Africa, and good stock selection in Saudi
Arabia, Qatar, and the UAE. Poor performance of our UK-listed companies
operating in Africa detracted from our results.
PORTFOLIO REVIEW
Gulf Cooperation
Council
The fund is currently
investing in five of the six GCC countries—Saudi Arabia, the UAE, Oman, Qatar,
and Kuwait. These markets represented a little more than half of fund assets at
the end of April. We have no investments in Bahrain due to ongoing political
unrest. We have
strong conviction in the GCC
and believe that the fundamentals of many companies in these countries are not
currently reflected in stock market valuations.
Saudi Arabia
The Kingdom of Saudi Arabia is one of the largest and
most diverse markets in our opportunity set, and its annual gross domestic
product growth rate is around 5% to 6%. As measured by the S&P Saudi Arabia
Index, the market advanced 7.27% in the last six months. At 29% of fund assets,
Saudi Arabia is our largest country allocation, and it is one of our largest
overweights versus the fund’s benchmark. Our holdings span several sectors, but
we currently favor financials and other companies that should benefit from
increasing consumption. Because foreign investors may not yet own Saudi shares
directly, we gain exposure to the country through participation notes linked to
common stocks.
In the financials sector, we like the
long-term prospects for several Saudi banks. The macroeconomic backdrop is
strong, the banks are well capitalized, the quality of the assets they hold is
high, and they are enjoying decent profitability. In the last six months, three
of our Saudi Arabian banks—
Saudi British
Bank
,
Samba Financial
, and
Arab National Bank
—produced good returns, but
Al Rajhi Bank
,
which is one of the portfolio’s largest holdings, lagged. We have a high degree
of conviction in Al Rajhi Bank: It has the largest branch and ATM network across
Saudi Arabia, strong retail brand loyalty, robust fee income, and very high
profitability. The company is disciplined in controlling costs, and it has one
of the strongest management teams among its Saudi banking peers. Over the long
term, we believe Al Rajhi Bank will be the key beneficiary of growth in retail
credit demand from a new mortgage law, healthy consumer spending, and Saudi
demographic trends. Near the end of our reporting period, we initiated a
position in
Banque Saudi
Fransi
, which has been trading at a
discount to the industry. It is the market leader in corporate lending, it has
some of the best asset quality metrics among Saudi banks, and we anticipate that
it will increase its dividend over time. (Please refer to the fund’s portfolio
of investments for a complete list of holdings and the amount each represents in
the portfolio.)
Beyond the financials sector, we have
investments in various Saudi companies that we believe will thrive with the
development of a consumer economy. In the consumer discretionary and staples
sectors, we own “big box” electronics and appliance retailer
United Electronics
and multinational food group
Savola
, respectively. United
Electronics, whose stores are branded eXtra, was one of our largest absolute
contributors to performance. The company is benefiting significantly from
increasing consumer demand for computers, smart-phones, and other devices.
Savola was less robust but still fared well. The company continues to enjoy
favorable sales growth and increased market share in its Panda supermarket
business. During our reporting period, we added
Herfy Food Services
to the
portfolio. This leading fast-food operator has a sound business model and a
focused management team that aspires to double its number of stores over the
next five years.
Other sectors of the Saudi market
feature some good opportunities to harness growing consumer demand for
technological and medical products and services. Our investments in electronics
retailer
Jarir Marketing
,
telecommunication services company
Etihad
Etisalat
, and hospital operator
Al Mouwasat Medical Services
all performed very well in the last six
months.
In the materials sector, our large
investment in petrochemicals company
Saudi Basic Industries
lagged
with modest gains during our reporting period, as slowing global growth weighed
on commodity
prices. During the period, we
established a position in
Yanbu National
Petrochemical
. The company benefits from
high free cash flow, which could lead to a dividend increase, and it is
attractively valued versus its peers.
United Arab
Emirates
The UAE market surged 40% in
the last six months, and our significant overweight (12% of fund assets versus
the benchmark’s 4% weighting) greatly contributed to our performance. Market
strength has been derived from the faster-than-expected and broadening recovery
in the property and banking sectors, the UAE’s emergence as a trade and
transportation hub, increasing tourism, and Dubai’s safe-haven appeal amid
continued unrest in other Middle East countries.
In the financials sector,
Emaar Properties
was the portfolio’s top contributor to absolute
performance. Emaar owns a substantial amount of land in ideal locations in
Dubai, and it is experiencing significant demand for the properties it is
developing, resulting in higher sales prices and rents. We have high conviction
in Emaar and believe that it still has significant upside potential.
First Gulf Bank
also did very well, benefiting from increased lending
and credit card activity, improvement in its portfolio of older loans, and its
international expansion. Late in our reporting period, we added
Emirates NBD
,
Dubai’s largest bank, and
Abu Dhabi
Commercial Bank
to the fund. We believe
the continued recovery of the UAE banking industry will bode well for
them.
In the industrials and business
services sector,
Aramex
and
DP
World
generated strong returns. Aramex,
a global provider of transportation and logistics solutions, has established
itself as a logistics leader in the GCC, which is underserved by major U.S.
logistics companies. The company is producing strong earnings and revenue growth
and expanding its operations into Africa. DP World, a global ports owner and
operator, reported good 2012 financial results as strong pricing power and
noncontainer revenue, particularly in emerging Europe, the Middle East, and
Africa, offset slower container volumes in the latter part of the year. In
addition, the company benefited from a partial monetization of its Hong Kong
assets and the formation of a strategic partnership with a Hong Kong logistics
and warehousing entity.
Oman and Qatar
Stock markets in Oman and Qatar advanced 9% and 7.5%,
respectively, in our reporting period. We continue to overweight both countries
relative to the fund’s benchmark.
In Oman, where the economy is
projected to grow about 4% in 2013, our primary holding is
Bank Muscat
, the
dominant bank with 40% market share of Oman’s banking sector. Our equity
investment
performed very well during our
six-month reporting period. Last year, the bank reported 16% loan growth,
steadying margins, and improving cost efficiency. We anticipate that the bank’s
earnings and loan growth in 2013 will be favorable, helped by the government’s
increased infrastructure spending. We eliminated our small position in
Oman Telecommunications Company
but established one in
Galfar Engineering & Contracting
. The Omani government seems to prefer Galfar for various
infrastructure projects, but the company’s leadership is more selective than in
previous years when bidding for contracts. With a significant pipeline of
business, we believe Galfar’s profit margins are poised to start
rising.
In Qatar, economic growth is poised
to remain strong, as the country is on the verge of a megabuildout ahead of the
FIFA World Cup soccer tournament in 2022. All tournament-related construction
must be finished at least two years prior to the games, and winning bidders for
many infrastructure projects are likely to be announced in the months ahead. We
believe Qatari banks are very attractive: their earnings have been strong, but
their stock price appreciation has not been commensurate. Still, our investment
in
Qatar National Bank
produced good returns in our reporting period. We
believe the bank will be a significant beneficiary of the government’s ramp-up
of infrastructure spending. Our other Qatari investments should also benefit
from the country’s development in the years ahead. In the last six months, our
positions in
Industries
Qatar
, a holding company with businesses
across several sectors, produced excellent returns.
Gulf Warehousing
,
a logistics and storage company, also did well. The company is likely to handle
much of the construction equipment that will be arriving in the years prior to
the World Cup tournament.
Kuwait
Stocks in Kuwait rose 10% in the last six months.
Kuwait’s economy is expected to decelerate this year, in part because of reduced
oil output as well as delays in starting major infrastructure projects. Growth
is likely to improve if the parliament votes in favor of a plan that will
authorize $100 billion in spending on oil-related projects over the next five
years. However, the political situation has been essentially frozen in the last
few months, as the country awaits a court ruling in June on the
constitutionality of a decree last year that changed the voting rules shortly
before the elections and sparked large protests. If the decree is struck down,
the parliament will be dissolved, and any legislation it passed could be
nullified.
Our main investment in Kuwait over
the last six months was
Kuwait Projects
Company Holding
. This holding company
had good financial results in 2012—although there was a negative impact from
losses realized by a couple of investment banks it owns—and our investment
produced a decent return. With an attractive valuation and 5% dividend yield, as
well as signs that 2013 will be a year of stronger revenue growth, we believe
shares will continue to perform well. During our reporting period, we added
Burgan Bank
to the portfolio. Burgan enjoyed above-average loan
growth and increased market share in Kuwait in 2012—helped by strong ties with
large corporate entities—and its presence in North Africa and other Middle
Eastern countries is a significant part of its operations. We anticipate another
good year of loan growth in 2013, though perhaps not as robust as last year, and
believe that the bank will benefit from a pickup in the Kuwaiti
economy.
AFRICA
Egypt
Egyptian equities tumbled 18% in dollar terms in the last
six months, as a sharp fall in the currency added to stock market losses. The
situation in Egypt remains fluid, and investor sentiment has been waning.
Economic growth has been restrained by political turmoil, reduced tourism, and
high interest rates. Inflation is high, and there are concerns about the
stability of Egypt’s currency. There is a president and a constitution, and the
upper house of parliament is currently exercising legislative powers. Elections
for the lower house of parliament have been delayed and will hopefully be held
later this year. In addition, the country needs financial assistance from the
International Monetary Fund (IMF), but a deal is unlikely to be signed for at
least a few more months, especially considering that Egypt just selected a new
team of IMF negotiators.
We believe Egypt still has good
long-term potential that can be realized if a stable political infrastructure is
put into place and if the government adopts sound fiscal policies that promote
economic growth. For the time being, the country is likely to muddle through its
current situation, and things could get worse before they get better, especially
as President Morsi’s ruling party attempts to collect taxes and fines from
companies that profited from Egyptian resources in recent years. During our
reporting period, we eliminated
Commercial International
Bank
but retained a very small position
in
Orascom Construction
Industries
, which is now listed in the
Netherlands. We believe Egyptian shares, in general, could be under pressure in
the short run, but as the situation in Egypt stabilizes, we will look for
attractively valued investment opportunities.
South Africa
In U.S. dollar terms, stocks in South Africa slipped less
than 1% in the last six months. As mentioned earlier, weakness in the rand
offset the market’s modest gains in local currency terms. Interestingly, the
market has been achieving all-time highs in rand terms, led by large,
high-quality, nonresource-related companies with strong earnings growth and
business opportunities beyond South Africa. The resource sector, which
traditionally leads in a rising market, has been lagging significantly amid
continuing labor unrest. The mining industry is in structural decline: Companies
are uncompetitive due to cost increases, and they continue to use old methods to
extract deeper resources in an attempt to keep production steady.
At 28% of fund assets, South Africa
is our second-largest country allocation, but it is our biggest underweight
relative to its 48% allocation in the benchmark. We have become increasingly
cautious due to the growing current account deficit, sluggish economic growth,
high unemployment and inflation, and credit rating downgrades, among other
factors. On the plus side, the country has several companies with some of the
best management teams in the emerging markets universe, a well-developed
financial system, and companies with strong domestic operations or successful
expansions into other parts of Africa. In addition, there is a long-term
national development plan under consideration that, if implemented, could
address many of South Africa’s major issues and help get the country on a better
long-term trajectory.
We are broadly diversified across
several sectors in South Africa, but we favor the defensive consumer and health
care sectors. Given that much economic activity is driven by wage growth and the
availability of consumer credit, we also like companies in other sectors that
should benefit from consumption growth. In the consumer staples sector, our
investments in
Tongaat
Hulett
, an agricultural and land
management company, and Africa’s largest food retailer,
Shoprite Holdings
, declined during our reporting period. We added to our positions on
weakness, which we felt was unwarranted considering that the companies still
have good long-term prospects. In health care, we own shares of
Aspen Pharmacare Holdings
, which is South Africa’s largest pharmaceutical company, and
Life Healthcare Group
Holdings
, a large and low-cost hospital
operator. Aspen performed very well in the last six months, helped by solid
financial results in 2012 and expanding activity in Latin America and Asia, and
it is one of our higher-conviction names. We have a smaller position in Life
Healthcare, which made a lesser contribution to fund performance in absolute
terms. The company’s 2012 financial results were favorable and its long-term
prospects remain strong, but we believe 2013 will be a more modest year for its
earnings.
We own several consumer discretionary
companies that we believe are well positioned for the long term.
Naspers
, the
fund’s largest holding, produced good returns in the last six months. We like
the company’s new low-cost pay-TV service available to consumers in sub-Saharan
Africa. High-end retailer
Woolworths
Holdings
produced mild gains, whereas
car retailer
Imperial Holdings
edged lower. During the period, we
eliminated
The Foschini
Group
. Sales have been soft, and while
the stock is attractively valued versus its peers, we see very few catalysts in
the near term. Following a period of weakness stemming from fears of softer
consumer demand, we established a small position in
Mr Price
, a
quality apparel retailer that is mostly a cash-based business, pays a dividend
of about 4%, and has good long-term growth prospects in Africa.
In the natural resources sectors, we
eliminated three of our holdings: gold mining company
AngloGold Ashanti
, coal producer and mineral sands mining company
Exxaro Resources
,
and energy and chemicals company
Sasol
. We sold out of AngloGold
because we felt that
Impala
Platinum
has better prospects,
especially because it has a couple of upcoming projects that should be able to
deliver decent production growth over the medium term. Both stocks were hammered
amid
falling metals prices and continued
labor unrest in the mining industry in the last six months. Exxaro fell
slightly, and we eliminated it because we have greater conviction in other
holdings. In the case of Sasol, which produced mild gains, we felt that the
company’s earnings momentum was waning after two strong years and that 2013
would be a difficult year due to cost pressures and the lack of new projects
coming online.
In the financials sector, we
benefited from strong performance of insurance company
Sanlam
, a quality
company in a market dominated by a small number of players. Over time, we
believe the company is capable of achieving a 15% annual growth rate as
investments in various higher-growth segments and outside of South Africa bear
fruit. We eliminated our position in
Standard Bank Group
at the end of
2012 in favor of other companies in which we have higher conviction.
Sub-Saharan
Africa
Sub-Saharan markets were
outstanding performers in the last six months, as mentioned earlier. We have a
few small investments in Ghana, Zambia, and Kenya—such as
Ghana Commercial Bank
,
Zambeef Products
, and telecom company
Safaricom
, respectively—but the
bulk of our exposure to this region remains in Nigeria, which, at 10% of assets,
is one of the fund’s largest country overweights versus the
benchmark.
Strong broad-based growth, improving
fiscal fundamentals, and relative political stability continue to create a
favorable backdrop for the Nigerian market, and our overweight contributed
materially to the fund’s relative performance. Our investments in Nigeria are
primarily banks and other companies that should benefit from the growth of a
consumer economy.
Guaranty Trust Bank
was one of the largest contributors to
absolute performance, but
Zenith
Bank
and
FBN Holdings
(formerly First Bank
of Nigeria) also did very well. All three have strong balance sheets, solid
earnings, and favorable prospects for loan growth, but Guaranty has one of the
most efficient operating models in the Nigerian banking industry and aspirations
to become one of the top three banks in Africa by 2016. In the consumer staples
sector, our investments in
Nestlé Foods
Nigeria
and Heineken-owned
Nigerian Breweries
were major contributors to fund performance.
Dangote Cement
, a high-growth, leading cement producer, also did
well.
UK-Listed Companies Operating in
Africa
At the end of April, we owned
shares of several companies listed in the UK but whose operations are primarily
in Africa. These invest
ments help us
diversify the portfolio and gain access to markets in which it may not be
practical or possible to invest directly.
In the first half of our fiscal year,
our positions in
Petra
Diamonds
and
Ophir Energy
were
lack-luster. Mining company
Centamin
, which operates in
Egypt, declined as the company is in a legal battle with the Egyptian government
regarding its mining license.
Tullow
Oil
also fared poorly, in part because
of weaker oil prices, the acquisition of a private Norwegian energy
company, the sale of some mature oil-producing wells to
pay for that acquisition, and excessive concerns about its oil production in
Kenya. We are encouraged, however, that the company will sharpen its focus on
exploration, which will keep it from getting bogged down in large development
projects, and that it may be more interested in returning value to shareholders
in the form of special dividends.
OUTLOOK
Emerging markets have generally
underperformed developed markets thus far in 2013, in part because of weaker
commodity prices and emerging markets currencies. But African and Middle Eastern
markets have performed very well, helped by attractive growth prospects relative
to developed and other emerging markets and an increase in risk appetite
stemming from aggressive monetary easing by major central banks. We believe that
the long-term case for investing in Africa and the Middle East is intact,
supported by improving governance, attractive demographics, rising urbanization,
high levels of infrastructure investment, and a strong asset base in natural
resources.
In the Middle East and North Africa,
there are encouraging macroeconomic fundamentals and fiscal and current account
surpluses. Government revenues of oil-producing nations have increased in recent
years and are being used to increase public spending. While government reliance
on natural resource wealth in supporting fiscal balances is a risk, we believe
commodity prices would need to fall considerably before governments come under
pressure. The potential upgrade of Qatar and the UAE to emerging market status
and the possible opening of the Saudi market to direct foreign ownership could
attract additional investments to the region.
Despite the persistence of a number
of macro headwinds in South Africa, we are continuing to seek well-managed
companies with good fundamentals, strong domestic operations, and growth
opportunities in other parts of Africa. In sub-Saharan Africa, gross domestic
product growth remains high, helped by Chinese consumption and investment. While
corruption can be found in many African countries, we believe those countries
that have been able to implement social and economic reforms are reaping the
benefits.
Throughout our opportunity set, we
continue to search for quality companies trading at attractive valuations with
high returns on equity and strong growth while being mindful of potential
geopolitical risks and exaggerated economic cycles. As always, we would like to
remind our investors that this fund has a high risk/return profile. Because of
its narrow geographic focus and relatively small number of holdings, this fund
can be extremely volatile and should represent only a small portion of a
long-term investor’s well-diversified portfolio.
Respectfully
submitted,
Oliver Bell
Portfolio Manager
May 23, 2013
The portfolio manager has
day-to-day responsibility for managing the portfolio and works with committee
members in developing and executing the fund’s investment
program.
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, limited geographic region, or emerging markets 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.
GLOSSARY
Gross domestic product:
The total market value of all goods and
services produced in a country in a given year.
S&P Emerging/Frontier ME &
Africa BMI ex IL:
An index that includes
all of the daily priced, free-float market cap that S&P covers across the
Middle East and Africa, excluding Israel.
Performance and Expenses
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.
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.
Unaudited
The accompanying notes are an
integral part of these financial statements.
Unaudited
The accompanying notes are an
integral part of these financial statements.
Unaudited
The accompanying notes are an
integral part of these financial statements.
Unaudited
The accompanying notes are an
integral part of these financial statements.
Unaudited
The accompanying notes are an
integral part of these financial statements.
Unaudited
|
Notes to Financial
Statements
|
T. Rowe Price International Funds,
Inc. (the corporation), is registered under the Investment Company Act of 1940
(the 1940 Act). The Africa & Middle East Fund (the fund) is a
nondiversified, open-end management investment company established by the
corporation. The fund commenced operations on September 4, 2007. The fund seeks
long-term growth of capital by investing primarily in the common stocks of
companies located (or with primary operations) in Africa and the Middle
East.
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. Dividends received
from mutual fund investments are reflected as dividend income; capital gain
distributions are reflected as realized gain/loss. 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
annually. 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.
Redemption Fees
A 2% fee is assessed on redemptions of fund shares held
for 90 days or less to deter short-term trading and to protect the interests of
long-term shareholders. Redemption fees are withheld from proceeds that
shareholders receive from the sale or exchange of fund shares. The fees are paid
to the fund and are recorded as an increase to paid-in capital. The fees may
cause the redemption price per share to differ from the net asset value per
share.
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.
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.
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 April
30, 2013:
There were no material transfers
between Levels 1 and 2 during the period.
NOTE 3 - 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.
Emerging Markets
At April 30, 2013, approximately 96% of the fund’s net
assets were invested, either directly or through investments in T. Rowe Price
institutional funds, in securities of companies located in emerging markets,
securities issued by governments of emerging market countries, and/or securities
denominated in or linked to the currencies of emerging market countries.
Emerging market securities are often subject to greater price volatility, less
liquidity, and higher rates of inflation than U.S. securities. In addition,
emerging markets may be subject to greater political, economic, and social
uncertainty, and differing regulatory environments that may potentially impact
the fund’s ability to buy or sell certain securities or repatriate proceeds to
U.S. dollars.
Participation Notes
During the six months ended April 30,
2013, the fund was a party to participation notes and other types of
equity-linked derivative instruments (referred to collectively as participation
notes), through which a counterparty provides exposure to common stock, in the
form of an
unsecured interest, in markets
where direct investment by the fund is not possible. Participation notes provide
the economic benefit of common stock ownership to the fund, while legal
ownership and voting rights are retained by the counterparty. Although
participation notes are usually structured with a defined maturity or
termination date, early redemption may be possible. Risks associated with
participation notes include the possible failure of a counterparty to perform in
accordance with the terms of the agreement, inability to transfer or liquidate
the notes, potential delays or an inability to redeem before maturity under
certain market conditions, and limited legal recourse against the issuer of the
underlying common stock.
Other
Purchases and sales of portfolio securities other than
short-term securities aggregated $48,944,000 and $50,473,000, respectively, for
the six months ended April 30, 2013.
NOTE 4 - 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 amount and character of tax-basis distributions and composition
of net assets are finalized at fiscal year-end; accordingly, tax-basis balances
have not been determined as of the date of this report.
The fund intends to retain realized
gains to the extent of available capital loss carryforwards. As a result of the
Regulated Investment Company Modernization Act of 2010, net capital losses
realized on or after November 1, 2011 (effective date) may be carried forward
indefinitely to offset future realized capital gains; however, post-effective
losses must be used before pre-effective capital loss carryforwards with
expiration dates. Accordingly, it is possible that all or a portion of the
fund’s pre-effective capital loss carryforwards could expire unused. As of
October 31, 2012, the fund had $351,855,000 of available capital loss
carryforwards, which expire as follows: $137,943,000 in fiscal 2016,
$186,525,000 in fiscal 2017, and $27,387,000 in fiscal 2019.
At April 30, 2013, the cost of
investments for federal income tax purposes was $137,832,000. Net unrealized
gain aggregated $25,494,000 at period-end, of which $31,636,000 related to
appreciated investments and $6,142,000 related to depreciated
investments.
NOTE 5 - FOREIGN
TAXES
The fund is subject to foreign income
taxes imposed by certain countries in which it invests. Acquisition of certain
foreign currencies related to security transactions are also subject to tax.
Additionally, capital gains realized by the fund upon disposition of securities
issued in or by certain foreign countries are subject to capital gains tax
imposed by those countries. All taxes are computed in accordance with the
applicable foreign tax law, and, to the extent permitted, capital losses are
used to offset capital gains. Taxes attributable to income are accrued by the
fund as a reduction of income. Taxes incurred on the purchase of foreign
currencies are recorded as realized loss on foreign currency transactions.
Current and deferred tax expense attributable to net capital gains is reflected
as a component of realized and/or change in unrealized gain/loss on securities
in the accompanying financial statements. At April 30, 2013, the fund had no
deferred tax liability attributable to foreign securities and no foreign capital
loss carryforwards.
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). Price Associates has entered into a subadvisory
agreement with T. Rowe Price International Ltd, a wholly owned subsidiary of
Price Associates, to provide investment advisory services to the fund; the
subadvisory agreement provides that Price Associates may pay the subadvisor up
to 60% of the management fee that Price Associates receives from the fund. 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 0.75% 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 0.28% for assets in excess of $300 billion. The fund’s group fee is
determined by applying the group fee rate to the fund’s average daily net
assets. At April 30, 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 six
months ended April 30, 2013, expenses incurred pursuant to these service
agreements were $89,000 for Price Associates; $94,000 for T. Rowe Price
Services, Inc.; and $2,000 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 is also one of several
mutual funds sponsored by Price Associates (underlying Price funds) in which the
T. Rowe Price Spectrum Funds (Spectrum Funds) may invest. The Spectrum Funds do
not invest in the underlying Price funds for the purpose of exercising
management or control. Pursuant to a special servicing agreement, expenses
associated with the operation of the Spectrum Funds are borne by each underlying
Price fund to the extent of estimated savings to it and in proportion to the
average daily value of its shares owned by the Spectrum Funds. Expenses
allocated under this agreement are reflected as shareholder servicing expense in
the accompanying financial statements. For the six months ended April 30, 2013,
the fund was allocated $4,000 of Spectrum Funds’ expenses, of which $3,000
related to services provided by Price. The amount payable at period-end pursuant
to this agreement is reflected as Due to Affiliates in the accompanying
financial statements. Additionally, redemption fees received by the Spectrum
Funds are allocated to each underlying Price fund in proportion to the average
daily value of its shares owned by the Spectrum Funds. At April 30, 2013,
approximately 3% of the outstanding shares of the fund were held by the Spectrum
Funds.
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.
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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.
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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 and
Subadvisory Agreement
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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), as well as the continuation of the investment subadvisory
agreement (Subadvisory Contract) that the Advisor has entered into with T. Rowe
Price International Ltd (Subadvisor) on behalf of the fund. In connection with
its 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 and Subadvisory Contract, also taking
into account information provided by the Advisor during the course of the year,
as discussed below:
Services Provided by the Advisor
and Subadvisor
The Board considered
the nature, quality, and extent of the services provided to the fund by the
Advisor and Subadvisor. 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 and Subadvisor’s senior management teams 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 and
Subadvisor.
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 three-year, five-year, and since-inception
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,
including the Subadvisor) 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 and Subadvisor 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. Under the
Subadvisory Contract, the Advisor may pay the Subadvisor up to 60% of the
advisory fee that the Advisor receives from the fund. 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. The information provided to the Board indicated
that the fund’s management fee rate was at or above the median for comparable
funds, and the fund’s total expense ratio was above the median for certain
groups of comparable funds and below the median for other groups of 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
and Subadvisory Contract
As noted,
the Board approved the continuation of the Advisory Contract and Subadvisory
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
and Subadvisory Contract (including the fees to be charged for services
thereunder). The independent directors were advised throughout the process by
independent legal counsel.