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: 811-05833
| T. Rowe Price Institutional International Funds, 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, 2013
Item 1. Report to Shareholders
 |
|
Institutional Emerging Markets Bond Fund |
June 30, 2013 |
| Highlights |
- Emerging markets bonds fell in the first six
months of 2013 amid concerns about slowing global economic growth and
the potential consequences of less supportive
U.S. monetary policies.
- The Institutional Emerging Markets Bond Fund
returned -6.57% for the six-month period ended June 30, 2013, and outpaced the J.P. Morgan Emerging Markets Bond Index
Global Diversified.
- We continue to find compelling investment
opportunities in emerging markets corporate bonds but reduced our exposure modestly due to concerns about limited
liquidity and stretched valuations after recent outperformance.
- Despite the potential for near-term volatility, credit fundamentals and economic growth prospects in emerging markets are generally favorable relative to many developed countries and should continue to support our asset class over the long term.
The views and opinions in this report were current as of June 30, 2013. 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.
Manager’s Letter
T. Rowe Price Institutional Emerging Markets Bond
Fund
Dear Investor
Emerging markets debt declined for the six months ended June 30, 2013, with both U.S. dollar-denominated and local currency bonds experiencing significant losses. Investors were unnerved and risk appetite declined amid slowing global economic growth and concerns about the potential for limited global liquidity due to less accommodative monetary policy from the U.S. Federal Reserve. The Institutional Emerging Markets Bond Fund lost ground against this volatile backdrop but outpaced the J.P. Morgan Emerging Markets Bond Index Global Diversified.
As shown in the Performance Comparison table, your portfolio returned -6.57% for the period. Security selection in Brazil and Mexico helped results versus the J.P. Morgan index. Unhedged exposure to the Brazilian real, an underweight allocation to Lebanon, and security selection in the Philippines weighed on returns.
Market Environment
Emerging markets debt declined over the first six months of 2013 as concerns about slower economic growth, limited liquidity, and weaker currencies sapped investors’ appetite for riskier assets. A slow but steady economic recovery and partial resolution of fiscal challenges in the U.S. supported risk sentiment earlier in the period, but this was offset by global uncertainties as the period progressed. Economic growth in China, Brazil, and other economies slumped noticeably, while Italy’s elections stalemate and Cyprus’s controversial bank deposit tax highlighted ongoing challenges in the eurozone.
Investor sentiment declined further in May after the Fed indicated that it could begin winding down its quantitative easing program later in the year, provided the U.S. economic recovery continues to progress as expected. U.S. Treasury yields rose to their highest level in nearly two years as a result, and inflows to emerging markets debt turned negative as investors anticipated a coming era of reduced liquidity and rising yields. Country-specific events also weighed on the asset class, particularly an unexpected wave of political protests and social unrest in Brazil and Turkey. Many developed and emerging markets currencies weakened against the U.S. dollar.
Portfolio Review and Positioning
Security selection in Brazil was the top contributor to the portfolio’s performance over the six-month period. An underweight allocation to dollar-denominated sovereign debt added to performance, as the longer duration profile was more sensitive to the rise in U.S. Treasury rates. A preference for locally denominated and corporate debt within Brazil provided positive returns.
Security selection in Mexico boosted performance. U.S. dollar-denominated corporate bonds, including CEMEX and Grupo Cementos Chihuahua, posted strong results. Corporate bonds performed well as promising fiscal and energy sector reforms will likely increase the country’s economic growth potential over the mid to long term. An allocation to peso-denominated sovereign bonds, which are not included in the benchmark, also boosted results as benign inflation allowed Mexico’s central bank to cut its policy rate in March. (Please refer to the portfolio of investments for a complete list of holdings and the amount each represents in the portfolio.)
Although locally denominated Brazilian bonds were strong, unhedged exposure to the Brazilian real detracted from performance as the country’s growth slowed materially. This slowdown, along with concerns around the country’s fiscal discipline and recent social unrest, contributed to significant depreciation of the Brazilian real. More recently, concerns about inflation have increased the chances of interest rate hikes. However, central bank authorities continue to support the currency within a range to control inflation, and the real remains relatively attractive on several key metrics.
An underweight allocation to Lebanon, which is based on regional instability and Lebanon’s poor growth prospects, weighed on returns as the sovereign benefited from a strong local investor base that tends to support bond prices during periods of declining global investor appetite. Security selection in the Philippines was another detractor. Our allocation to lower-duration corporate and quasi-sovereign bonds outperformed amid a rising U.S. interest rate environment later in the second quarter, but it was not enough to make up for underperformance earlier in the period.
In terms of positioning, we are generally underweight U.S. dollar-denominated sovereign debt in favor of select corporate and local currency bonds. In Brazil, dollar-denominated sovereign debt exhibits a longer-duration profile and is more sensitive to U.S. interest rate movements. We have a preference for locally denominated sovereign debt, which offers a better risk/return profile relative to hard currency debt, as well as corporate debt, where we focus on companies that stand to benefit from growing domestic demand and an expanding middle class.
We continue to find compelling investment opportunities in emerging markets corporate bonds but reduced our exposure modestly due to concerns about limited liquidity and stretched valuations after recent outperformance. We have been consolidating our positions to emphasize companies with greater liquidity and prefer retailers and food processors that stand to benefit from rising domestic demand from developing middle classes. We are also looking at opportunities in China’s growing property sector, as well as financial firms in Turkey and Russia.
We have rotated from hard currency debt into local currency debt in select markets that offer better risk/return profiles. These include inflation-linked bonds in Brazil, where we see rising inflationary risks and compelling values. We trimmed our exposure to locally denominated Russian and Mexican debt and maintain an overweight to local Turkish bonds, one of our highest-conviction markets.
We significantly reduced our currency exposure given concerns over slowing growth in certain emerging markets economies and the prospects for a stronger U.S. dollar. We are focused on select opportunities with the Brazilian real and Mexican peso. We are also optimistic about the Russian ruble given stabilization in oil prices.
Outlook
Emerging markets debt has been volatile in recent months, due in part to investor outflows, marginally weaker sovereign fundamentals, and the potential for diminished global liquidity. Volatility may remain over the near term as previously supportive factors recede, including accommodative U.S. monetary policy and commodity demand from China. While certain lower-risk U.S. dollar-denominated government bonds appear attractively valued after recent underperformance, several other markets still hold more favorable investment potential given attractive yields and credit rating upgrade prospects. We are concerned about country-specific risks, including social unrest in Brazil and Turkey and slowing growth in China. As always, security selection remains an important factor in limiting downside risk.
While the current market environment may warrant a more defensive posture that favors portfolio liquidity, we remain optimistic about the long-term prospects for emerging markets debt. Overall economic growth in emerging markets, while weaker than in previous years, continues to outpace that of most developed markets. Sovereign fundamentals are still largely stable, although some countries are experiencing a moderate deterioration in credit metrics. In addition to higher growth expectations and lower debt burdens than the average developed country, emerging markets benefit from a much broader variety of policy tools than many developed markets. Overall, we are encouraged that credit fundamentals and economic growth potential in emerging markets countries are generally favorable relative to many highly indebted developed countries. We believe this will continue to drive secular capital flows into emerging debt markets in the long term and support bond prices.
As the emerging debt market grows in size, complexity, and maturity, we believe the extended reach of T. Rowe Price’s global credit and equity research platforms, combined with an emphasis on professional collaboration, gives us a critical edge in evaluating opportunities and risks.
Respectfully submitted,
Michael J.
Conelius
Lead portfolio manager and
chairman of the fund’s
Investment Advisory Committee
July 25, 2013
The committee chairman has day-to-day responsibility for the portfolio and works with committee members in developing and executing the fund’s investment program.
| Risk of International Bond Investing |
Funds that invest overseas generally carry more risk than funds that invest strictly in U.S. assets, including unpredictable changes in currency values. Investments in emerging markets are subject to abrupt and severe price declines and should be regarded as speculative. The economic and political structures of developing nations, in most cases, do not compare favorably with the U.S. or other developed countries in terms of wealth and stability, and their financial markets often lack liquidity. Some countries also have legacies of hyperinflation, currency devaluations, and governmental interference in markets.
International investments are subject to currency risk, 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. The overall impact on a fund’s holdings can be significant and long-lasting depending on the currencies represented in the portfolio, how each one appreciates or depreciates in relation to the U.S. dollar, and whether currency positions are hedged. Further, exchange rate movements are unpredictable, and it is not possible to effectively hedge the currency risks of many developing countries.
Bonds are also 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.
| Glossary |
Duration: A measure of a bond’s or bond fund’s sensitivity to changes in interest rates. For example, a fund with a duration of six years would fall about 6% in response to a one-percentage-point rise in rates, and vice versa.
J.P. Morgan Emerging Markets Bond Index Global Diversified: A capitalization-weighted index tracking emerging market government bonds denominated in local currencies.
Quasi-sovereign debt: Debt issued by a corporation and backed by the respective government, typically offering the higher yields of corporate debt with the added benefit of government support.
Weighted average maturity: A measure of a fund’s sensitivity to interest rates. 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 the interest rate readjustment dates for certain securities. Money funds must maintain a weighted average maturity of less than 60 days.
Portfolio Highlights
Performance and
Expenses
T. Rowe Price Institutional
Emerging Markets Bond Fund
| Performance Comparison |
This chart shows the value of a hypothetical $1 million 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.
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
actual expenses. 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.
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.
Financial Highlights
T. Rowe Price Institutional Emerging Markets Bond
Fund
(Unaudited)
The accompanying notes are an integral part of these financial statements.
Portfolio of
Investments‡
T. Rowe Price Institutional Emerging Markets Bond
Fund
June 30, 2013 (Unaudited)
The accompanying notes are an integral part of these financial statements.
Statement of Assets and
Liabilities
T. Rowe Price
Institutional Emerging Markets Bond Fund
June 30, 2013
(Unaudited)
($000s, except shares and per
share amounts)
The accompanying notes are an integral part of these financial statements.
Statement of
Operations
T. Rowe Price
Institutional Emerging Markets Bond Fund
(Unaudited)
($000s)
The accompanying notes are an integral part of these financial statements.
Statement of Changes in Net
Assets
T. Rowe Price Institutional
Emerging Markets Bond Fund
(Unaudited)
($000s)
The accompanying notes are an integral part of these financial statements.
Notes to Financial
Statements
T. Rowe Price
Institutional Emerging Markets Bond Fund
June 30, 2013 (Unaudited)
T. Rowe Price Institutional International Funds, Inc. (the corporation), is registered under the Investment Company Act of 1940 (the 1940 Act). The Institutional Emerging Markets Bond Fund (the fund) is a nondiversified, open-end management investment company established by the corporation. The fund commenced operations on November 30, 2006. The fund seeks to provide high income and capital appreciation.
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. Premiums and discounts on debt securities are amortized for financial reporting purposes. Paydown gains and losses are recorded as an adjustment to interest income. Inflation adjustments to the principal amount of inflation-indexed bonds are reflected as interest income. 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 daily and paid monthly. Capital gain distributions, if any, are generally declared and paid by the fund annually.
Currency Translation Assets, including investments, and liabilities denominated in foreign currencies are translated into U.S. dollar values each day at the prevailing exchange rate, using the mean of the bid and asked prices of such currencies against U.S. dollars as quoted by a major bank. Purchases and sales of securities, income, and expenses are translated into U.S. dollars at the prevailing exchange rate on the date of the transaction. The effect of changes in foreign currency exchange rates on realized and unrealized security gains and losses is reflected as a component of security gains and losses.
Credits Credits are earned on the fund’s temporarily uninvested cash balances held at the custodian and such credits reduce the amount paid by the manager for custody of the fund’s assets. In order to pass the benefit of custody credits to the fund, the manager has voluntarily reduced its investment management and administrative expense in the accompanying financial statements.
Redemption Fees A 2% fee is assessed on redemptions of fund shares held for 90 days or less to deter short-term trading and to protect the interests of long-term shareholders. Redemption fees are withheld from proceeds that shareholders receive from the sale or exchange of fund shares. The fees are paid to the fund and are recorded as an increase to paid-in capital. The fees may cause the redemption price per share to differ from the net asset value per share.
New Accounting Guidance In December 2011, the Financial Accounting Standards Board issued amended guidance requiring an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. The guidance is effective for fiscal years and interim periods beginning on or after January 1, 2013. Adoption had no effect on the fund’s net assets or results of operations.
NOTE 2 - VALUATION
The fund’s financial instruments are valued and its net asset value (NAV) per share is computed at the close of the New York Stock Exchange (NYSE), normally 4 p.m. ET, each day the NYSE is open for business.
Fair Value The fund’s financial instruments are reported at fair value, which GAAP defines as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The T. Rowe Price Valuation Committee (the Valuation Committee) has been established by the fund’s Board of Directors (the Board) to ensure that financial instruments are appropriately priced at fair value in accordance with GAAP and the 1940 Act. Subject to oversight by the Board, the Valuation Committee develops and oversees pricing-related policies and procedures and approves all fair value determinations. Specifically, the Valuation Committee establishes procedures to value securities; determines pricing techniques, sources, and persons eligible to effect fair value pricing actions; oversees the selection, services, and performance of pricing vendors; oversees valuation-related business continuity practices; and provides guidance on internal controls and valuation-related matters. The Valuation Committee reports to the fund’s Board; is chaired by the fund’s treasurer; and has representation from legal, portfolio management and trading, operations, and risk management.
Various valuation techniques and inputs are used to determine the fair value of financial instruments. GAAP establishes the following fair value hierarchy that categorizes the inputs used to measure fair value:
Level 1 – quoted prices (unadjusted) in active markets for identical financial instruments that the fund can access at the reporting date
Level 2 – inputs other than Level 1 quoted prices that are observable, either directly or indirectly (including, but not limited to, quoted prices for similar financial instruments in active markets, quoted prices for identical or similar financial instruments in inactive markets, interest rates and yield curves, implied volatilities, and credit spreads)
Level 3 – unobservable inputs
Observable inputs are developed using market data, such as publicly available information about actual events or transactions, and reflect the assumptions that market participants would use to price the financial instrument. Unobservable inputs are those for which market data are not available and are developed using the best information available about the assumptions that market participants would use to price the financial instrument. GAAP requires valuation techniques to maximize the use of relevant observable inputs and minimize the use of unobservable inputs. When multiple inputs are used to derive fair value, the financial instrument is assigned to the level within the fair value hierarchy based on the lowest-level input that is significant to the fair value of the financial instrument. Input levels are not necessarily an indication of the risk or liquidity associated with financial instruments at that level but rather the degree of judgment used in determining those values.
Valuation Techniques Debt securities generally are traded in the over-the-counter (OTC) market. Securities with remaining maturities of one year or more at the time of acquisition are valued at prices furnished by dealers who make markets in such securities or by an independent pricing service, which considers the yield or price of bonds of comparable quality, coupon, maturity, and type, as well as prices quoted by dealers who make markets in such securities. Securities with remaining maturities of less than one year at the time of acquisition generally use amortized cost in local currency to approximate fair value. However, if amortized cost is deemed not to reflect fair value or the fund holds a significant amount of such securities with remaining maturities of more than 60 days, the securities are valued at prices furnished by dealers who make markets in such securities or by an independent pricing service. Generally, debt securities are categorized in Level 2 of the fair value hierarchy; however, to the extent the valuations include significant unobservable inputs, the securities would be categorized in Level 3.
Investments in mutual funds are valued at the mutual fund’s closing net asset value per share on the day of valuation and are categorized in Level 1 of the fair value hierarchy. Forward currency exchange contracts are valued using the prevailing forward exchange rate and are categorized in Level 2 of the fair value hierarchy. Swaps are valued at prices furnished by independent swap dealers or by an independent pricing service and generally are categorized in Level 2 of the fair value hierarchy; however, if unobservable inputs are significant to the valuation, the swap would be categorized in Level 3. Assets and liabilities other than financial instruments, including short-term receivables and payables, are carried at cost, or estimated realizable value, if less, which approximates fair value.
Thinly traded financial instruments and those for which the above valuation procedures are inappropriate or are deemed not to reflect fair value are stated at fair value as determined in good faith by the Valuation Committee. The objective of any fair value pricing determination is to arrive at a price that could reasonably be expected from a current sale. Financial instruments fair valued by the Valuation Committee are primarily private placements, restricted securities, warrants, rights, and other securities that are not publicly traded.
Subject to oversight by the Board, the Valuation Committee regularly makes good faith judgments to establish and adjust the fair valuations of certain securities as events occur and circumstances warrant. For instance, in determining the fair value of troubled or thinly traded debt instruments, the Valuation Committee considers a variety of factors, which may include, but are not limited to, the issuer’s business prospects, its financial standing and performance, recent investment transactions in the issuer, strategic events affecting the company, market liquidity for the issuer, and general economic conditions and events. In consultation with the investment and pricing teams, the Valuation Committee will determine an appropriate valuation technique based on available information, which may include both observable and unobservable inputs. The Valuation Committee typically will afford greatest weight to actual prices in arm’s length transactions, to the extent they represent orderly transactions between market participants; transaction information can be reliably obtained; and prices are deemed representative of fair value. However, the Valuation Committee may also consider other valuation methods such as a discount or premium from market value of a similar, freely traded security of the same issuer; discounted cash flows; yield to maturity; or some combination. Fair value determinations are reviewed on a regular basis and updated as information becomes available, including actual purchase and sale transactions of the issue. Because any fair value determination involves a significant amount of judgment, there is a degree of subjectivity inherent in such pricing decisions and fair value prices determined by the Valuation Committee could differ from those of other market participants. Depending on the relative significance of unobservable inputs, including the valuation technique(s) used, fair valued securities may be categorized in Level 2 or 3 of the fair value hierarchy.
Valuation Inputs The following table summarizes the fund’s financial instruments, based on the inputs used to determine their fair values on June 30, 2013:
There were no material transfers between Levels 1 and 2 during the period.
NOTE 3 - DERIVATIVE INSTRUMENTS
During the six months ended June 30, 2013, the fund invested in derivative instruments. As defined by GAAP, a derivative is a financial instrument whose value is derived from an underlying security price, foreign exchange rate, interest rate, index of prices or rates, or other variable; it requires little or no initial investment and permits or requires net settlement. The fund invests in derivatives only if the expected risks and rewards are consistent with its investment objectives, policies, and overall risk profile, as described in its prospectus and Statement of Additional Information. The fund may use derivatives for a variety of purposes, such as seeking to hedge against declines in principal value, increase yield, invest in an asset with greater efficiency and at a lower cost than is possible through direct investment, or to adjust portfolio duration and credit exposure. The risks associated with the use of derivatives are different from, and potentially much greater than, the risks associated with investing directly in the instruments on which the derivatives are based. Investments in derivatives can magnify returns positively or negatively; however, the fund at all times maintains sufficient cash reserves, liquid assets, or other SEC-permitted asset types to cover the settlement obligations under its open derivative contracts.
The fund values its derivatives at fair value, as described below and in Note 2, and recognizes changes in fair value currently in its results of operations. Accordingly, the fund does not follow hedge accounting, even for derivatives employed as economic hedges. Generally, the fund accounts for its derivatives on a gross basis. It does not offset the fair value of derivative liabilities against the fair value of derivative assets on its financial statements, nor does it offset the fair value of derivative instruments against the right to reclaim or obligation to return collateral.
The following table summarizes the fair value of the fund’s derivative instruments held as of June 30, 2013, and the related location on the accompanying Statement of Assets and Liabilities, presented by primary underlying risk exposure:
Additionally, the amount of gains and losses on derivative instruments recognized in fund earnings during the six months ended June 30, 2013, and the related location on the accompanying Statement of Operations is summarized in the following table by primary underlying risk exposure:
Counterparty Risk and Collateral The fund invests in derivatives, such as swaps, forward currency exchange contracts, and options, that are transacted in OTC markets and thereby expose the fund to counterparty risk. To mitigate this risk, the fund has entered into master netting arrangements (MNAs) with certain counterparties that permit net settlement under specified conditions and, for certain counterparties, also provide collateral agreements. MNAs may be in the form of International Swaps and Derivatives Association master agreements (ISDAs) and/or foreign exchange letter agreements (FX letters).
MNAs govern the ability to offset amounts the fund owes a counterparty against amounts the counterparty owes the fund (net settlement). Both ISDAs and FX letters generally allow net settlement in the event of contract termination and permit termination by either party prior to maturity upon the occurrence of certain stated events, such as failure to pay or bankruptcy. In addition, ISDAs specify other events, the occurrence of which would allow one of the parties to terminate. For example, a downgrade in credit rating of a counterparty would allow the fund to terminate while a decline in the fund’s net assets of more than a certain percentage would allow the counterparty to terminate. Upon termination, all derivatives with the counterparty typically would be liquidated and a net amount settled. ISDAs typically include collateral agreements, whereas FX letters do not. Collateral requirements are determined and transfers are made based on the net aggregate unrealized gain or loss on all OTC derivatives with each counterparty, subject to minimum transfer amounts that typically range from $100,000 to $250,000. Any additional collateral required due to changes in security values is transferred the next business day.
The following table summarizes the fund’s derivatives at the reporting date by loss exposure to each counterparty after consideration of collateral, if any.
Collateral may be in the form of cash or debt securities issued by the U.S. government or related agencies. Collateral posted pursuant to an ISDA is held in a segregated account by the fund’s custodian. Cash posted by the fund as collateral is reflected as restricted cash in the accompanying financial statements, and securities posted by the fund are so noted in the accompanying Portfolio of Investments; both remain in the fund’s assets. Collateral pledged by counterparties is not included in the fund’s assets because the fund does not obtain effective control over those assets.
Forward Currency Exchange Contracts The fund is subject to foreign currency exchange rate risk in the normal course of pursuing its investment objectives. It uses forward currency exchange contracts (forwards) primarily to protect its non-U.S. dollar-denominated securities from adverse currency movements and to gain exposure to currencies for the purposes of risk management or enhanced return. A forward involves an obligation to purchase or sell a fixed amount of a specific currency on a future date at a price set at the time of the contract. Although certain forwards may be settled by exchanging only the net gain or loss on the contract, most forwards are settled with the exchange of the underlying currencies in accordance with the specified terms. Forwards are valued at the unrealized gain or loss on the contract, which reflects the net amount the fund either is entitled to receive or obligated to deliver, as measured by the difference between the forward exchange rates at the date of entry into the contract and the forward rates at the reporting date. Appreciated forwards are reflected as assets, and depreciated forwards are reflected as liabilities on the accompanying Statement of Assets and Liabilities. Risks related to the use of forwards include the possible failure of counterparties to meet the terms of the agreements; that anticipated currency movements will not occur, thereby reducing the fund’s total return; and the potential for losses in excess of the fund’s initial investment. During the six months ended June 30, 2013, the fund’s exposure to forwards, based on underlying notional amounts, was generally between 11% and 13% of net assets.
Credit Default Swaps The fund is subject to credit risk in the normal course of pursuing its investment objectives and uses swap contracts to help manage such risk. The fund may use swaps in an effort to manage exposure to changes in interest rates, inflation rates, and credit quality; to adjust overall exposure to certain markets; to enhance total return or protect the value of portfolio securities; to serve as a cash management tool; and/or to adjust portfolio duration or credit exposure. Credit default swaps are agreements where one party (the protection buyer) agrees to make periodic payments to another party (the protection seller) in exchange for protection against specified credit events, such as certain defaults and bankruptcies related to an underlying credit instrument, or issuer or index of such instruments. Upon occurrence of a specified credit event, the protection seller is required to pay the buyer the difference between the notional amount of the swap and the value of the underlying credit, either in the form of a net cash settlement or by paying the gross notional amount and accepting delivery of the relevant underlying credit. For credit default swaps where the underlying credit is an index, a specified credit event may affect all or individual underlying securities included in the index and will be settled based upon the relative weighting of the affected underlying security(s) within the index. Generally, the payment risk for the seller of protection is inversely related to the current market price and/or credit rating of the underlying credit, both of which are indicators of market valuations of credit quality. Therefore, payment risk increases as the price of the relevant underlying credit and/or credit rating declines. Generally payment risk increases as the market value of a swap contract declines in relation to the notional amount. As of June 30, 2013, the notional amount of protection sold by the fund totaled $1,300,000 (0.5% of net assets), which reflects the maximum potential amount the fund could be required to pay under such contracts. The value of a swap included in net assets is the unrealized gain or loss on the contract plus or minus any unamortized premiums paid or received, respectively. Appreciated swaps and premiums paid are reflected as assets, and depreciated swaps and premiums received are reflected as liabilities on the accompanying Statement of Assets and Liabilities. Net periodic receipts or payments required by swaps are accrued daily and are recorded as realized gain or loss for financial reporting purposes when settled; fluctuations in the fair value of swaps are reflected in the change in net unrealized gain or loss and are reclassified to realized gain or loss upon termination prior to maturity or cash settlement. Risks related to the use of credit default swaps include the possible inability of the fund to accurately assess the current and future creditworthiness of underlying issuers, the possible failure of a counterparty to perform in accordance with the terms of the swap agreements, potential government regulation that could adversely affect the fund’s swap investments, and potential losses in excess of the fund’s initial investment. During the six months ended June 30, 2013, the fund’s exposure to swaps, based on underlying notional amounts, was generally less than 1% of net assets.
NOTE 4 - OTHER INVESTMENT TRANSACTIONS
Consistent with its investment objective, the fund engages in the following practices to manage exposure to certain risks and/or to enhance performance. The investment objective, policies, program, and risk factors of the fund are described more fully in the fund’s prospectus and Statement of Additional Information.
Emerging Markets At June 30, 2013, approximately 88% of the fund’s net assets were invested, either directly or through investments in T. Rowe Price institutional funds, in securities of companies located in emerging markets, securities issued by governments of emerging market countries, and/or securities denominated in or linked to the currencies of emerging market countries. Emerging market securities are often subject to greater price volatility, less liquidity, and higher rates of inflation than U.S. securities. In addition, emerging markets may be subject to greater political, economic, and social uncertainty, and differing regulatory environments that may potentially impact the fund’s ability to buy or sell certain securities or repatriate proceeds to U.S. dollars.
Noninvestment-Grade Debt Securities At June 30, 2013, approximately 37% of the fund’s net assets were invested, either directly or through its investment in T. Rowe Price institutional funds, in noninvestment-grade debt securities, commonly referred to as “high yield” or “junk” bonds. The noninvestment-grade bond market may experience sudden and sharp price swings due to a variety of factors, including changes in economic forecasts, stock market activity, large sustained sales by major investors, a high-profile default, or a change in market psychology. These events may decrease the ability of issuers to make principal and interest payments and adversely affect the liquidity or value, or both, of such securities.
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.
Other Purchases and sales of portfolio securities other than short-term and U.S. government securities aggregated $82,368,000 and $69,136,000, respectively, for the six months ended June 30, 2013. Purchases and sales of U.S. government securities aggregated $260,000 and $0, respectively, for the six months ended June 30, 2013.
NOTE 5 - FEDERAL INCOME TAXES
No provision for federal income taxes is required since the fund intends to continue to qualify as a regulated investment company under Subchapter M of the Internal Revenue Code and distribute to shareholders all of its taxable income and gains. Distributions determined in accordance with federal income tax regulations may differ in amount or character from net investment income and realized gains for financial reporting purposes. Financial reporting records are adjusted for permanent book/tax differences to reflect tax character but are not adjusted for temporary differences. The amount and character of tax-basis distributions and composition of net assets are finalized at fiscal year-end; accordingly, tax-basis balances have not been determined as of the date of this report.
The fund intends to retain realized gains to the extent of available capital loss carryforwards. Net realized capital losses may be carried forward indefinitely to offset future realized capital gains.
At June 30, 2013, the cost of investments for federal income tax purposes was $253,508,000. Net unrealized loss aggregated $3,111,000 at period-end, of which $8,819,000 related to appreciated investments and $11,930,000 related to depreciated investments.
NOTE 6 - RELATED PARTY TRANSACTIONS
The fund is managed by T. Rowe Price Associates, Inc. (Price Associates), a wholly owned subsidiary of T. Rowe Price Group, Inc. (Price Group). The investment management and administrative agreement between the fund and Price Associates provides for an all-inclusive annual fee equal to 0.70% of the fund’s average daily net assets. The fee is computed daily and paid monthly. The all-inclusive fee covers investment management, shareholder servicing, transfer agency, accounting, and custody services provided to the fund, as well as fund directors’ fees and expenses. Interest, taxes, brokerage commissions, and extraordinary expenses are paid directly by the fund.
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.
Mutual funds and other accounts managed by T. Rowe Price and its affiliates (collectively, T. Rowe Price funds) may invest in the fund; however, no T. Rowe Price fund may invest for the purpose of exercising management or control over the fund. At June 30, 2013, approximately 69% of the fund’s outstanding shares were held by T. Rowe Price funds.
| Information on Proxy Voting Policies, Procedures, and Records |
A description of the policies and procedures used by T. Rowe Price funds and portfolios to determine how to vote proxies relating to portfolio securities is available in each fund’s Statement of Additional Information. You may request this document by calling 1-800-225-5132 or by accessing the SEC’s website, sec.gov.
The description of our proxy voting policies and procedures is also available on our website, troweprice.com. To access it, click on the words “Social Responsibility” at the top of our corporate homepage. Next, click on the words “Conducting Business Responsibly” on the left side of the page that appears. Finally, click on the words “Proxy Voting Policies” on the left side of the page that appears.
Each fund’s most recent annual proxy voting record is available on our website and through the SEC’s website. To access it through our website, follow the directions above to reach the “Conducting Business Responsibly” page. Click on the words “Proxy Voting Records” on the left side of that page, and then click on the “View Proxy Voting Records” link at the bottom of the page that appears.
| How to Obtain Quarterly Portfolio Holdings |
The fund files a complete schedule of portfolio holdings with the Securities and Exchange Commission for the first and third quarters of each fiscal year on Form N-Q. The fund’s Form N-Q is available electronically on the SEC’s website (sec.gov); hard copies may be reviewed and copied at the SEC’s Public Reference Room, 100 F St. N.E., Washington, DC 20549. For more information on the Public Reference Room, call 1-800-SEC-0330.
| Approval of Investment Management Agreement |
On March 5, 2013, the fund’s Board of Directors (Board), including a majority of the fund’s independent directors, approved the continuation of the investment management agreement (Advisory Contract) between the fund and its investment advisor, T. Rowe Price Associates, Inc. (Advisor). In connection with its deliberations, the Board requested, and the Advisor provided, such information as the Board (with advice from independent legal counsel) deemed reasonably necessary. The Board considered a variety of factors in connection with its review of the Advisory Contract, also taking into account information provided by the Advisor during the course of the year, as discussed below:
Services Provided by the
Advisor
The Board considered the
nature, quality, and extent of the services provided to the fund by the Advisor.
These services included, but were not limited to, directing the fund’s
investments in accordance with its investment program and the overall management
of the fund’s portfolio, as well as a variety of related activities such as
financial, investment operations, and administrative services; compliance;
maintaining the fund’s records and registrations; and shareholder
communications. The Board also reviewed the background and experience of the
Advisor’s senior management team and investment personnel involved in the
management of the fund, as well as the Advisor’s compliance record. The Board
concluded that it was satisfied with the nature, quality, and extent of the
services provided by the Advisor.
Investment Performance of the Fund
The Board reviewed the fund’s
three-month, one-year, and year-by-year returns, as well as the fund’s average
annualized total returns over the three- and five-year and since-inception
periods, and compared these returns with a wide variety of previously agreed
upon comparable performance measures and market data, including those supplied
by Lipper and Morningstar, which are independent providers of mutual fund
data.
On the basis of this evaluation and the Board’s ongoing review of investment results, and factoring in the relative market conditions during certain of the performance periods, the Board concluded that the fund’s performance was satisfactory.
Costs, Benefits, Profits, and
Economies of Scale
The Board reviewed
detailed information regarding the revenues received by the Advisor under the
Advisory Contract and other benefits that the Advisor (and its affiliates) may
have realized from its relationship with the fund, including any research
received under “soft dollar” agreements and commission-sharing arrangements with
broker-dealers. The Board considered that the Advisor may receive some benefit
from soft-dollar arrangements pursuant to which research is received from
broker-dealers that execute the applicable fund’s portfolio transactions. The
Board received information on the estimated costs incurred and profits realized
by the Advisor from managing T. Rowe Price mutual funds. The Board also reviewed
estimates of the profits realized from managing the fund in particular, and the
Board concluded that the Advisor’s profits were reasonable in light of the
services provided to the fund.
The Board also considered whether the fund benefits under the fee levels set forth in the Advisory Contract from any economies of scale realized by the Advisor. The Board noted that, under the Advisory Contract, the fund pays the Advisor a single fee based on the fund’s average daily net assets that includes investment management services and provides for the Advisor to pay all expenses of the fund’s operations except for interest, taxes, portfolio transaction fees, and any nonrecurring extraordinary expenses that may arise. The Board concluded that, based on the profitability data it reviewed and consistent with this single-fee structure, the Advisory Contract provided for a reasonable sharing of any benefits from economies of scale with the fund.
Fees
The Board was provided with information regarding
industry trends in management fees and expenses, and the Board reviewed the
fund’s single-fee structure in comparison with fees and expenses of other
comparable funds based on information and data supplied by Lipper. For these
purposes, the Board assumed that the fund’s management fee rate was equal to the
single fee less the fund’s operating expenses. The information provided to the
Board indicated that the fund’s management fee rate was at or below the median
for comparable funds and the total expense ratio was below the median for
comparable funds.
The Board also reviewed the fee schedules for institutional accounts and private accounts with similar mandates that are advised or subadvised by the Advisor and its affiliates. Management provided the Board with information about the Advisor’s responsibilities and services provided to institutional account clients, including information about how the requirements and economics of the institutional business are fundamentally different from those of the mutual fund business. The Board considered information showing that the mutual fund business is generally more complex from a business and compliance perspective than the institutional business and that the Advisor generally performs significant additional services and assumes greater risk in managing the fund and other T. Rowe Price mutual funds than it does for institutional account clients.
On the basis of the information provided and the factors considered, the Board concluded that the fees paid by the fund under the Advisory Contract are reasonable.
Approval of the Advisory Contract
As noted, the Board approved the
continuation of the Advisory Contract. No single factor was considered in
isolation or to be determinative to the decision. Rather, the Board concluded,
in light of a weighting and balancing of all factors considered, that it was in
the best interests of the fund and its shareholders for the Board to approve the
continuation of the Advisory Contract (including the fees to be charged for
services thereunder). The independent directors were advised throughout the
process by independent legal counsel.
Item 2. Code of Ethics.
A code of ethics, as defined in Item 2 of Form N-CSR, applicable to its principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions is filed as an exhibit to the registrant’s annual Form N-CSR. No substantive amendments were approved or waivers were granted to this code of ethics during the registrant’s most recent fiscal half-year.
Item 3. Audit Committee Financial Expert.
Disclosure required in registrant’s annual Form N-CSR.
Item 4. Principal Accountant Fees and Services.
Disclosure required in registrant’s annual Form N-CSR.
Item 5. Audit Committee of Listed Registrants.
Not applicable.
Item 6. Investments.
(a) Not applicable. The complete schedule of investments is included in Item 1 of this Form N-CSR.
(b) Not applicable.
Item 7. Disclosure of Proxy Voting Policies and Procedures for Closed-End Management Investment Companies.
Not applicable.
Item 8. Portfolio Managers of Closed-End Management Investment Companies.
Not applicable.
Item 9. Purchases of Equity Securities by Closed-End Management Investment Company and Affiliated Purchasers.
Not applicable.
Item 10. Submission of Matters to a Vote of Security Holders.
Not applicable.
Item 11. Controls and Procedures.
(a) The registrant’s principal executive officer and principal financial officer have evaluated the registrant’s disclosure controls and procedures within 90 days of this filing and have concluded that the registrant’s disclosure controls and procedures were effective, as of that date, in ensuring that information required to be disclosed by the registrant in this Form N-CSR was recorded, processed, summarized, and reported timely.
(b) The registrant’s principal executive officer and principal financial officer are aware of no change in the registrant’s internal control over financial reporting that occurred during the registrant’s second fiscal quarter covered by this report that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting.
Item 12. Exhibits.
(a)(1) The registrant’s code of ethics pursuant to Item 2 of Form N-CSR is filed with the registrant’s annual Form N-CSR.
(2) Separate certifications by the registrant's principal executive officer and principal financial officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 and required by Rule 30a-2(a) under the Investment Company Act of 1940, are attached.
(3) Written solicitation to repurchase securities issued by closed-end companies: not applicable.
(b) A certification by the registrant's principal executive officer and principal financial officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and required by Rule 30a-2(b) under the Investment Company Act of 1940, is attached.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934 and the Investment Company Act of 1940, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
T. Rowe Price Institutional International Funds, Inc.
| By | /s/ Edward C. Bernard | |
| Edward C. Bernard | ||
| Principal Executive Officer | ||
| Date August 16, 2013 | ||
Pursuant to the
requirements of the Securities Exchange Act of 1934 and the Investment Company
Act of 1940, this report has been signed below by the following persons on
behalf of the registrant and in the capacities and on the dates indicated.
| By | /s/ Edward C. Bernard | |
| Edward C. Bernard | ||
| Principal Executive Officer | ||
| Date August 16, 2013 | ||
| By | /s/ Gregory K. Hinkle | |
| Gregory K. Hinkle | ||
| Principal Financial Officer | ||
| Date August 16, 2013 | ||