Working in Tandem Adding stewardship into an

140 Pages·2015·20.97 MB·English

The magazine of independent research for the world’s financial professionals June/July 2015
Working in Tandem
Adding stewardship into an investment-selection process can help portfolios avoid problems.
Also in this issue
g401(k) Millionaire Myth? gCreating a Sensible Income Portfolio gAnd the latest investing trends from around the world...
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5 Citigroup C 5.43%
6 Goldman Sachs GS 2.67%
7 American Intl Group AIG 2.59%
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10 Morgan Stanley MS 1.93%
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June/July 2015
6 Contributors
7 Letter From the Editor
Dispatches Letter From the Board
8 Valuation-Driven Asset Allocation
Phillips Curve
12 Remaining Vigilant on Stewardship
Policy
14 An Odd Focus on Funds
Ivory Towers
17 The 401(k) Millionaire
Behavior Gap
20 Providing Real Financial Planning
Economic Outlook
22 In Search of a True U.S. GDP
Global Briefs
26 Americas
38 Greater Europe
39 Australia & New Zealand
43 Asia
Spotlight
49 More Than Warm and Fuzzy
Good stewards of capital have produced
better results for investors.
53 Evaluating Capital Allocators
54 Standing Still Is Falling Behind
56 Fund Firms Embrace Portfolio Holdings Disclosure
3
June/July 2015
Strategies Asset Allocation
60 Beyond Target-Date: Lifetime Allocations
Quant U
64 Which Portfolio Is the Most Diversified?
Investment Research
68 Passive: Russell 2000’s Achilles’ Heel
72 Active: Buyer Beware With Managed-Futures Funds
Best Ideas
76 Manager: Buy Old World to Get New One
78 Passive: Consumer Advocate
80 Equity: This Crown Is a Potential Jewel
Investors
Morningstar Conversation
82 David Blanchett and Steve Wendel
Undiscovered Manager
90 Staying Close to Home
In Practice
94 An Efficient Portfolio for the Income Investor
Sector Rap
98 Outsourcing 2.0
101 Sector Snapshot: Information Technology Services
User Profile
102 Singles Champ Stays Solo
Data Dashboard
104 Morningstar Global Market Barometer
106 Morningstar Global Valuation Lens
110 Morningstar Global Fund Flows
112 Ten Questions
4
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The fund’s investment strategies and techniques will make significant use of derivatives relative to its direct investments in stocks, bonds and other
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Contributors
Magazine
In this issue’s Quick Poll, 49% of respondents
Editor-in-Chief Jerry Kerns
said the mutual fund industry deserved a C when Associate Editor Rob Wherry
it comes to stewardship. That lackluster grade Editorial Board David Blanchett, Joel Bloomer, Heather Brilliant,
Andrew Carter, Sylvester Flood, Jon Hale, David Harrell, Michael Holt,
may not be surprising to Bridget Hughes, who has
Thomas Idzorek, Paul D. Kaplan, Kunal Kapoor, Haywood Kelly,
Bridget B. Hughes seen the best and the worst the industry has Grant Kennaway, Warren Miller, Daniel Needham, Don Phillips, Jeffrey
to offer over a 20-year career at Morningstar, most Ptak, Hal Ratner, Christopher Traulsen
Contributors Alex Bryan, Scott Cooley, Christopher Davis, Beth Foos,
recently as an associate director of manager Robert Goldsborough, Brian Han, Suruchi Jain, Robert Johnson,
research in charge of the Parent and Stewardship Jason Kephart, Russel Kinnel, Alec Lucas, Rudy Luukko, Ross MacMillan,
Tim Mann, Magdalena Mroczek, Michael Rawson, Carl Richards,
committees, which play a part in the Parent
Christine St. Anne, Jennifer Song, Kate Stalter, Iris Tan, Emma Wall,
pillar of the Morningstar Analyst Rating. While Janet Yang, Adam Zoll
Hughes can point to strides the industry has
Art Director Alex Skoirchet
made when it comes to being good stewards Designers Mike Pettit, Zach Sherwood
of capital, in “More Than Warm and Fuzzy” (Page Illustrator Noma Bar
Photographers Alex Chessare, Nathan Elson, David Lees, Andy Richter
49) she reveals where firms still have room
Proofreader Mike Eiler
to improve.
Publisher Leslie Marshall
Design Directors Jason Ackley, Renee Benz
Mutual fund analyst Jason Kephart specializes Director of Advertising Sales Mary Uribe
in analyzing some of the mutual fund world’s Regional Sales Directors Dan Atkinson, Tony Lignelli, Stuart Roge
newest (and hottest) entrants—alternative mutual
Morningstar, Inc.
funds. These offerings often cover new ground
Chairman and CEO Joe Mansueto
Jason Kephart and use complex investment vehicles as the Managing Director, Design David Williams
Head of Marketing Services Kristin Mateja
foundations of their strategies. While these funds
are giving retail investors a chance to invest
How to Reach Morningstar Magazine
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accessible a decade ago, Kephart, a well-respected Editorial and Letters to the Editor [email protected]
Advertising [email protected]
journalist before joining Morningstar in 2014,
Rate card available at global.morningstar.com/MorningstarMagazine
has cautioned that investors take a close look Reprints and Licensing [email protected]
at these funds before taking the plunge. Indeed,
How to Reach Morningstar
in “Buyer Beware With Managed-Futures
Customer Service [phone]
Funds” (Page 72), Kephart turns the spotlight Advisor Product Sales [phone]
on managed-futures funds and reveals whether Data Questions [phone]
they deserve all the assets they have been
Morningstar magazine is published bimonthly by Morningstar, Inc.,
attracting lately.
22 W. Washington St., Chicago, IL 60602. An annual subscription
for delivery in the U.S. is $60. All exhibit data in this magazine is provided
When investors think about stewardship by Morningstar and Ibbotson Associates unless otherwise noted.

issues, they usually gravitate toward data such © 2015 Morningstar. All Rights Reserved. The information contained
as manager ownership and retention, fees, herein: (1) is intended solely for informational purposes; (2) is proprietary
to Morningstar and/or its content providers; (3) may not be copied
and regulatory records. Noma Bar, though, thought
or distributed; (4) is not warranted to be accurate, complete, or timely;
Noma Bar about birds. That shouldn’t come as a surprise and (5) does not constitute investment advice of any kind. Neither
Morningstar nor its content providers are responsible for any damages
to people who are familiar with his work. Bar, who
or losses arising from any use of this information. Past performance
illustrated this issue’s cover and the magazine’s is no guarantee of future results. “Morningstar” and the Morningstar logo
Spotlight section, is known for his ability to see are registered marks of Morningstar, Inc.

things differently, often creating witty images that Disclosure Morningstar licenses its indexes to certain providers,
cause readers to do double-takes. (Take a close including BlackRock Institutional Trust Company, N.A., First Trust, and
Deutsche Bank, for use in exchange-traded funds and exchange-traded
look at the cover to see two birds.) His work
notes. These ETFs and ETNs are not sponsored, endorsed, issued,
has appeared in several books and publications or sold by Morningstar. Morningstar does not make any representation
regarding the advisability of investing in ETFs and ETNs that are
such as Esquire, Wallpaper, and The New York
based on Morningstar indexes.
Times. Born in Israel, but now calling London home,
Bar was nominated for a Design Museum’s
Designs of the Year award in 2012.
6 Morningstar June/July 2015 2155407
Letter From the Editor
Finding Good Partners
Every year, Morningstar issues a report on data-driven variables. Those weak relationships
the stewardship practices exhibited by U.S. fund suggest that no one variable tells much about
firms, and every year, our data show the same the others and that each attribute provides some
results: The firms that have strong stewardship unique information.
traits produce better investment outcomes for their
Jerry Kerns
shareholders. As fund analyst Bridget Hughes In a nutshell, there is no perfect fund company.
writes in our lead Spotlight article, “More Than Investors must make tradeoffs. But Morningstar’s
Warm and Fuzzy” (Page 49), the results presented comprehensive research in stewardship
in the 2015 Morningstar U.S. Mutual Fund assessment can give investors more conviction
Follow Jerry on Twitter
Industry Stewardship Survey are no different. when they make their investment choices. After all,
@jerrykerns
in times good and bad, shouldn’t we want
Morningstar has long maintained that investors to partner with those asset managers that we can
win when they partner with good stewards of trust to be on our side?
capital, and our research, year after year, supports
that position. Our analysts, led by Hughes, Correction
annually examine data that Morningstar created In the table inset in EXHIBIT 1 on Page 49 in the
in 2011 to evaluate asset managers’ stewardship April/May 2015 issue, we ran incorrect data. Below
attributes among the mutual funds they are the correct numbers.
manage. Analysts continually find that firms with
the highest levels of manager tenure, manager Geometric Arithmetic Standard
retention, and ownership of mutual fund shares Mean (%) Mean (%) Deviation (%)
also have delivered better outcomes for their Large Stocks 10.1 12.1 20.1
investors. The same is true of firms that offer funds
Small Stocks 12.2 16.7 32.1
with lower expense ratios.
Corporate Bonds 6.1 6.4 8.4
Morningstar measures investor outcomes at Government Bonds 5.7 6.1 10.0
the firm level through the Morningstar Success
Treasury Bills 3.5 3.5 3.1
Ratio and the Morningstar Risk-Adjusted
Success Ratio, which express as a percentage the Inflation 2.9 3.0 4.1
number of fund share classes that survive and
outperform based on the funds’ category rank and
risk-adjusted category rank over the subsequent
three, five, and 10 years. As Hughes reports,
our study says that firms with stronger firm-level
data have higher Morningstar Success Ratios,
on average. This is not to say that there’s a perfect
correlation between a fund family’s stewardship
practices and the outcomes for investors.
Hughes says that her team found that overall there
is very limited correlation among the many
global.morningstar.com/Morningstarmagazine 7
Dispatches
Valuation-Driven Asset In the world of investing, market timing is more
akin to a dark art than a legitimate investment
Allocation Fair value approach. We would find it difficult to defend
market timing, with very few renowned long-term
is not only relevant at
market timers and many disastrous tales. Market
timing relates to one’s ability to predict price
the security level.
movements, and we don’t think all asset-allocation
changes should be viewed through this lens.
Stock selection on the other hand is viewed
as inherently bottom-up, searching through the
Phillips Curve universe of individual companies to find
LETTER FROM THE BOARD
12 Remaining Vigilant on Stewardship Daniel Needham underpriced securities based on the estimated
value of the underlying business. Adjusting
Policy one’s portfolio through time is, therefore, one of
14 An Odd Focus on Funds Valuation-driven investing has been around for the essential elements of this strategy. This is
nearly a century and has been applied by almost the antonym of market timing. Nose-
Ivory Towers some of the world’s most successful investors. to-the-grindstone investing—always trying to find
17 The 401(k) Millionaire Valuation is normally associated with the selection attractively priced companies irrespective of
of stocks based on the value of the underlying aggregate influences.
Behavior Gap company. Warren Buffett paints a good picture of
20 Providing Real Financial Planning this approach: Marrying Church and State
Asset allocation and stock selection are typically
Economic Outlook “What is ‘investing’ if it is not the act of seeking separated as distinctly as church and state.
22 In Search of a True U.S. GDP value at least sufficient to justify the amount paid? In general, the asset allocation is determined
Consciously paying more for a stock than its separately to the other investment decisions, and
Global Briefs calculated value—in the hope that it can soon be then the underlying investments are selected.
26 Americas sold for a still-higher price—should be labeled It is only at this point where valuation becomes
38 Greater Europe speculation (which is neither illegal, immoral nor— important for those employing a bottom-up
39 Australia & New Zealand in our view—financially fattening).” approach to security selection. Asset allocation is
43 Asia largely disconnected from valuation across the
We are interested in investing, and the good investment industry.
news is a decent chunk of the investment industry
is not, which turns out to be a benefit to the It is our belief that valuation is not only relevant
long-term investor. One of Bill Miller’s three at the security level; it is equally important
sources of competitive advantage for investment at the asset-class level. When describing this, it
managers is behavioral, along with informational helps to think about valuation-driven asset
and analytical. Behavioral is arguably allocation as bottom-up asset allocation, which
the most enduring. Doing things differently to involves adjusting the exposure to asset
others, who fail to be different due to their classes based on valuation through time. This
lack of capability or ability, is a big advantage is in contrast to market-timing-based strategies,
when investing. where the decision to hold an asset class is driven
by a prediction of the macroenvironment or
When thinking about asset allocation, the most the direction of asset prices over the short term.
common description is top-down, and images
of the famous “efficient frontier” come to Valuation-driven asset allocation requires
mind. The strategic or policy portfolio is seen as a fun-damentally derived fair value or valuation
the bedrock of multiasset investing, and any anchor for each asset class. Estimating the fair
deviation from this is referred to critically value of any investment requires the discounting
as market timing, drawing on the deeply flawed of the expected future cash flow across the
capital asset pricing model, or CAPM. life of the investment. This involves an estimate
8 Morningstar June/July 2015