T. Rowe Price Spectrum Fund, Inc.

N-CSRS 1 srspc.htm T. ROWE PRICE SPECTRUM FUND T. Rowe Price Spectrum Fund, Inc. - June 30, 2011

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, 2011

Item 1: Report to Shareholders

Spectrum Fund, Inc.

June 30, 2011

The views and opinions in this report were current as of June 30, 2011. 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.

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Manager’s Letter

Fellow Shareholders

U.S. stocks and bonds rose in the past six months as the economy strengthened, but the pace of recovery has been sluggish compared with prior post-recession periods. Optimism about a strong recovery at the start of the year drove stocks higher into April, but disappointing employment data near the end of the period revived worries about the strength of the recovery. Developed stock markets advanced, driven by brisk economic growth in Germany, France, and several peripheral countries. But Greece’s growing debt problem and the risk that it would spread across Europe continued to dominate the news. Political unrest in the Middle East and North Africa and repercussions from the calamitous earthquake and tsunami that struck Japan in March also fed risk aversion over the period.

MARKET ENVIRONMENT

Initial signs of a sustainable economic recovery drove U.S. stocks higher at the beginning of 2011, building on the market’s strong finish to 2010. The economy benefited from the two-year extension of the Bush-era tax cuts signed into law in December, as well as monetary stimulus from the Federal Reserve’s second round of quantitative easing, in which the central bank agreed to buy $600 billion in Treasury bonds. Known informally as QE2, the program aimed to suppress longer-term interest rates and spur economic growth. Corporate earnings were generally robust, and private employers added to payrolls in the spring, which helped whittle down a high jobless rate. Other data were mostly encouraging, and the S&P 500 Index rose to its highest level in nearly three years on April 29.

However, a number of economic reports at the end of the period renewed fears that the recovery was flagging. Job growth in May and June was surprisingly weak, pushing up the nation’s unemployment rate to 9.2%. In June, the Federal Reserve downgraded its forecast for economic and jobs growth for this year and next, citing financials sector weakness, problems in the housing sector, and other factors. News about Greece’s ballooning debt and its efforts to avoid a default also unnerved global markets. These factors caused stocks to fall in May and June, trimming the period’s earlier gains, as investors started to question the durability of the global recovery. Still, major stock indexes ended the reporting period higher. All sectors within the S&P 500 Index rose, except for financials.

Most developed overseas stock markets rose over the period. Developed markets in Europe had positive returns, but the pace of growth was uneven across the continent as major economies led by Germany expanded while some peripheral markets grappled with high debt and weak growth. Developed Asian markets trailed their developed European peers, and Japanese stocks fell as its economy slumped after the earthquake. Emerging markets rose slightly as inflation concerns weighed on markets. Strong growth in the developing world has led countries from Brazil to China to repeatedly raise interest rates in the past year, and inflation is showing signs of abating as a result.

Most U.S. bond segments rose over the period, largely driven by gains in the last three months. In the first quarter, longer-term Treasury yields increased and prices fell amid expectations of stronger growth, but during the second quarter, Treasury yields retreated as signs of slowing growth, stock market weakness, and renewed concerns about Greece’s debt problems curbed investors’ risk appetite.

Although the Federal Reserve ended QE2 at the end of June, the central bank said it would hold its benchmark interest rate near 0% “for an extended period.” High yield bonds outperformed investment-grade issues as investors continued favoring securities with a yield advantage in a low interest rate environment. Longer-term Treasuries, commercial mortgage-backed securities, and investment-grade corporate bonds performed well, but asset-backed and agency mortgage-backed securities lagged.

SPECTRUM GROWTH FUND
The Spectrum Growth Fund returned 5.65% for the six months ended June 30, 2011, but trailed the Russell 3000 Index and the Lipper Multi-Cap Core Funds Index. The portfolio’s allocation to non-U.S. equities contributed to underperformance relative to the Russell 3000 Index, which represents the broad U.S. equity market. Despite trailing the benchmark, each of Spectrum Growth’s underlying funds rose over the period. The Emerging Markets Stock Fund, the International Stock Fund, and the Growth Stock Fund weighed on absolute and relative returns. At the same time, the New Horizons Fund and the International Growth & Income Fund supported absolute returns. Toward the end of the second quarter, we moved to an overweight position in domestic growth stocks versus value stocks. Growth stocks are currently attractively valued relative to historical trends and tend to be less reliant on a strong economy for earnings growth, making them more attractive in a weak recovery.

Since our last shareholder letter in December, our sector allocations remained broadly the same, with information technology, financials, and consumer discretionary continuing to represent the top three sectors. The financials sector, which has lagged for a prolonged period since the global financial crisis, continued to trail the broader market amid uncertainty about new regulations and worries about the durability of the U.S. recovery.

Over the coming months, we will gradually be increasing the international equity exposure of the fund, moving from a neutral allocation of roughly 20% to approximately 30% of its total equity allocation. International developed and emerging markets equities continue to increase as a percentage of the global equity market and now represent nearly 60% of the world’s market capitalization. These areas often include countries that enjoy higher economic growth rates than the U.S. and companies with stronger long-term earnings growth potential or more favorable valuations, offering attractive investment opportunities that complement U.S. investments. The fund’s domestic equity exposure will be proportionately reduced from large-cap and small-cap equities, and the portfolio will maintain its current overall allocation to stocks and bonds.

Finally, in September we will start buying shares in companies that derive a substantial portion of their profits or revenues from “real assets.” Real assets include any investments that have physical properties, such as energy and natural resources, real estate, basic materials, equipment, utilities and infrastructure, and commodities. Exposure to companies operating in this space is intended to expand the portfolio’s broad diversification and to position it to perform well under a variety of market conditions, including periods of high or rising inflation. We believe the additional flexibility afforded to our portfolio management team will help create long-term value for our shareholders.

SPECTRUM INCOME FUND
The Spectrum Income Fund returned 3.78% for the six months ended June 30, 2011, exceeding both the Barclays Capital U.S. Aggregate Index and the Lipper General Bond Funds Average. All of the underlying funds rose over the period, led by the International Bond Fund. The Equity Income Fund, a value-focused fund that invests in dividend-paying stocks, also contributed to absolute performance.

The Spectrum Income Fund’s allocation to diversifying sectors such as high yield bonds, non-U.S. dollar-denominated bonds, and dividend-paying stocks were particularly strong drivers of performance relative to the Barclays benchmark. We raised the allocation to the High Yield Fund modestly over the period while lowering the allocation to the New Income Fund. High Yield and New Income continue to represent the two largest holdings in the portfolio.

The fund benefited from an overweight to high yield and an underweight to investment-grade bonds, particularly longer-maturity Treasury bonds, over the period. High yield bonds performed well as new issues from companies eager to take advantage of low interest rates and refinance their debt met strong demand from investors seeking extra yield in a low interest rate environment. We remain overweight to high yield relative to investment-grade bonds as a slowly improving economic environment and low default expectations have created a supportive backdrop for high yield, although yield spreads relative to Treasury bonds widened during the past few months.

We remain overweight to emerging markets bonds. Most emerging markets have resumed growing briskly after the 2008 financial crisis and proved to be in far better shape than much of the developed world. Many emerging markets bond issuers have fiscal positions that compare favorably with those in many developed markets grappling with large deficits and weak growth prospects. Although faster economic growth has bred inflation worries and forced monetary tightening across the developing world, we think the fundamentals and yield spreads in emerging markets bonds are attractive and balanced relative to their market-specific risks.

SPECTRUM INTERNATIONAL FUND
The Spectrum International Fund returned 5.86% for the six months ended June 30, 2011, outperforming both the MSCI All Country World ex-U.S.A. Index and the Lipper International Multi-Cap Growth Funds Average (Lipper revised the category to International Multi-Cap Growth effective March 11, 2011. The newly assigned category does not reflect any change in the fund’s investment approach, management, or process. The category change was based on Lipper’s review of the portfolio).

Overseas stock markets advanced in the year’s first half, although returns varied by region. Developed European equities had positive returns as the euro appreciated against the dollar. Emerging European shares rose due to strong currencies and stock markets in Hungary, the Czech Republic, Poland, and Russia. However, performance in emerging Asian markets was more subdued due to inflation and tightening of monetary policy. Nearly all of the Spectrum International Fund’s underlying funds rose over the period, led by the European Stock Fund, which focuses on established companies in developed Europe. The International Growth & Income Fund, a value-oriented fund that invests in large-cap, dividend-paying companies located mostly in developed Europe and Japan, also contributed to absolute returns. The Emerging Europe & Mediterranean Fund fell during the period as risk aversion rose in response to unrest in the Middle East and the European debt crisis.

Our underlying fund allocations stayed roughly unchanged over the reporting period, with International Stock, International Growth & Income, and European Stock remaining the top three funds. From a geographic perspective, Europe remains the portfolio’s largest regional exposure, followed by Pacific ex-Japan. We continue to favor emerging markets over developed markets, as we believe developing countries have stronger growth potential over the long run. Many emerging markets, including China, India, and Brazil, have repeatedly raised interest rates over the past year to contain inflation. However, we believe that a growing middle class and rising living standards in developing countries will drive robust growth over the long term. We modestly increased our overweight to emerging markets stocks in the second quarter.

OUTLOOK

The global economy continues to recover at a modest pace, although optimism about a strong recovery has diminished since the start of the year. In the U.S., we expect the economy to continue strengthening in the coming months. Corporate earnings and balance sheets are generally strong, and interest rates are close to historically low levels; however, the housing and jobs markets remain weak. As for international markets, the risk of a wider European debt crisis due to a possible Greek sovereign default continues to unnerve investor sentiment. This uncertain environment continues to heighten risk awareness and underscore the value of the fund’s diversified holdings. We continue to believe that broad diversification, intensive fundamental research, and prudent security selection can help mitigate risks while still providing opportunities to profit from market volatility. (Of course, diversification cannot assure a profit or protect against loss in a declining market.)

In closing, we would like to inform our investors that Ned Notzon will be retiring at the end of 2011 after more than two decades with T. Rowe Price. We are pleased to announce that Charles Shriver has agreed to assume responsibility for the Spectrum Funds effective October 1, 2011. Charles has worked closely with Ned for 12 years on both the firm’s fixed income and asset allocation capabilities and will continue to work closely with Ned over the coming months to ensure a thoughtful and seamless transition. We are grateful to our investors for the trust you have placed in us through the years, and we will work hard to maintain your trust in the future.

Respectfully submitted,

Edmund M. Notzon III
Cochairman of the portfolio’s Investment Advisory Committee

Charles Shriver
Cochairman of the portfolio’s Investment Advisory Committee

July 15, 2011

The committee chairmen have day-to-day responsibility for managing the portfolios and work with committee members in developing and executing the funds’ investment programs.

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

Weighted average effective duration (years): A measure of a security’s price sensitivity to changes in interest rates. Securities with longer durations are more sensitive to changes in interest rates than securities of shorter durations.

Weighted average maturity: A measure of a fund’s interest rate sensitivity. In general, the longer the average maturity, the greater the fund’s sensitivity to interest rate changes. The weighted average maturity may take into account interest rate readjustment dates for certain securities. Money funds must maintain a weighted average maturity of less than 60 days.

Performance and Expenses

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.

GROWTH OF $10,000

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 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 ($1,000 for UGMA/UTMA). The fee is waived for any investor whose T. Rowe Price mutual fund accounts total $50,000 or more; accounts employing automatic investing; accounts electing to receive electronic delivery of account statements, transaction confirmations, prospectuses, and shareholder reports; 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); 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