Item 1. Report to
Shareholders
Diversified Mid-Cap Growth Fund
|
December
31, 2012
|
The views and opinions in this report
were current as of December 31, 2012. 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 funds 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.
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Managers Letter
Fellow Shareholders
Mid-cap growth stocks produced solid
returns in the second half of 2012, capping a strong year. Corporate earnings
remained strongalthough year-over-year earnings growth has been slowingand
balance sheets were flush with cash. Improving U.S. economic data, encouraging
comments from European leaders about the future of the eurozone, signs that the
Chinese economic slowdown was bottoming, and new stimulus efforts by the Federal
Reserve and other central banks were also supportive. Risk aversion remains
high, however, and equities remain very attractive relative to fixed income
options.
Your fund returned 5.82% in the
second half of 2012 and 16.51% for the full year. As shown in the Performance
Comparison table, the fund outperformed its Russell and Lipper benchmarks for
the year. In
the second half of the year,
the fund fared modestly better than the Lipper index and produced reasonable
returns relative to the Russell index. These results reflect the efforts of our
research analysts who help us find good long-term growth opportunities
throughout the mid-cap universe.
For the 12-month period, the funds
outperformance of the Russell index was driven by stock selection in the
consumer staples, health care, and information technology sectors.
Underweighting the energy and consumer staples sectors, which significantly
lagged the index, also helped our results. However, stock selection in
materials, consumer discretionary, and energy reduced our performance advantage,
as did overweighting information technology. In the second half of 2012,
stock selection in several sectors,
especially consumer discretionary, hurt our performance relative to the Russell
index. Sector allocations in aggregate had a marginal positive impact on
relative performance. Well discuss portfolio holdings and sector allocations in
greater detail in the Portfolio Review section of the letter.
MARKET ENVIRONMENT
The market environment for U.S.
equity investors for most of 2012 was quite favorable, although the
macroeconomic backdrop was far from robust. The economy expanded at a slow but
steady pace. Employment growth was modest, and the national unemployment level
remained elevated. Also, the housing market rebound has been gaining traction.
To support the economic recovery, the Federal Reserve initiated new asset
purchase plans to suppress interest rates for a few more years. Corporate
fundamentals remained strong, and many companies have refinanced their debts at
lower rates and judiciously managed their expenses in an environment of
macroeconomic, political, and fiscal policy uncertainty. In addition, many
companies prudently used the reserves on their balance sheets to initiate or
increase the size of dividends or share repurchase plans. Thus, this is a great
time to invest in stocks of quality companies.
Mid-cap stocks outperformed their
smaller and larger counterparts in 2012. The Russell Midcap Index returned
17.28% versus 16.35% for the small-cap Russell 2000 Index and 16.00% for the
large-cap S&P 500 Index. These are surprising returns considering the macro
backdrop and quite strong relative to low-yielding fixed income alternatives.
Given recent history, the fact that stocks outperformed bonds may have taken
many risk-averse investors by surprise. This demonstrates that staying fully
invested in equities, rather than trying to time the market, is the best course
for those seeking long-term capital growth. It also shows that when other
investors are terrified and willing to accept negative real (inflation-adjusted)
returns in many fixed income asset classes, it is prudent to take reasonable
risks and invest in equities.
As measured by Russell style indexes,
value stocks outpaced growth stocks across all market capitalizations in 2012.
Within the Russell Midcap Growth Index, sector performance was mostly positive.
Telecommunication services did best, but it is a very small segment in our
investment universe. Materials and health care were also top-performing areas in
percentage terms. Financials, industrials and
business services, and consumer discretionary stocks produced strong
returns, but information technology and consumer staples lagged. Energy stocks
were flat, while utilities declined.
As shown in the Mid-Cap Stock Returns
table, mid-cap growth stocks lagged their value counterparts in the second half
of 2012, for the full year, and over the last five tumultuous years. However,
mid-caps in general have outperformed U.S. large-caps and international stocks
since the end of 2007. For the five-year period ended December 31, 2012, the
Russell Midcap Index produced an annualized return of 3.57% versus 1.66% for the
S&P 500 and -3.21% for the MSCI EAFE Index. While there is no guarantee that
this outperformance will continue, we believe that the domestic mid-cap universe
offers a wide variety of companies with superior long-term growth potential and
other favorable characteristics relative to many established large-cap companies
around the world. It is notable that the five-year annualized return for the
Barclays U.S. Aggregate Bond Index is 5.95%, as central bank market manipulation
has materially boosted fixed income returns.
INVESTMENT STRATEGY
Before discussing the portfolios
performance in detail, we would like to welcome new investors and thank all of
our longer-term investors for their continuing confidence in our portfolio
management abilities. Our reports to shareholders focus on fund activity and
performance in the most recent 6- or 12-month periods, but our time horizon for
investing is much longer, so we are prepared to wait for years for our
investments to bear fruit. While the investment landscape is constantly changing
and occasionally challenging, we remain committed to the same strategy and
principles that have guided our management of the
portfolio since its inception nine years ago. We believe these will help
us navigate through the period ahead and provide patient investors with
long-term capital growth:
-
The Diversified Mid-Cap Growth Fund
invests in stocks of mid-cap companies whose earnings are expected to grow at
an above-average rate. We define mid-cap companies as those whose market
capitalization at the time of purchase falls within the range of either the
S&P MidCap 400 Index or the Russell Midcap Growth Index.
-
We keep the fund fully invested
because we believe that successful market timing is virtually impossibleyou
would need to be right twiceand that the costs associated with frequent
trading reduce the likelihood of outperforming the market. We do not worry
about short-term performance or try to forecast the direction of the economy
or the market. Our focus is to find mid-cap companies with the best long-term
growth potential.
-
We use a number of proprietary
quantitative models to identify and evaluate the characteristics of individual
mid-cap growth companies and the portfolio as a whole.
-
Stock selection is based on a
combination of fundamental, bottom-up analysis and quantitative strategies in
an attempt to identify companies with superior long-term
appreciation prospects.
-
We use a growth approach, looking
for companies with a demonstrated ability to increase revenues, earnings, and
cash flow consistently; capable management; attractive business niches; and a
sustainable competitive advantage. We favor companies with above-average
earnings growth and lower earnings variability.
-
Valuations are also very important.
We look for the best relative values among companies with the strongest
businesses and managements.
-
Unlike other mid-cap growth
portfolios that are highly concentrated, the Diversified Mid-Cap Growth Fund
typically invests in about 300 stocks. A high degree of diversification helps
to mitigate the downside risk attributable to any single poorly performing
security. We invest in companies that are early in their life cycles, and some
will ultimately not be as successful as we hope. Accordingly, we balance risk
with potential returns.
-
Our time horizons are longer than
those of other mid-cap growth investors. Our portfolio turnover rate in 2012
was 24.5%, which is substantially less than the 2012 average of 95.4% for
mid-cap growth funds, according to data from
Morningstar Direct. (Morningstar only calculates portfolio turnover for
their averages at year-end, using the most recent year-end portfolio turnover
figures provided to Morningstar by each of the underlying funds in the
average. The Morningstar data were quoted as of January 16, 2013.) This means
our holding period for a typical stock is about four years, whereas our
average competitor holds a given stock for about one year. Consequently, we
view ourselves as long-term investors; we are not short-term speculators
or day-traders.
PORTFOLIO REVIEW
The Diversified Mid-Cap Growth Funds
fundamental characteristics are somewhat similar to those of the Russell Midcap
Growth Index, as indicated in the Portfolio Characteristics table. The
portfolios median market capitalization ($7.9 billion), price/earnings (P/E)
ratio (18.3), and projected earnings growth rate (13.9%) are all comparable with
those of the index. These metrics reflect our commitment to mid-cap companies
with excellent long-term growth prospects.
The funds return on equity (ROE),
which measures how effectively and efficiently a company and its management are
using stockholder investments, is 18.1% versus 21.7% for the benchmark. We
consider a high ROE to be desirable, and we look throughout the mid-cap growth
universe for businesses that can sustain high profitability. We would also note
that our holdings have lower debt than businesses represented in the Russell
index.
At the end of December, as shown in
the Sector Diversification table on page 7, our largest commitments were to
consumer discretionary, information technology, industrials and business
services, and health care. We have very little exposure to utilities and
telecommunication services because there are very few businesses in those
sectors that meet our growth criteria. Relative to the Russell benchmark, we had
meaningful underweights in the consumer discretionary and consumer staples
sectors and material overweights in information technology, health care, and
industrials and business services.
Health care stocks produced moderate
gains in the last six months and were the most significant contributors to the
funds 2012 absolute results. We emphasize providers and services companies
given demographic factors and growing demand for access to health care services.
We also like biotechnology companies but have broad diversification to reduce
our risks. These two industries provided the bulk of our full-year gains in the
sector. Health care providers and service companies were lifted by good
fundamentals and by industry consolidation. Top performers included
Catamaran
and
Amerigroup
, which was acquired by
WellPoint in the second half of the year. In the biotech industry, several of
our holdings produced strong returns, but
Regeneron Pharmaceuticals
far
outpaced its peers, propelled by the success of its new macular degeneration
drug Eylea. Life sciences tools and services companies and health care equipment
companies were less robust, though
Mettler-Toledo International
, a
maker of laboratory measuring instruments, and medical device manufacturer
C.R. Bard
did well. Our health care technology and pharmaceutical companies were
mostly flat for the year. (Please refer to the funds portfolio of investments
for a complete list of holdings and the amount each represents
in the portfolio.)
Our holdings in the consumer staples
sector, which is a fairly small part of the mid-cap growth universe, produced
excellent returns. We are underweighting this defensive sector because we
believe that most companies are fairly valued, if not overvalued. High levels of
risk aversion drove this flocking to perceived safety. Many of our holdings are
food or beverage makers with strong, nationally recognized brands, and some of
our strongest performers included spice maker
McCormick
,
Hershey Foods
,
and
Dr. Pepper Snapple
. Organic food retailer
Whole Foods Market
also did very
well. We established a position in cereal and snack food maker
Kellogg
in the
third quarter, as the company slipped into the upper portion of the mid-cap
range in the summer and its valuation became very attractive in part because of
Europe-related earnings weakness. Our
investment did well in the last six months as Kelloggs business improved and as
European officials acted to stabilize the sovereign debt crisis.
The information technology sector is
one of our largest commitments in absolute terms and our largest overweight
versus the Russell benchmark. Our approach to this dynamic sector is to
diversify broadly to mitigate the risks and to favor companies with strong
business models in industries with high barriers to entry and low risk of
commoditization. Tech stocks underperformed in 2012, and while our stock
selection helped our relative performance, the benefits were reduced, to some
extent, by our overweighting. We are disappointed that the tech sector has not
been a leading area for some timeexcept for software, where innovation over the
last decade has been remarkable. In fact, our software investments were top
contributors in the sector in 2012, led by
Ariba
, which we sold following
SAPs announcement in May to acquire the company;
Salesforce.com
, a
leading provider of customer relationship management applications to help
businesses interact with
their customers;
and
Red Hat
. Other tech industries trailed significantly. With a few
exceptions, such as
ARM
Holdings
and
Analog Devices
,
semiconductor-related companies have been mostly disappointing. Given the
compression of earnings multiples and lack of growth among companies in the
industry, we have been paring back our semiconductor overweighting throughout
the year.
In absolute terms, industrials and business services stocks produced strong
returns in the 6- and 12-month periods ended
December 31, 2012. Many companies in the
sector have attractive valuations and are world-class in their respective niches. While some industrials may have wide
earnings variance due to the cyclical nature of their businesses, we tend to favor higher-quality industrials with greater
earnings
stability throughout the business cycle. Machinery stocks were solid contributors, led by
Valmont
Industries
and
WABCO Holdings
. Mining equipment
maker
Joy Global
sagged, however, amid weaker
global demand for various natural resources.
Cooper Industries
,
which we sold in the second half of the year after the company received a takeover offer, and
Roper
Industries
were top performers in the electrical equipment industry. In the
fourth quarter, we established a modest position in Netherlands-based
Sensata
Technologies Holding
, a maker of sensors and controls. Road and rail stocks such as
Kansas
City Southern Industries
benefited from increased industrial activity. One of
the funds top performers for the entire year was
Copa Holdings
,
a rapidly growing Panama-based airline serving Central America and the Caribbean region. In the aerospace and
defense industry, our investment in
Spirit Aerosystems Holdings
didnt work out as we had hoped, and we eliminated it from the portfolio.
Our stocks in the consumer
discretionary sector produced moderate gains in the last six months and
contributed significantly to the funds absolute performance over the last year.
At the end of 2012, it was our
largest
sector allocation in percentage terms, but also our largest underweight versus
the Russell benchmark. The sector includes a variety of specialty retailers,
media firms, hotels, restaurants, and other companies that benefit from consumer
spending on nonessentials. We focus on companies that have good business models,
excellent cash flow, and other desirable attributes and are leaders in their
respective niches. Among media companies, cable network owner and operator
Discovery Communications
,
publisher
McGraw-Hill
, and the famed
entertainment venue
Madison Square
Garden
were among our largest
contributors in both the 6- and 12-month reporting periods. Specialty retailers
rose broadly, but iconic jewelry retailer
Tiffany
lagged for the year.
Womens apparel and accessory
maker
Michael Kors Holdings
, which went public about one year ago, was one of the
funds top contributors to performance in 2012. Hotel operators
Starwood Hotels & Resorts Worldwide
and
Wynn
Resorts
were strong performers
throughout the year.
Energy stocks, a small portion of the mid-cap growth universe, detracted the most
from the funds 2012 absolute performance amid increasing U.S. energy supplies and slowing global demand. While
underweighting the sector was helpful, the benefits were negated by stock selection. As long-term investors know, our energy
investments are not made in a futile attempt to take advantage of short-term
commodity
price movements. Rather, we look to invest in differentiated service companies or those that are skilled at finding
underlying resources, particularly the lowest-cost producers. Equipment and supply companies were widely mixed, with gains
in
Oceaneering International
and
Diamond
Offshore Drilling
offsetting losses among other holdings. Our oil and gas industry
investments sagged for the year, especially
SM Energy
and coal producer
Peabody Energy
.
Materials, another small segment of
our investment universe, produced very strong returns in 2012. Our approach is
to seek differentiated companies that can add value to a commodity or are well
positioned for the long term. As with the energy sector, we do not try to
predict or invest based on commodity price trends. Our materials holdings are
concentrated in the chemicals and metals and mining industries. The former was
responsible for virtually all of the funds gains in the sector, led by
Sherwin-Williams
. Shares soared as the housing market recovery led to
increased demand for paint. Metals and mining stocks were mixed, with poor
performance of
Walter
Energy
offsetting solid gains in
Compass Minerals
. We eliminated several holdings in the second half of
the year, such as
Agnico-Eagle
Mines
, in favor of better long-term
investment candidates elsewhere.
Financials in the mid-cap growth
universe performed well in 2012, helped in part by the improving housing market,
though returns lagged those of their larger peers. This is a small sector in the
portfolio in light of its slow growth and commoditized nature. Among diversified
financial services companies, credit rating agency
Moodys
produced
stellar returns. Capital markets companies rose with the financial markets,
particularly
Lazard
and
Invesco
. Although our insurance
companies were fairly lackluster, we continue to believe that the industry will
benefit from improved pricing trends. We maintained small positions in a few
commercial banks that are strong players in their respective markets.
OUTLOOK
In 2012, the market generally
rewarded companies that have done well in this muddle through environment with
higher price/earnings ratios, while punishing those whose earnings are
faltering. Corporate earnings growth could weaken in 2013, but it may be a solid
year for stocks. The bubble in fixed income and extreme risk aversion may be
abating. While European governments continue to wrestle with economic weakness,
the actions of European leaders and monetary officials to shore up the eurozone
seem to have made a catastrophic
scenario a
low-probability event. In the U.S., economic growth is likely to be slow in the
first part of the year due to the tax increases that took effect at the
beginning of 2013.
Our basic outlook has not changed
since our last report. We believe the current environment continues to provide
patient investors who are willing to take prudent risks with a great opportunity
to invest in equities for long-term capital growth. Consider the positives: The
U.S. economy and corporate earnings are growing, the Federal Reserves monetary
policies are likely to remain highly accommodative for a few more years, and
corporations have substantial cash reserves on their strong balance sheets and
have generally been responsible stewards of capital. In addition, equity
valuations remain attractive, and speculative activity has been low. In fact,
the increase in bond yields at the end of 2012 could be an early signal that
bond returns may be peaking and that investors are on the verge of reembracing
risk in a more significant way.
We believe the environment remains
very favorable for our investment management approach. Through the Diversified
Mid-Cap Growth Fund, we provide investors with broad diversification in the
mid-cap growth universe, a focus on risk control, and investments in
high-quality companies that we believe have the potential to produce strong
long-term returns.
Thank you for your confidence in T.
Rowe Price.
Respectfully
submitted,
Donald J. Peters
Cochairman of the funds Investment Advisory
Committee
Donald J. Easley
Cochairman of the funds Investment Advisory
Committee
January 17, 2013
The committee cochairmen have
day-to-day responsibility for managing the portfolio and work with committee
members in developing and executing the funds investment
program.
RISKS OF
INVESTING
As with all equity funds, this funds
share price can fall because of weakness in the broad market, a particular
industry, or specific holdings. The market as a whole can decline for many
reasons, including adverse political or economic developments here or abroad,
changes in investor psychology, or heavy institutional selling. The prospects
for an industry or company may deteriorate because of a variety of factors,
including disappointing earnings or changes in the competitive environment. In
addition, our assessment of companies held in the fund may prove incorrect,
resulting in losses or poor performance even in a rising market. Finally, the
funds investment approach could fall out of favor with the investing public,
resulting in lagging performance versus other types of stock funds.
The stocks of mid-cap companies
entail greater risk and are usually more volatile than the shares of large
companies. In addition, growth stocks can be volatile for several reasons. Since
they usually reinvest a high proportion of earnings in their own businesses,
they may lack the dividends usually associated with value stocks that can
cushion their decline in a falling market. Also, since investors buy these
stocks because of their expected superior earnings growth, earnings
disappointments often result in sharp price declines.
Diversification cannot assure a
profit or protect against loss in a declining market.
GLOSSARY
Earnings growth rate current
fiscal year:
Measures the annualized
percent change in earnings per share from the prior fiscal year to the current
fiscal year.
Lipper indexes:
Fund benchmarks that consist of a small number (10 to
30) of the largest mutual funds in a particular category as tracked by Lipper
Inc.
Price-to-earnings (P/E) ratio 12
months forward:
A valuation measure
calculated by dividing the price of a stock by the analysts forecast of the
next 12 months expected earnings. The ratio is a measure of how much investors
are willing to pay for the companys future earnings. The higher the P/E, the
more investors are paying for a companys earnings growth in the next 12
months.
Projected earnings growth
rate:
A companys expected earnings per
share growth rate for a given time period based on the forecast from the
Institutional Brokers Estimate System, which is commonly referred to as
IBES.
Return on equity (ROE) current
fiscal year:
A valuation measure
calculated by dividing the companys current fiscal year net income by
shareholders equity (i.e., the companys book value). ROE measures how much a
company earns on each dollar that common stock investors have put into the
company. It indicates how effectively and efficiently a company and its
management are using stockholder investments.
Russell Midcap Growth
Index:
An index that tracks the
performance of mid-cap stocks with higher price-to-book ratios and higher
forecast growth values.
Russell Midcap
Index:
An unmanaged index that tracks
the performance of the 800 smallest companies in the Russell 1000
Index.
Russell Midcap Value
Index:
An index that tracks the
performance of mid-cap stocks with lower price-to-book ratios and lower forecast
growth values.
S&P 500 Index:
An unmanaged index that tracks the stocks of 500
primarily large-cap U.S. companies.
S&P MidCap 400
Index:
An unmanaged index that tracks
the stocks of 400 U.S. mid-cap companies.
Note: Russell Investment Group is the
source and owner of the trademarks, service marks, and copyrights related to the
Russell indexes. Russell
®
is a trademark of Russell Investment
Group.
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 funds 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 funds actual expense ratio and an assumed
5% per year rate of return before expenses (not the funds 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.
The accompanying notes are an
integral part of these financial statements.
The accompanying notes are an
integral part of these financial statements.
The accompanying notes are an
integral part of these financial statements.
The accompanying notes are an
integral part of these financial statements.
The accompanying notes are an
integral part of these financial statements.
Notes to Financial
Statements
|
T. Rowe Price Diversified Mid-Cap
Growth Fund, Inc. (the fund), is registered under the Investment Company Act of
1940 (the 1940 Act) as a diversified, open-end management investment company.
The fund commenced operations on December 31, 2003. The fund seeks to provide
long-term capital growth by investing primarily in the common stocks of mid-cap
growth companies.
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.
Rebates and
Credits
Subject to best execution, the
fund may direct certain security trades to brokers who have agreed to rebate a
portion of the related brokerage commission to the fund in cash. Commission
rebates are reflected as realized gain on securities in the accompanying
financial statements.
Additionally, the fund
earns credits on temporarily uninvested cash balances held at the custodian,
which reduce the funds custody charges. Custody expense in the accompanying
financial statements is presented before reduction for credits.
New Accounting
Pronouncements
In December 2011, the
FASB issued amended guidance to enhance disclosure for offsetting assets and
liabilities. The guidance is effective for fiscal years and interim periods
beginning on or after January 1, 2013. Adoption will have no effect on the
funds net assets or results of operations.
NOTE 2 - VALUATION
The funds financial instruments are
reported at fair value as defined by GAAP. The fund determines the values of its
assets and liabilities and computes its net asset value per share at the close
of the New York Stock Exchange (NYSE), normally 4 p.m. ET, each day that the
NYSE is open for business.
Valuation Methods
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, except for OTC Bulletin Board securities,
which are valued at the mean of the latest 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 latest
bid and asked prices for domestic securities and the last quoted sale price for
international securities.
Investments in mutual funds are
valued at the mutual funds closing net asset value per share on the day of
valuation.
Other investments, including
restricted securities and private placements, and those financial instruments
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
T. Rowe Price Valuation Committee, established by the funds Board of Directors
(the Board). Subject to oversight by the Board, the Valuation Committee develops
pricing-related policies and procedures and approves all fair-value
determinations. The Valuation Committee regularly makes good faith judgments,
using a wide variety of sources and information, to establish and adjust
valuations of certain securities as events occur and circumstances warrant. For
instance, in determining the fair value of private-equity instruments, the
Valuation Committee considers a variety of factors, including the companys
business prospects, its financial
performance, strategic events impacting the company, relevant valuations
of similar companies, new rounds of financing, and any negotiated transactions
of significant size between other investors in the company. Because any
fair-value determination involves a significant amount of judgment, there is a
degree of subjectivity inherent in such pricing decisions.
Valuation Inputs
Various inputs are used to determine the value of the
funds financial instruments. These inputs are summarized in the three broad
levels listed below:
Level 1 quoted prices in active
markets for identical financial instruments
Level 2 observable inputs other
than Level 1 quoted prices (including, but not limited to, quoted prices for
similar financial instruments, interest rates, prepayment speeds, and credit
risk)
Level 3 unobservable
inputs
Observable inputs are those based on
market data obtained from sources independent of the fund, and unobservable
inputs reflect the funds own assumptions based on the best information
available. The input levels are not necessarily an indication of the risk or
liquidity associated with financial instruments at that level. The following
table summarizes the funds financial instruments, based on the inputs used to
determine their values on December 31, 2012:
Following is a reconciliation of the
funds Level 3 holdings for the year ended December 31, 2012. Transfers into and
out of Level 3 are reflected at the value of the financial instrument at the
beginning of the period. Gain (loss) reflects both realized and change in
unrealized gain (loss) on Level 3 holdings during the period, if any, and is
included on the accompanying Statement of Operations. The change in unrealized
gain (loss) on Level 3 instruments held at December 31, 2012, totaled $(274,000)
for the year ended December 31, 2012.
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 funds
prospectus and Statement of Additional Information.
Restricted
Securities
The fund may invest in
securities that are subject to legal or contractual restrictions on resale.
Prompt sale of such securities at an acceptable price may be difficult and may
involve substantial delays and additional costs.
Securities Lending
The fund lends its securities to approved brokers to
earn additional income. It receives as collateral cash and U.S. government
securities valued at 102% to 105% of the value of the securities on loan.
Collateral is maintained over the life of the loan in an amount not less than
the value of loaned securities as determined at the close of fund business each
day; any additional collateral required due to changes in security values is
delivered to the fund the next business day. Cash collateral is invested by the
funds lending
agent(s) in accordance with
investment guidelines approved by management. Although risk is mitigated by the
collateral, the fund could experience a delay in recovering its securities and a
possible loss of income or value if the borrower fails to return the securities
or if collateral investments decline in value. Securities lending revenue
recognized by the fund consists of earnings on invested collateral and borrowing
fees, net of any rebates to the borrower and compensation to the lending agent.
In accordance with GAAP, investments made with cash collateral are reflected in
the accompanying financial statements, but collateral received in the form of
securities is not. At December 31, 2012, the value of loaned securities was
$9,704,000; the value of cash collateral investments was $9,747,000.
Other
Purchases and sales of portfolio securities other than
short-term securities aggregated $47,146,000 and $50,288,000, respectively, for
the year ended December 31, 2012.
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 fund files U.S. federal, state,
and local tax returns as required. The funds tax returns are subject to
examination by the relevant tax authorities until expiration of the applicable
statute of limitations, which is generally three years after the filing of the
tax return but which can be extended to six years in certain circumstances. Tax
returns for open years have incorporated no uncertain tax positions that require
a provision for income taxes.
Distributions during the year ended
December 31, 2012 were characterized for tax purposes as $592,000 of ordinary
income. There were no distributions in the year ended December 31, 2011. At
December 31, 2012, the tax-basis cost of investments and components of net
assets were as follows:
The difference between book-basis and
tax-basis net unrealized appreciation (depreciation) is attributable to the
deferral of losses from wash sales for tax purposes. 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 January 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 funds pre-effective capital loss carryforwards could expire
unused. The funds available capital loss carryforwards as of December 31, 2012,
expire as follows: $2,121,000 in fiscal 2017; $4,748,000 have no
expiration.
NOTE 5 - 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). 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 0.35% of the funds 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 funds group fee is determined by applying the group fee rate to the funds
average daily net assets. At December 31, 2012, 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 funds transfer and dividend disbursing agent. T. Rowe Price
Retirement Plan Services, Inc., provides sub-accounting and recordkeeping
services for certain retirement accounts invested in the fund. For the year
ended December 31, 2012, expenses incurred pursuant to these service agreements
were $101,000 for Price Associates; $239,000 for T. Rowe Price Services, Inc.;
and $6,000 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 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.
Report of Independent Registered Public
Accounting Firm
|
To the Board of Directors and
Shareholders of
T. Rowe Price Diversified Mid-Cap Growth Fund,
Inc.
In our opinion, the accompanying
statement of assets and liabilities, including the portfolio of investments, and
the related statements of operations and of changes in net assets and the
financial highlights present fairly, in all material respects, the financial
position of T. Rowe Price Diversified Mid-Cap Growth Fund, Inc. (the Fund) at
December 31, 2012, and the results of its operations, the changes in its net
assets and the financial highlights for each of the periods indicated therein,
in conformity with accounting principles generally accepted in the United States
of America. These financial statements and financial highlights (hereafter
referred to as financial statements) are the responsibility of the Funds
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these financial
statements in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits, which included confirmation of securities at
December 31, 2012 by correspondence with the custodian and brokers, and
confirmation of the underlying funds by correspondence with the transfer agent,
provide a reasonable basis for our opinion.
PricewaterhouseCoopers
LLP
Baltimore, Maryland
February 15, 2013
Tax Information (Unaudited) for the Tax Year
Ended 12/31/12
|
We are providing
this information as required by the Internal Revenue Code. The amounts shown may
differ from those elsewhere in this report because of differences between tax
and financial reporting requirements.
For taxable non-corporate
shareholders, $773,000 of the funds income represents qualified dividend income
subject to the 15% rate category.
For corporate shareholders, $773,000
of the funds income qualifies for the dividends-received deduction.
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 funds Statement
of Additional Information, which you may request by calling 1-800-225-5132 or by
accessing the SECs 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 Our Company at the top of our corporate
homepage. Then, when the next page appears, click on the words Proxy Voting
Policies on the left side of the page.
Each funds most recent annual proxy
voting record is available on our website and through the SECs website. To
access it through our website, follow the directions above, then click on the
words Proxy Voting Records on the right side of the Proxy Voting Policies
page.
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 funds Form N-Q is available
electronically on the SECs website (sec.gov); hard copies may be reviewed and
copied at the SECs Public Reference Room, 100 F St. N.E., Washington, DC 20549.
For more information on the Public Reference Room, call 1-800-SEC-0330.
About the Funds Directors and
Officers
|
Your fund is overseen by a Board of
Directors (Board) that meets regularly to review a wide variety of matters
affecting the fund, including performance, investment programs, compliance
matters, advisory fees and expenses, service providers, and other business
affairs. The Board elects the funds officers, who are listed in the final
table. At least 75% of the Boards members are independent of T. Rowe Price
Associates, Inc. (T. Rowe Price), and its affiliates; inside or interested
directors are employees or officers of T. Rowe Price. The business address of
each director and officer is 100 East Pratt Street, Baltimore, Maryland 21202.
The Statement of Additional Information includes additional information about
the fund directors and is available without charge by calling a T. Rowe Price
representative at 1-800-638-5660.
Independent
Directors
Name
|
|
|
(Year of
Birth)
|
|
|
Year
Elected*
|
|
|
[Number
of T. Rowe Price
|
|
Principal Occupation(s) and Directorships of Public Companies
and
|
Portfolios Overseen]
|
|
Other
Investment Companies During the Past Five Years
|
|
|
|
William R.
Brody, M.D.,
|
|
President
and Trustee, Salk Institute for Biological Studies (2009
|
Ph.D.
|
|
to
present); Director, Novartis, Inc. (2009 to present); Director,
IBM
|
(1944)
|
|
(2007 to
present); President and Trustee, Johns Hopkins University
|
2009
|
|
(1996 to
2009); Chairman of Executive Committee and Trustee,
|
[142]
|
|
Johns
Hopkins Health System (1996 to 2009)
|
|
|
|
Anthony W.
Deering
|
|
Chairman,
Exeter Capital, LLC, a private investment firm (2004
|
(1945)
|
|
to
present); Director, Under Armour (2008 to present); Director,
|
2003
|
|
Vornado
Real Estate Investment Trust (2004 to present); Director
|
[142]
|
|
and Member
of the Advisory Board, Deutsche Bank North America
|
|
|
(2004 to
present); Director, Mercantile Bankshares (2002 to 2007)
|
|
|
|
Donald W.
Dick, Jr.
|
|
Principal,
EuroCapital Partners, LLC, an acquisition and management
|
(1943)
|
|
advisory
firm (1995 to present)
|
2003
|
|
|
[142]
|
|
|
|
|
|
Robert J.
Gerrard, Jr.
|
|
Chairman of
Compensation Committee and Director, Syniverse
|
(1952)
|
|
Holdings,
Inc. (2008 to 2011); Executive Vice President and General
|
2012
|
|
Counsel,
Scripps Networks, LLC (1997 to 2009); Advisory Board
|
[90]
|
|
Member,
Pipeline Crisis/Winning Strategies (1997 to present)
|
|
|
|
Karen N.
Horn
|
|
Senior
Managing Director, Brock Capital Group, an advisory and
|
(1943)
|
|
investment
banking firm (2004 to present); Director, Eli Lilly and
|
2003
|
|
Company
(1987 to present); Director, Simon Property Group (2004
|
[142]
|
|
to
present); Director, Norfolk Southern (2008 to present);
Director,
|
|
|
Fannie Mae
(2006 to 2008)
|
|
|
|
Theo C.
Rodgers
|
|
President,
A&R Development Corporation (1977 to present)
|
(1941)
|
|
|
2005
|
|
|
[142]
|
|
|
|
|
|
Cecilia E.
Rouse, Ph.D.
|
|
Professor
and Researcher, Princeton University (1992 to present);
|
(1963)
|
|
Director,
MDRC (2011 to present); Member, National Academy of
|
2012
|
|
Education
(2010 to present); Research Associate, National Bureau
|
[90]
|
|
of Economic
Researchs Labor Studies Program (1998 to 2009
|
|
|
and 2011 to
present); Member, Presidents Council of Economic
|
|
|
Advisors
(2009 to 2011); Member, The MacArthur Foundation
|
|
|
Network on
the Transition to Adulthood and Public Policy (2000 to
|
|
|
2008);
Member, National Advisory Committee for the Robert Wood
|
|
|
Johnson
Foundations Scholars in Health Policy Research Program
|
|
|
(2008);
Director and Member, National Economic Association
|
|
|
(2006 to
2008); Member, Association of Public Policy Analysis and
|
|
|
Management
Policy Council (2006 to 2008); Member, Hamilton
|
|
|
Projects
Advisory Board at The Brookings Institute (2006 to 2008);
|
|
|
Chair of
Committee on the Status of Minority Groups in the Economic
|
|
|
Profession,
American Economic Association (2006 to 2008)
|
|
|
|
John G.
Schreiber
|
|
Owner/President, Centaur Capital Partners, Inc., a real
estate
|
(1946)
|
|
investment
company (1991 to present); Cofounder and Partner,
|
2003
|
|
Blackstone
Real Estate Advisors, L.P. (1992 to present); Director,
|
[142]
|
|
General
Growth Properties, Inc. (2010 to present)
|
|
|
|
Mark R.
Tercek
|
|
President
and Chief Executive Officer, The Nature Conservancy (2008
|
(1957)
|
|
to
present); Managing Director, The Goldman Sachs Group, Inc.
|
2009
|
|
(1984 to
2008)
|
[142]
|
|
|
|
*Each independent director serves until retirement, resignation, or
election of a successor
|
Inside Directors
Name
|
|
|
(Year of
Birth)
|
|
|
Year
Elected*
|
|
|
[Number
of T. Rowe Price
|
|
Principal Occupation(s) and Directorships of Public Companies
and
|
Portfolios Overseen]
|
|
Other
Investment Companies During the Past Five Years
|
|
|
|
Edward C.
Bernard
|
|
Director
and Vice President, T. Rowe Price; Vice Chairman of the
|
(1956)
|
|
Board,
Director, and Vice President, T. Rowe Price Group, Inc.;
|
2006
|
|
Chairman of
the Board, Director, and President, T. Rowe Price
|
[142]
|
|
Investment
Services, Inc.; Chairman of the Board and Director,
|
|
|
T. Rowe
Price Retirement Plan Services, Inc., T. Rowe Price Savings
|
|
|
Bank, and
T. Rowe Price Services, Inc.; Chairman of the Board, Chief
|
|
|
Executive
Officer, and Director, T. Rowe Price International; Chief
|
|
|
Executive
Officer, Chairman of the Board, Director, and President,
|
|
|
T. Rowe
Price Trust Company; Chairman of the Board, all funds
|
|
|
|
John H.
Laporte, CFA
|
|
Vice
President, T. Rowe Price, T. Rowe Price Group, Inc., and
|
(1945)
|
|
T. Rowe
Price Trust Company
|
2006
|
|
|
[16]
|
|
|
|
*Each inside director serves until retirement, resignation, or
election of a successor.
|
Officers
Name
(Year of Birth)
|
|
|
Position
Held With Diversified
|
|
|
Mid-Cap
Growth Fund
|
|
Principal Occupation(s)
|
|
|
|
Kennard W.
Allen (1977)
|
|
Vice
President, T. Rowe Price and T. Rowe Price
|
Vice
President
|
|
Group,
Inc.
|
|
|
|
Peter J.
Bates, CFA (1974)
|
|
Vice
President, T. Rowe Price and T. Rowe Price
|
Vice
President
|
|
Group,
Inc.
|
|
|
|
Brian W.H.
Berghuis, CFA (1958)
|
|
Vice
President, T. Rowe Price, T. Rowe Price
|
Vice
President
|
|
Group,
Inc., and T. Rowe Price Trust Company
|
|
|
|
Donald J.
Easley, CFA (1971)
|
|
Vice
President, T. Rowe Price and T. Rowe Price
|
Executive
Vice President
|
|
Group,
Inc.
|
|
|
|
Roger L.
Fiery III, CPA (1959)
|
|
Vice
President, Price Hong Kong, Price
|
Vice
President
|
|
Singapore,
T. Rowe Price, T. Rowe Price Group,
|
|
|
Inc., T.
Rowe Price International, and T. Rowe
|
|
|
Price Trust
Company
|
|
|
|
John R.
Gilner (1961)
|
|
Chief
Compliance Officer and Vice President,
|
Chief
Compliance Officer
|
|
T. Rowe
Price; Vice President, T. Rowe Price
|
|
|
Group,
Inc., and T. Rowe Price Investment
|
|
|
Services,
Inc.
|
|
|
|
Gregory S.
Golczewski (1966)
|
|
Vice
President, T. Rowe Price and T. Rowe Price
|
Vice
President
|
|
Trust
Company
|
|
|
|
Gregory K.
Hinkle, CPA (1958)
|
|
Vice
President, T. Rowe Price, T. Rowe Price
|
Treasurer
|
|
Group,
Inc., and T. Rowe Price Trust Company
|
|
|
|
Patricia B.
Lippert (1953)
|
|
Assistant
Vice President, T. Rowe Price and
|
Secretary
|
|
T. Rowe
Price Investment Services, Inc.
|
|
|
|
Sudhir
Nanda, Ph.D., CFA (1959)
|
|
Vice
President, T. Rowe Price and T. Rowe Price
|
Vice
President
|
|
Group,
Inc.
|
|
|
|
David
Oestreicher (1967)
|
|
Director,
Vice President, and Secretary, T. Rowe
|
Vice
President
|
|
Price
Investment Services, Inc., T. Rowe Price
|
|
|
Retirement
Plan Services, Inc., T. Rowe Price
|
|
|
Services,
Inc., and T. Rowe Price Trust Company;
|
|
|
Vice
President and Secretary, T. Rowe Price,
|
|
|
T. Rowe
Price Group, Inc., and T. Rowe Price
|
|
|
International; Vice President, Price Hong Kong
|
|
|
and Price
Singapore
|
|
|
|
Timothy E.
Parker, CFA (1974)
|
|
Vice
President, T. Rowe Price and T. Rowe Price
|
Vice
President
|
|
Group,
Inc.
|
|
|
|
Donald J.
Peters (1959)
|
|
Vice
President, T. Rowe Price and T. Rowe Price
|
President
|
|
Group,
Inc.
|
|
|
|
Deborah D.
Seidel (1962)
|
|
Vice
President, T. Rowe Price, T. Rowe Price
|
Vice
President
|
|
Group,
Inc., T. Rowe Price Investment Services,
|
|
|
Inc., and
T. Rowe Price Services, Inc.
|
|
|
|
Amit Seth
(1979)
|
|
Vice
President, T. Rowe Price and T. Rowe Price
|
Vice
President
|
|
Group,
Inc.; formerly student, Harvard Business
|
|
|
School (to
2009)
|
|
|
|
John F.
Wakeman (1962)
|
|
Vice
President, T. Rowe Price and T. Rowe Price
|
Vice
President
|
|
Group,
Inc.
|
|
|
|
Julie L.
Waples (1970)
|
|
Vice
President, T. Rowe Price
|
Vice
President
|
|
|
|
|
|
Rouven J.
Wool-Lewis, Ph.D. (1973)
|
|
Vice
President, T. Rowe Price and T. Rowe
|
Vice
President
|
|
Price
Group, Inc.; formerly Vice President
|
|
|
of
Corporate Strategy, UnitedHealth Group
|
|
|
(to 2011);
Associate Analyst, Oppenheimer
|
|
|
&
Company (to 2009); Senior Associate,
|
|
|
Friedman,
Billings, Ramsey & Co. (to 2008)
|
|
Unless
otherwise noted, officers have been employees of T. Rowe Price or T. Rowe
Price International for at least 5
years.
|