Bringing a tested investment process to a wider market

The Capital Appreciation and Income Fund (CAFI) incepted on November 29, 2023, reaching its one‑year anniversary on November 29, 2024. The fund seeks to generate attractive current income and limit losses while also aiming to generate long‑term capital growth. The fund employs a bottom‑up approach to security selection that yields a portfolio with a quality bias that is diversified¹ across and within asset classes.

In this Q&A, Co-portfolio Managers David Giroux and Farris Shuggi reflect on their first year managing the Capital Appreciation and Income Fund.

In 2023, markets really soared for two reasons: artificial intelligence and a total reversal in the macroeconomic and stock market consensus. It’s hard to believe now, but entering 2023, almost every economist, strategist, investor, and CEO seemed to think that we were destined to go into a recession. At the start of 2023, growth stocks were dead and it was a new regime in which a recession was inevitable. By the end of 2023, growth stocks were back in vogue and the consensus had reversed. Corporate earnings had remained strong and inflation pressures had receded, and the pendulum of market expectations swung hard away from a recession and heavily favored a soft landing and imminent cuts.

Looking at the last 12 months within the S&P 500, momentum, growth, and high beta names have been the greatest beneficiaries of the runup in markets. Tech and communication services have led the way, nearly doubling the returns of the broader index. While traditionally defensive sectors like utilities and health care generated strong double‑digit returns over the period, they lagged in this risk‑on market. This environment wasn’t particularly favorable for our fund, which is focused on delivering income while limiting potential losses. When enthusiasm wavers and an emphasis on corporate fundamentals comes back into focus, we are confident that our long‑established process, philosophy, and framework will work in our favor.

As portfolio managers, it is really hard to invest against the grain. It is really hard to buy cyclicals when everyone says we are going into a recession. It is really hard to buy utilities when everyone thinks rates are going higher. It is really hard to buy stocks as they are going down every day, and it is just as hard to sit out a rally when we see the underpinnings are shaky. However, we believe this is one of the greatest market inefficiencies that we can exploit. Time and time again, by taking a longer view than the market, by focusing on trying to maximize returns over the next five years as opposed to the next five minutes, five hours, or five days, we aim to create shareholder value by investing against the macroeconomic consensus.

One thing we would highlight up front is that the equity investment universe for CAFI is actually not materially different from that of the Capital Appreciation Fund. CAFI employs the same time‑tested investment philosophy and process and rigorous approach to security selection and portfolio construction as the Capital Appreciation Fund, favoring companies that the team deems as having superior capital allocation, strong management teams, and reasonable valuations. Both portfolios have a quality tilt, are significantly overweight GARP, and are filled with names that offer the potential for attractive risk‑adjusted returns.

One key difference with respect to CAFI is that we add quantitative overlays to help construct a portfolio that seeks to deliver higher income and manage risk by helping to highlight some of the fundamental characteristics of individual companies. For the Capital Appreciation Fund, our investment framework yields a fairly concentrated equity allocation of 50 to 70 names. For the Capital Appreciation and Income Fund, the fund’s lower risk profile encourages a more diversified equity allocation of about 100 names.²

When we think about the Capital Appreciation Fund, we think it’s a highly differentiated strategy that has historically delivered on its objectives over the long term to the benefit of our investors. We’ve always thought about delivering new strategies that could have a positive impact for different segments of investors, with two clear caveats:

Our Capital Appreciation and Income Fund is designed for investors who may value an emphasis on income generation and capital preservation—such as investors who are approaching or are in retirement—without sacrificing the potential for long-term capital appreciation. CAFI is our solution‑oriented approach to providing attractive income, particularly as lifetime income³ becomes a growing priority for many investors.

On the other side, for the Capital Appreciation Equity ETF, managed by David Giroux, we think we’ve built a portfolio that may be a good option for investors looking for U.S. large‑cap exposure. Our value proposition is seeking to outperform the S&P 500 Index with less risk and better tax efficiency than S&P 500 Index ETFs, and we think that’s a really compelling opportunity. Our ETF addresses a need for investors looking for higher equity exposure.

Early indications are that the needs for these funds are real. In the year since we launched the ETF, we’ve seen really incredible flows and interest, which helped propel assets under management to more than USD 2.9 billion dollars.⁴ That growth has made it the fastest‑growing ETF that T. Rowe Price has ever offered. When we look at the suite now, we’re excited to be able to bring our experience and investment capabilities to a much wider spectrum of investors than we had with the Capital Appreciation Fund alone.

We’ve actually found the opposite to be the case. We mentioned before that one of our key requirements for new strategies was to do no harm to the Capital Appreciation Fund and its investors. What we’ve found is that introducing these new strategies has been additive for our process and investment professionals across each portfolio.

Part of our long‑standing investment process has been to devote significant time and energy to deep dives into specific industries or strategic opportunities for our portfolio. Some recent examples include the deep dives we did to try to understand the impact of the COVID‑19 pandemic in early 2020 or, more recently, to evaluate the impact and potential of AI. Now, when we dedicate that time for one strategy, whether it be the Capital Appreciation Fund or the ETF or the Capital Appreciation and Income Fund, the analysis our research yields can benefit both of the other strategies as well.

The investments that we’ve made in our team, whether it be adding associate portfolio managers and dedicated analysts or building out our research platform and capabilities, have brought us to a place where we are better resourced than ever. The daily collaboration across the team has helped us sharpen our ideas and enhance our research and analysis in ways that we think make each portfolio stronger on its own and each of us as investment professionals better collectively.

We really like the utilities sector over the long term. Utilities companies are, in our view, structurally undervalued relative to the S&P 500. Several sector names have been able to grow their earnings faster than they have traditionally while still also offering attractive dividend yields. These companies don’t face pressure from foreign currency risk or international exposure, they don’t have secular risks that we see in other market segments like consumer staples or legacy tech, and we believe several have a strong environmental, social, and governance (ESG) tailwind from their investments in grid modernization and shift to renewable energy. We also think utilities could be among the second derivative winners from artificial intelligence (AI). The energy demand for graphics processing units (GPUs) to power AI is substantial, and growing adoption across a range of industries could meaningfully increase usage and revenue for utilities.

Within the Capital Appreciation and Income Fund’s fixed income allocation, we hold a healthy mix of U.S. Treasuries, high-quality BB and BBB bonds,⁵ and bank loans. Looking at the current environment, we think BB and high‑quality bank loans create a compelling opportunity to generate equity-like returns while taking on less risk than the broader equity market.

Taking a broader view, valuations are stretched across substantial portions of the market. With a bit more policy uncertainty and elevated earnings expectations, we could see a pickup in volatility in the year ahead, especially as markets become more reactive and focused on the very short term. We think volatility creates opportunities for disciplined investors who are able to cut through noise and focus on fundamentals, and we think this would be an environment that would work in our favor.

We are playing a fundamentally different game than the market and our competitors. So much capital is focused on returns and performance over the short term, and you see vast sums chasing momentum and trends. On the other hand, we’re focused on meeting our goals and delivering performance over the long term, which allows us to stay focused on fundamental research, follow our analysis, and scrutinize every dollar we invest. We think this imbalance in objectives in the market creates a durable opportunity for investors with a long‑term orientation to outperform over time.

We have a strong team of experienced investment professionals and a great culture on our team. Being contrarian is part of the DNA of the Capital Appreciation team, and that plays out in our collaboration every day. There are no yes‑men or yes‑women on our team. Every person is committed to doing the research and analysis to come to the strongest possible ideas, and we aren’t afraid to challenge ourselves or each other to do that.

And lastly, we’d say we have a really strong process that was developed and refined for years over the existence of the Capital Appreciation Fund. And that’s laid a firm foundation for everything we do for the Capital Appreciation and Income Fund and the Capital Appreciation Equity ETF. We’re focused on identifying and exploiting durable market efficiencies in pursuit of our investment objectives, and that commitment holds true no matter how markets shift over the short term.

Call 1-800-225-5132 to request a prospectus or summary prospectus; each includes investment objectives, risks, fees, expenses, and other information you should read and consider carefully before investing.