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UNITED STATES |
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SECURITIES AND EXCHANGE COMMISSION |
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Washington, D.C. 20549 |
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FORM N-CSR |
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CERTIFIED SHAREHOLDER REPORT OF REGISTERED |
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MANAGEMENT INVESTMENT COMPANIES |
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Investment Company Act File Number: 811-10093 |
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T. Rowe
Price U.S. Bond Enhanced Index Fund, Inc. |
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(Exact name of registrant as specified in charter) |
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100 East Pratt Street,
Baltimore, MD 21202 |
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(Address of
principal executive offices) |
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David Oestreicher |
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100 East Pratt Street,
Baltimore, MD 21202 |
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(Name and
address of agent for service) |
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Registrant’s telephone number, including area code: (410) 345-2000 |
| Date of fiscal year end: October 31 |
| Date of reporting period: April 30, 2011 |
Item 1: Report to Shareholders
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| U.S. Bond Enhanced Index Fund | April 30, 2011 |
The views and opinions in this report were current as of April 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.
REPORTS ON THE WEB
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Manager’s Letter
Fellow Shareholders
Investment-grade U.S. bonds produced flat returns over the six months ended April 30, 2011, as early weakness in many sectors was offset by broad gains late in the period. Expectations of stronger economic growth and higher inflation caused Treasury prices to fall for five consecutive months before rebounding in April amid signs of a slowing economy. Credit-sensitive sectors outperformed Treasuries throughout the six-month period. The U.S. Bond Enhanced Index Fund’s return narrowly exceeded that of the broad Barclays Capital U.S. Aggregate Index over the past six months.
ECONOMY AND INTEREST RATES
U.S. economic growth appeared to be regaining momentum as 2010 came to a close. Business activity continued to expand, and consumer income and spending grew steadily. Private employers added to payrolls, helping to gradually push down an elevated unemployment rate. At major U.S. corporations, a combination of revenue growth and cost reductions led to annual profits that generally exceeded analysts’ expectations and, as a whole, approached record levels achieved prior to the 2008 credit crisis.
Meanwhile, continued monetary and fiscal stimulus supported the economy. In early November, the Fed formally announced plans to begin a second program of quantitative easing—commonly referred to as “QE2”—in which the central bank would purchase $600 billion of Treasuries by mid-2011 with the goal of driving down borrowing costs and adding liquidity to the financial system. In December, the White House and Congress agreed to extend expiring Bush-era tax cuts for two years while also extending unemployment benefits and initiating a temporary Social Security payroll tax cut. As a result of the infusions of dollars into the financial system and consumers’ pockets, many economists raised their growth forecasts.
Dark clouds emerged on the international front in the first quarter of 2011 that threatened to stall the domestic recovery. An eruption of political unrest quickly spread across the Middle East and North Africa, causing oil prices to surge on fears of supply disruptions. In mid-March, northeastern Japan suffered a devastating earthquake and tsunami that set off a nuclear crisis and disrupted global manufacturing supply chains. The sovereign debt crisis on the periphery of Europe also continued to generate uncertainty and occasional flights into investments perceived to be safe havens.
Indeed, there were signs of slowing growth in the U.S. According to the Commerce Department’s preliminary estimates, the economy expanded by only 1.8% in the first quarter of 2011—well below its 3.1% pace in the previous quarter. The housing market appeared to have not yet found a bottom, while higher gasoline prices eroded consumer purchasing power. Despite higher inflation expectations arising from the increase in energy and commodities prices, the Federal Reserve reported in April that its members expected “these effects to be transitory.” The Fed said it intends to complete its QE2 purchases at the end of June but made no indication that it would move to raise the fed funds target rate from its near 0% level any time soon.
MARKET NEWS
The domestic bond market produced mixed results over the past six months. Despite volatility late in the period, commercial mortgage-backed securities (CMBS) posted strong returns thanks to continued investor demand for higher-yielding assets, scarce supply, and improving economic sentiment. Agency mortgage-backed securities (MBS) also outperformed the overall investment-grade market, though returns were considerably more subdued. The asset class benefited from generally favorable valuations and fewer prepayments as mortgage rates rose. MBS also experienced solid demand, as demonstrated by the market’s successful absorption of sales by the Treasury Department of some of its $142 billion mortgage portfolio acquired during the financial crisis. Corporate bonds were another area of relative strength, benefiting from exceptional corporate profits, fortified balance sheets, and demand from investors seeking both good quality and yield.
Treasuries generally declined amid increased optimism about the economic recovery early in the period, concerns about food- and energy-driven inflation, and growing worries about the fiscal stability of the U.S. government. On April 18, the Standard & Poor’s credit rating agency affirmed its top AAA rating on Treasury securities but lowered its long-term outlook to “negative” from “stable” for the first time ever. The revised outlook raises the possibility of a credit rating downgrade within the next two years, a move that could increase borrowing costs and exacerbate the government’s fiscal problems if U.S. policymakers fail to reach a consensus on an effective strategy to tackle mounting deficits. Contrary to conventional wisdom, Treasury yields reversed the upward trajectory they had followed since last autumn and fell following the S&P announcement, perhaps due to investors seeking refuge in Treasuries amid signs of a worsening situation in Europe and slower economic growth at home. The decline in yields in late April helped Treasuries trim their losses, but they still lagged other sectors by a wide margin over the full period. Longer-term bonds underperformed shorter-term issues.
PERFORMANCE REVIEW
The U.S. Bond Enhanced Index Fund returned 0.08% in the six-month period ended April 30, 2011, versus 0.02% for the unmanaged Barclays Capital U.S. Aggregate Index. The fund’s net asset value declined by $0.20 over the past six months, but the lower price per share was offset by a comparable amount of dividend income. The fund’s 30-day SEC yield increased from 2.72% to 3.01% as Treasury yields climbed. The portfolio’s duration and weighted average maturity increased over the period, making the fund somewhat more sensitive to interest rate fluctuations, but ended slightly below those of the benchmark (see the glossary for definitions).
On February 3, 2011, the fund’s Board of Directors approved changing the fund’s investment objective so that it seeks to provide a total return that matches or incrementally exceeds the performance of the U.S. investment-grade bond market. Previously, the fund aimed to match the performance of the Barclays index after subtracting expenses. The fund will remain an index fund, but, based on our views as to the relative value or attractiveness of a specific sector or characteristic—such as interest rate sensitivity and credit quality—we will place a slightly greater or lesser emphasis on these areas than the benchmark in an effort to gain a small performance advantage. The fund will also focus slightly more on security selection than would a typical passively managed fund that attempts to simply replicate an index. The objective change was approved by a majority of the fund’s shareholders at a meeting held on April 21, 2011. To better reflect the fund’s new investment objective, which took effect shortly after the end of the reporting period, the fund was renamed the T. Rowe Price U.S. Bond Enhanced Index Fund.
We largely maintained our recent positioning throughout the period, which has been to overweight CMBS, MBS, investment-grade corporate bonds, and asset-backed securities (ABS). The fund’s largest overweight is to corporates (+3.1%), based on the sector’s strong fundamentals, sturdy balance sheets, and a favorable economic outlook. We increased this overweight position slightly, as we did with our overweights in CMBS (+2.1%) and MBS (+1.5%). CMBS should benefit from a number of factors, including negative net issuance, a situation that occurs when more securities are redeemed than issued. MBS stand to continue benefiting from declining prepayment rates. ABS are appealing due to their limited supply and anticipated demand from investors seeking a substitute for low-yielding cash. Our largest underweight position is in Treasuries (-8.1%) because we believe that government bond yields will trend upward—and their prices will decline—over the longer term in response to an improving economy, higher inflation, concerns about federal deficits, and the expected end of monetary accommodation by the Federal Reserve.
The fund’s asset allocation was the primary driver of its marginal outperformance of the Barclays index. The main contributor to our relative results was the fund’s underweight position in Treasuries, the only asset class to suffer a meaningful decline. Other contributors were our overweight allocations to CMBS, which produced the strongest return by far, and investment-grade corporate credit. Security selection in MBS, the largest weighting in the fund and index, was particularly strong and contributed to the fund’s relative results.
As shown in the Security Diversification chart, MBS, corporate bonds, and Treasuries accounted for approximately 81% of the portfolio. The next-largest allocation was in government-related securities, such as agency debt and dollar-denominated foreign obligations, with the remaining assets spread across ABS, CMBS, taxable municipal bonds, and cash reserves.
OUTLOOK
The upcoming end of the Fed’s second round of quantitative easing has raised uncertainty about the direction of interest rates. Those with a bearish outlook for bonds argue that the departure of a major buyer from the market will cause government borrowing costs to rise, which could result in higher rates for other types of borrowers. Others counter that QE2 bolstered the economic recovery and encouraged investors to purchase riskier assets. When central bank support disappears, investors may shift back into Treasuries—particularly if economic data fail to impress or disruptive events such as the European debt crisis stimulate risk aversion.
Regardless of where rates move in the near term, Treasury yields at current levels offer limited compensation for interest rate risk. At the same time, more credit-sensitive sectors have recently performed well, making valuations less compelling. We are now looking to position the fund more defensively in these areas by taking steps such as increasing the quality or reducing the interest rate sensitivity of our holdings. As we have mentioned in recent reports, we believe that we have entered a period in which dividend income will play a more important role in total return than price appreciation. Maintaining exposure to investment-grade bonds is an important component of a balanced portfolio, and we believe that a diversified bond fund with the flexibility to make strategic allocation adjustments as opportunities arise can serve investors well in an uncertain rate environment.
Respectfully submitted,
Robert M. Larkins
President of the fund and chairman of its Investment Advisory Committee
May 11, 2011
The committee chairman has day-to-day responsibility for managing the portfolio and works with committee members in developing and executing the fund’s investment program.
RISKS OF INVESTING IN FIXED INCOME SECURITIES
Funds that invest in fixed income securities are subject to price declines due to rising interest rates, with long-term securities generally most sensitive to rate fluctuations. Other risks include credit rating downgrades and defaults on scheduled interest and principal payments. MBS are subject to prepayment risk, particularly if falling rates lead to heavy refinancing activity, and extension risk, which is an increase in interest rates that causes a fund’s average maturity to lengthen unexpectedly due to a drop in mortgage prepayments. This would increase the fund’s sensitivity to rising interest rates and its potential for price declines.
GLOSSARY
Barclays Capital U.S. Aggregate Index: A widely used benchmark for the domestic investment-grade bond market, including corporate, government, and mortgage-backed securities. The index typically includes more than 5,000 fixed income securities with an overall intermediate- to long-term average maturity.
Duration: A measure of a bond fund’s sensitivity to changes in interest rates. For example, a fund with a duration of six years would fall about 6% in price in response to a one-percentage-point rise in interest rates, and vice versa.
Federal funds rate (or target rate): The interest rate charged on overnight loans of reserves by one financial institution to another in the United States. The Federal Reserve sets a target federal funds rate to affect the direction of interest rates.
SEC yield (30 day): A method of calculating a fund’s yield that assumes all portfolio securities are held until maturity. Yield will vary and is not guaranteed.
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 the interest rate readjustment dates for certain securities.
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.
| 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 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 account maintenance fee that is not included in the accompanying table. The account maintenance fee is charged on a quarterly basis, usually during the last week of a calendar quarter, and applies to accounts with balances below $10,000 on the day of the assessment. The fee is charged to accounts that fall below $10,000 for any reason, including market fluctuations, redemptions, or exchanges. When an account with less than $10,000 is closed either through redemption or exchange, the fee is charged and deducted from the proceeds. The fee applies to IRAs but not to retirement plans directly registered with T. Rowe Price Services or accounts maintained by intermediaries through NSCC® Networking. 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.
Unaudited
The accompanying notes are an integral part of these financial statements.
Unaudited
The accompanying notes are an integral part of these financial statements.
Unaudited
The accompanying notes are an integral part of these financial statements.
Unaudited
The accompanying notes are an integral part of these financial statements.
Unaudited
The accompanying notes are an integral part of these financial statements.
Unaudited
| NOTES TO FINANCIAL STATEMENTS |
T. Rowe Price U.S. Bond Enhanced Index Fund, Inc. (the fund), formerly the T. Rowe Price U.S. Bond Index Fund, is registered under the Investment Company Act of 1940 (the 1940 Act) as a diversified, open-end management investment company. The fund commenced operations on November 30, 2000. Effective May 6, 2011, the fund’s investment objective was modified to reflect a more active management style; the fund seeks to provide a total return that matches or incrementally exceeds the performance of the U.S. investment-grade bond market.
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. Dividends received from mutual fund investments are reflected as dividend income; capital gain distributions are reflected as realized gain/loss. Dividend income and capital gain distributions are recorded on the ex-dividend date. Income tax-related interest and penalties, if incurred, would be recorded as income tax expense. Investment transactions are accounted for on the trade date. Realized gains and losses are reported on the identified cost basis. Distributions to shareholders are recorded on the ex-dividend date. Income distributions are declared and paid monthly. Capital gain distributions, if any, are generally declared and paid by the fund annually.
Redemption Fees A 0.5% 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.
NOTE 2 - VALUATION
The fund’s financial instruments are reported at fair value as defined by GAAP. The fund determines the values of its assets and liabilities and computes its net asset value per share at the close of the New York Stock Exchange (NYSE), normally 4 p.m. ET, each day that the NYSE is open for business.
Valuation Methods Debt securities are generally 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.
Investments in mutual funds are valued at the mutual fund’s closing net asset value per share on the day of valuation.
Other investments, including restricted securities, and those financial instruments for which the above valuation procedures are inappropriate or are deemed not to reflect fair value are stated at fair value as determined in good faith by the T. Rowe Price Valuation Committee, established by the fund’s Board of Directors.
Valuation Inputs Various inputs are used to determine the value of the fund’s financial instruments. These inputs are summarized in the three broad levels listed below:
Level 1 – quoted prices in active markets for identical financial instruments
Level 2 – observable inputs other than Level 1 quoted prices (including, but not limited to, quoted prices for similar financial instruments, interest rates, prepayment speeds, and credit risk)
Level 3 – unobservable inputs
Observable inputs are those based on market data obtained from sources independent of the fund, and unobservable inputs reflect the fund’s own assumptions based on the best information available. The input levels are not necessarily an indication of the risk or liquidity associated with financial instruments at that level. The following table summarizes the fund’s financial instruments, based on the inputs used to determine their values on April 30, 2011:
NOTE 3 - OTHER INVESTMENT TRANSACTIONS
Consistent with its investment objective, the fund engages in the following practices to manage exposure to certain risks and/or to enhance performance. The investment objective, policies, program, and risk factors of the fund are described more fully in the fund’s prospectus and Statement of Additional Information.
Restricted Securities The fund may invest in securities that are subject to legal or contractual restrictions on resale. Prompt sale of such securities at an acceptable price may be difficult and may involve substantial delays and additional costs.
TBA Purchase and Sale Commitments During the six months ended April 30, 2011, the fund entered into to be announced (TBA) purchase and/or sale commitments, pursuant to which it agrees to purchase or sell, respectively, mortgage-backed securities for a fixed unit price, with payment and delivery at a scheduled future date beyond the customary settlement period for such mortgage-backed securities. With TBA transactions, the particular securities to be delivered are not identified at the trade date; however, delivered securities must meet specified terms, including issuer, rate, and mortgage term, and be within industry-accepted “good delivery” standards. The fund generally enters into TBA purchase transactions with the intention of taking possession of the underlying mortgage securities; however, for either purchase or sale transactions, the fund also may extend the settlement by “rolling” the transaction. Until settlement, the fund maintains cash reserves and liquid assets sufficient to settle its TBA commitments.
Dollar Rolls During the six months ended April 30, 2011, the fund entered into dollar roll transactions, pursuant to which it sells a mortgage-backed TBA or security and simultaneously purchases a similar, but not identical, TBA with the same issuer, rate, and terms. The fund may execute a “roll” to obtain better underlying mortgage securities or to enhance returns. The fund generally enters into dollar roll transactions with the intention of taking possession of the underlying mortgage securities, but may close a contract prior to settlement or “roll” settlement to a later date if deemed to be in the best interest of shareholders. Actual mortgages received by the fund may be less favorable than those anticipated. The fund accounts for dollar roll transactions as purchases and sales, which has the effect of increasing its portfolio turnover rate.
Securities Lending The fund lends its securities to approved brokers to earn additional income. It receives as collateral cash and U.S. government securities valued at 102% to 105% of the value of the securities on loan. Cash collateral is invested by the fund’s lending agent(s) in accordance with investment guidelines approved by management. Although risk is mitigated by the collateral, the fund could experience a delay in recovering its securities and a possible loss of income or value if the borrower fails to return the securities or if collateral investments decline in value. Securities lending revenue recognized by the fund consists of earnings on invested collateral and borrowing fees, net of any rebates to the borrower and compensation to the lending agent. In accordance with GAAP, investments made with cash collateral are reflected in the accompanying financial statements, but collateral received in the form of securities are not. On April 30, 2011, the value of loaned securities was $29,593,000 and cash collateral investments totaled $30,432,000.
Other Purchases and sales of portfolio securities other than short-term and U.S. government securities aggregated $38,503,000 and $17,098,000, respectively, for the six months ended April 30, 2011. Purchases and sales of U.S. government securities aggregated $138,924,000 and $188,182,000, respectively, for the six months ended April 30, 2011.
NOTE 4 - FEDERAL INCOME TAXES
No provision for federal income taxes is required since the fund intends to continue to qualify as a regulated investment company under Subchapter M of the Internal Revenue Code and distribute to shareholders all of its taxable income and gains. Distributions determined in accordance with federal income tax regulations may differ in amount or character from net investment income and realized gains for financial reporting purposes. Financial reporting records are adjusted for permanent book/tax differences to reflect tax character but are not adjusted for temporary differences. The 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.
At April 30, 2011, the cost of investments for federal income tax purposes was $596,293,000. Net unrealized gain aggregated $24,004,000 at period-end, of which $25,593,000 related to appreciated investments and $1,589,000 related to depreciated investments.
NOTE 5 - RELATED PARTY TRANSACTIONS
The fund is managed by T. Rowe Price Associates, Inc. (Price Associates), a wholly owned subsidiary of T. Rowe Price Group, Inc. (Price Group). The investment management and administrative agreement between the fund and Price Associates provides for an all-inclusive annual fee equal to 0.30% 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.
Additionally, the fund is one of several mutual funds in which certain college savings plans managed by Price Associates may invest. As approved by the fund’s Board of Directors, shareholder servicing costs associated with each college savings plan are allocated to the fund in proportion to the average daily value of its shares owned by the college savings plan. Shareholder servicing costs allocated to the fund are borne by Price Associates, pursuant to the fund’s all-inclusive fee agreement. At April 30, 2011, approximately 6% of the outstanding shares of the fund were held by college savings plans.
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.
As of April 30, 2011, T. Rowe Price Group, Inc., and/or its wholly owned subsidiaries owned 818,219 shares of the fund, representing 2% of the fund’s net assets.
NOTE 6 - SUBSEQUENT EVENT
Effective May 6, 2011, the T. Rowe Price U.S. Bond Index Fund was renamed the T. Rowe Price U.S. Bond Enhanced Index Fund and its investment objective was revised in order to reflect a more active management style.
| 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, which you may request 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 “Our Company” at the top of our corporate homepage. Then, when the next page appears, click on the words “Proxy Voting Policies” on the left side of the page.
Each 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, then click on the words “Proxy Voting
Records” on the right side of the Proxy Voting Policies page.
| HOW TO OBTAIN QUARTERLY PORTFOLIO HOLDINGS |
The fund files a complete schedule of portfolio holdings with the Securities and Exchange Commission for the first and third quarters of each fiscal year on Form N-Q. The 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, 450 Fifth St. N.W., Washington, DC 20549. For more information on the Public Reference Room, call 1-800-SEC-0330.
| APPROVAL OF INVESTMENT MANAGEMENT AGREEMENT |
On March 9, 2011, the fund’s Board of Directors (Board) unanimously approved the continuation of the investment advisory contract (Contract) between the fund and its investment advisor, T. Rowe Price Associates, Inc. (Advisor). The Board considered a variety of factors in connection with its review of the 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, management of the fund’s portfolio and a variety of related activities, as
well as financial and administrative services, reporting, and 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. 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 average annual total returns over the 1-, 3-, 5-, and 10-year periods, as well as the fund’s year-by-year returns, 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 Contract and other benefits that the Advisor (and its affiliates) may have realized from its relationship with the fund, including 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 also received information on the estimated costs incurred and profits realized by the Advisor and its affiliates from advising T. Rowe Price mutual funds. The
Board did not review information regarding profits realized from managing the fund in particular because the fund had not achieved sufficient scale in terms of portfolio asset size to produce meaningful profit margin percentages. 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 or other funds benefit under the fee levels set forth in the Contract from any economies of scale realized by the Advisor. The Board noted that, under the Contract, the fund pays the Advisor a single fee based on the fund’s assets and that the Advisor, in turn, pays all expenses of the fund, with certain exceptions. The Board concluded that, based on the profitability data it reviewed and consistent with this single-fee structure, the Contract provided for a reasonable sharing of any benefits from economies of scale with the fund.
Fees
The Board reviewed the fund’s single-fee structure and compared it with fees and expenses of other comparable funds based on information and data supplied by Lipper. 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 fund’s total expense ratio was below the median for comparable funds. (For these purposes, the Board assumed the fund’s management fee rate was equal
to the single fee less the fund’s operating expenses.) The Board also reviewed the fee schedules for institutional accounts of the Advisor and its affiliates with similar mandates. Management provided the Board with information about the
Advisor’s responsibilities and services provided to institutional account clients, which are more limited than its responsibilities for the fund and other T. Rowe Price mutual funds that it advises, and showing that the Advisor performs
significant additional services and assumes greater risk for the fund and other T. Rowe Price mutual funds that it advises than it does for institutional account clients. On the basis of the information provided, the Board concluded that the fees
paid by the fund under the Contract were reasonable.
Approval of the Contract
As noted, the Board approved the continuation of the Contract. No single factor was considered in isolation or to be determinative to the decision. Rather, the Board was assisted by the advice of independent legal counsel and concluded,
in light of a weighting and balancing of all factors considered, that it was in the best interests of the fund to approve the continuation of the Contract (including the fees to be charged for services thereunder).
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 U.S. Bond Enhanced Index Fund, Inc. | |
| By | /s/ Edward C. Bernard |
| Edward C. Bernard | |
| Principal Executive Officer | |
| Date | June 16, 2011 |
| 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 | June 16, 2011 |
| By | /s/ Gregory K. Hinkle |
| Gregory K. Hinkle | |
| Principal Financial Officer | |
| Date | June 16, 2011 |