T. Rowe Price Spectrum Funds

N-CSRS 1 srspc.htm T. ROWE PRICE SPECTRUM FUNDS T. Rowe Price Spectrum Funds - June 30, 2009

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM N-CSR

CERTIFIED SHAREHOLDER REPORT OF REGISTERED

MANAGEMENT INVESTMENT COMPANIES

Investment Company Act File Number: 811-4998

T. Rowe Price Spectrum Fund, Inc.

(Exact name of registrant as specified in charter)

100 East Pratt Street, Baltimore, MD 21202

(Address of principal executive offices)

David Oestreicher

100 East Pratt Street, Baltimore, MD 21202

(Name and address of agent for service)

Registrant’s telephone number, including area code: (410) 345-2000

Date of fiscal year end: December 31

Date of reporting period: June 30, 2009

Item 1: Report to Shareholders

Spectrum Funds

June 30, 2009

The views and opinions in this report were current as of June 30, 2009. They are not guarantees of performance or investment results and should not be taken as investment advice. Investment decisions reflect a variety of factors, and the managers reserve the right to change their views about individual stocks, sectors, and the markets at any time. As a result, the views expressed should not be relied upon as a forecast of the fund’s future investment intent. The report is certified under the Sarbanes-Oxley Act, which requires mutual funds and other public companies to affirm that, to the best of their knowledge, the information in their financial reports is fairly and accurately stated in all material respects.

REPORTS ON THE WEB

Sign up for our E-mail Program, and you can begin to receive updated fund reports and prospectuses online rather than through the mail. Log in to your account at troweprice.com for more information.

Manager’s Letter

Fellow Shareholders

Global financial markets stabilized in the first half of 2009, following one of the most volatile periods in market history. As government stimulus efforts worldwide began to gain traction, global economies showed uneven signs of recovery. Investors took advantage of buying opportunities, particularly in emerging markets. But amid the improved investor psychology, markets gave back some of the gains in early summer—a sign, if any was needed, that the recovery would be long and uneven. Each of the Spectrum Funds posted strong gains and outperformed its benchmarks during the period.

MARKET ENVIRONMENT

Global economic and financial trends that deteriorated at breathtaking speed last year appeared to hit bottom in early March as stocks fell to multiyear lows. Treasury yields plunged and prices soared during the nerve-wracking period in which once-iconic financial institutions began disappearing at rapid speed. The Federal Reserve made clear that it would take whatever steps were necessary to prevent the economy from revisiting the dark days of the Great Depression. Credit conditions began easing early in the year, and global equity markets rallied after the March lows. They peaked in June, before falling back.

Inflation remained very much in check, and the Federal Reserve reiterated that it would maintain its policy of quantitative easing by keeping overnight interest rates near 0%. The Fed also said it would honor its earlier pledge to buy $300 billion in longer-term U.S. government debt by the fall and $1.45 trillion in agency and mortgage-related debt by the end of the year. The economy has begun to heal, according to the Fed’s policy-setting panel, and worries about deflation (falling prices) have been fading. The Fed indicated that rates were likely to remain low until an economic revival was under way and concerns about higher future inflation resurfaced.

As investors developed a bit more confidence that perhaps the worst of the crisis was finally behind us, the investment environment has assumed a more positive tone, with riskier asset classes performing best in recent months. Credit spreads have narrowed in the bond markets, and overall liquidity has improved. The federal government’s “stress test” results for 19 of the largest U.S. banks were not as bad as feared.

Unemployment continued to climb and is likely to rise further in the months ahead. However, the pace of job losses is slowing. While unemployment is a lagging indicator, many leading indicators, including consumer confidence, have bounced from their lows. Signs of stabilization have begun to appear in housing, particularly at the lower end where credits for first-time homebuyers have helped. In general, investors have become more optimistic that a gradual process of stabilization and recovery may be under way.

U.S. stocks gained in the first half of 2009 amid improved investor sentiment. Small-cap shares fared about the same as their large-cap peers, but mid-cap stocks trumped both segments. As measured by various Russell indexes, growth stocks did significantly better than value stocks across all market capitalizations. Information technology shares produced powerful returns, as technology spending has not been as weak as previously expected and investors were drawn to companies with strong balance sheets, low debt levels, and attractive valuations. Materials stocks also did very well, helped by a sharp rebound in prices of various commodities, but energy stocks declined.

Foreign stocks fared better than U.S. shares in the first half of the year as risk aversion eased. Emerging markets outperformed significantly, led by shares in Latin America. Markets in Nordic countries produced solid returns, but other developed European markets rose moderately. Japanese stocks rose mildly in U.S. dollar terms.

U.S. bond returns in the first half of 2009 were mostly positive as investors showed renewed interest in fixed-income sectors with a significant yield advantage over securities with less credit risk. High-yield bonds generated huge gains; asset-backed securities, which are backed by credit card, auto loan, or other debt payments, also performed very well. Municipal and investment-grade corporate bonds produced moderate gains, whereas agency mortgage-backed securities lagged. U.S. Treasuries declined as intermediate- and long-term interest rates increased in response to heavy new issuance and nascent fears of higher future inflation. The Barclays Capital U.S. Aggregate Index, which measures the performance of domestic taxable investment-grade bonds, returned 1.90%.

Non-U.S. bonds were mixed. Emerging market debt produced significant gains. High-quality bonds issued in developed countries were flat in U.S. dollar terms, as gains among investment-grade corporate bonds were largely offset by falling government bond prices. The J.P. Morgan Non-U.S. Dollar Government Bond Index returned -0.97% in the first half of 2009, while the J.P. Morgan Emerging Markets Bond Index Plus returned 12.72%.

SPECTRUM GROWTH FUND

Spectrum Growth returned 13.10% for the six months ended June 30, 2009, outpacing the Russell 3000 Index and the Lipper Multi-Cap Core Funds Index.

There was wide variation in the performance of the portfolio’s individual components, with growth funds exceeding value, and foreign equity funds surpassing domestic. The best-performing holding in the portfolio was Emerging Markets Stock, which benefited from investors’ increased willingness to take on risk.

No single fund produced negative returns. However, value funds, which tend to perform poorly during the early stages of a recession, produced less inspiring results than other classes. The large-cap Equity Income Fund had the smallest percentage gain, followed by Small-Cap Value. Mid-Cap Value, on the other hand, produced solid gains amid improved consumer sentiment in the discretionary area and the recovery of the materials sector.

We made several adjustments to the portfolio’s asset allocation during the first half of the year. Although growth stocks remain cheap relative to historical valuations, we have trimmed our allocation to growth given their recent gains. We have moved to neutral between growth and value, as the value segment could benefit when corporate earnings prospects begin to gain momentum from low levels.

We have recently reduced our underweight to small-cap stocks as we no longer have the same strength of conviction about valuation differences between large-cap and small-cap stocks.

We increased our allocation to international equity relative to domestic equity toward the end of the period because we believe that valuations are favorable in non-U.S. markets as they currently price in continued economic weakness. Asian and Latin American shares rallied sharply over the last six months behind improved commodities demand, but plunging oil prices and ongoing financial and economic challenges plagued our holdings in the Middle East and Africa throughout last year. The long-term growth story of emerging markets remains promising, although the timing and scope of recovery will vary from country to country.

SPECTRUM INCOME FUND

Spectrum Income returned 8.20% for the six months ended June 30, 2009, exceeding returns of the Barclays Capital U.S. Aggregate Index and the Lipper General Bond Funds Average as shown in the accompanying Performance Comparison table.

The portfolio’s best absolute performer was the High Yield Fund, which generated outstanding gains amid improving liquidity. High-yield issuance surged to near-record levels in May and shows no signs of abating. Even relatively weak companies were able to get new capital, aided by a record amount of new money coming into the market. New Income, the fund’s largest position, also generated strong returns due to the solid performance of credit-sensitive corporate bonds and the fund’s exposure to high-yield issues. The fund’s lighter exposure to Treasuries, which declined during the period, also helped it perform better than its benchmark.

Other positive performers within the portfolio included Emerging Markets Bond, which benefited from increased appetite for risk, improved liquidity, and positive cash flows. A substantial increase in lending capacity from the International Monetary Fund provided much-needed assistance for emerging market issuers in need of external financing.

Short-Term Bond performed well, aided by its underweight to Treasuries and overweight to higher-yielding sectors. GNMA contributed modestly to fund performance. It produced solid returns early in the period, reflecting the high-quality mortgage-backed securities, but waned late in the period amid concerns that substantial government spending would reignite inflation. Corporate Income also produced solid returns due to improved credit conditions and the ability of firms to issue new debt. We increased our position in the fund as valuations in the corporate bond market have become more attractive.

Equity Income, the fund’s third-largest holding, which invests in dividend-paying stocks, recovered from the previous period. However, the fund lagged other components of Spectrum Income. U.S. Treasury Long-Term retreated as investors sought out higher-yielding securities.

SPECTRUM INTERNATIONAL FUND

Spectrum International returned 16.64% for the six months ended June 30, 2009, outperforming both its combined index benchmark and the Lipper International Multi-Cap Core Funds Average. It also outperformed the linked performance benchmark, which reflects the performance of the former combined index and the fund’s new benchmark, the MSCI All Country World Index ex-U.S. that the fund began transitioning to on March 1, 2009. This benchmark more accurately reflects the investment strategy of the fund, with its emphasis on non-U.S. equities in both developed and emerging markets.

Spectrum International benefited from its exposure to emerging markets, particularly in Asia, and its lighter allocation to markets in Europe. Every component of the portfolio, with the exception of the Japan Fund, posted positive returns during the six-month period. New Asia was the top contributor, due in part to our significant increase in the fund’s allocation. The developing Asia markets rebounded sharply. China, in particular, surged as aggressive government stimulus efforts took hold and investors went bargain hunting. We increased our allocation to New Asia over the period.

We increased our allocation to the Emerging Markets Stock Fund, which generated a significant gain. Latin America was the strongest regional performer, as commodity prices rebounded and it became clearer that the region was showing signs of resilience in its banking sector. While the global recession has surely impacted the developing world, the growth story among many emerging economies remains relatively strong. For that reason, we have modestly overweighted emerging markets relative to U.S. equities.

The International Stock Fund, Spectrum International’s largest holding, was also its top absolute contributor. Value-oriented International Growth & Income turned in a solid performance, while European Stock posted modest returns relative to the other funds due to continued economic problems that have beset Europe. The global recession has also hurt export-heavy Japan, and the Japan Fund was Spectrum International’s only detractor.

OUTLOOK

The economic recovery is in its early stages, and the summer stock market pullback is an indication that improvements will come in fits and starts. Earlier fears of deflation have eased, and the Federal Reserve’s decision to maintain short-term lending rates at historically low levels suggests that it is not currently concerned about inflationary pressures. Credit markets have improved, financial institutions are on the mend, and government stimulus efforts are beginning to spur development, but many challenges remain. If not for government spending, growth would likely be flat over the next several quarters. That has not given much confidence to consumers who are holding back in light of increasing unemployment and sagging wages. The U.S. consumer savings rate, which declined steadily through the 1990s, is now about 6.9% and projected to rise through 2010.

Nonetheless, markets have appeared to stabilize, having priced in much of the negative news that has buffeted investors during the past year. While growth may remain anemic in much of the developed world, the relatively strong growth in emerging markets is helping to offset the slowdown in the domestic economy.

Overall, the potential for additional market turmoil remains, highlighting the importance of the broad diversification found in the Spectrum Funds.

Respectfully submitted,

Edmund M. Notzon III
President of the Spectrum Funds and chairman of the Investment
Advisory Committee

July 21, 2009

The committee chairman has day-to-day responsibility for managing the portfolios and works with committee members in developing and executing the funds’ investment program.

RISKS OF INVESTING

As with all stock and bond mutual funds, each fund’s share price can fall because of weakness in the stock or bond markets, a particular industry, or specific holdings. Stock markets can decline for many reasons, including adverse political or economic developments, 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, the investment manager’s assessment of companies held in a fund may prove incorrect, resulting in losses or poor performance even in rising markets.

Bonds are subject to interest rate risk, the decline in bond prices that usually accompanies a rise in interest rates, and credit risk, the chance that any fund holding could have its credit rating downgraded or that a bond issuer will default (fail to make timely payments of interest or principal), potentially reducing the fund’s income level and share price. High-yield corporate bonds could have greater price declines than funds that invest primarily in high-quality bonds. Companies issuing high-yield bonds are not as strong financially as those with higher credit ratings, so the bonds are usually considered speculative investments.

Funds that invest overseas may carry more risk than funds that invest strictly in U.S. assets. 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

Barclays Capital U.S. Aggregate Index: An unmanaged index that tracks investment-grade corporate and government bonds.

J.P. Morgan Emerging Markets Bond Index Plus: Tracks the total return of U.S. dollar and external currency debt instruments traded in emerging markets.

J.P. Morgan Non-U.S. Dollar Government Bond Index: An unmanaged index that tracks the performance of major non-U.S. bond markets.

Lipper indexes: Fund benchmarks that consist of a small number of the largest mutual funds in a particular category as tracked by Lipper Inc.

MSCI All Country World Index ex-U.S.: An index that measures equity market performance of developed and emerging countries, excluding the U.S.

MSCI EAFE Index: An unmanaged index that tracks the stocks of about 1,000 companies in Europe, Australasia, and the Far East (EAFE).

MSCI Emerging Markets Index: An unmanaged index that tracks stocks in 26 emerging market countries.

Russell 2000 Index: An unmanaged index that tracks the stocks of 2,000 small U.S. companies.

Russell 3000 Index: An index that tracks the performance of the 3,000 largest U.S. companies, representing approximately 98% of the investable U.S. equity market.

S&P 500 Stock Index: An unmanaged index that tracks the stocks of 500 U.S. primarily large-cap companies.

GROWTH OF $10,000

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.

AVERAGE ANNUAL COMPOUND TOTAL RETURN

This table shows how the fund would have performed each year if its actual (or cumulative) returns had been earned at a constant rate.

GROWTH OF $10,000

AVERAGE ANNUAL COMPOUND TOTAL RETURN

This table shows how the fund would have performed each year if its actual (or cumulative) returns had been earned at a constant rate.

GROWTH OF $10,000

AVERAGE ANNUAL COMPOUND TOTAL RETURN

This table shows how the fund and its benchmarks would have performed each year if their actual (or cumulative) returns for the periods shown had been earned at a constant rate.

FUND EXPENSE EXAMPLE

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 in 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 in 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 small-account maintenance fee of $10, generally for accounts with less than $2,000 ($500 for UGMA/UTMA). The fee is waived for any investor whose T. Rowe Price mutual fund accounts total $25,000 or more, accounts employing automatic investing, and IRAs and other retirement plan accounts that utilize a prototype plan sponsored by T. Rowe Price (although a separate custodial or administrative fee may apply to such accounts). 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.

T. ROWE PRICE SPECTRUM GROWTH FUND

Unaudited