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Fund Times

4 Key Points of Morningstar Research Today

The importance of stewardship, total wealth, investor returns, and strategic beta for today's investors.

This analyst blog is part of our coverage of the 2015 Morningstar Investment Conference.

Moderated by John Rekenthaler, the all-Morningstar Research roundtable featured directors of manager research Russ Kinnel and Laura Lutton, global head of research of Morningstar Investment Management Hal Ratner, and director of equity research Dan Rohr.

Rekenthaler focused on a handful of investment topics that have evolved during the past 20 years. "The biggest debate in 1995 was, which are better, load or no-load funds?" he noted. Since then, research has come a long way.

One topic of focus within Morningstar Research today: stewardship. Back in 1995, the thinking was, "I buy a fund, not a fund company." Today, Morningstar urges investors to consider investments at an organizational level. "When you partner with a firm that aligns itself with its fundholders, you get better investor outcomes," said Lutton. Added Kinnel, "Fund success rates take a 'stair-step' up as you invest in funds with more significant manager ownership." Concluded Lutton, "We feel so strongly about the quality of the firm in our research process that we included it in the Fund Analyst Ratings."

Morningstar's equity analysts examine stewardship in their analyses, too, but use a slightly different lens. "We focus more on capital allocation rather than policy," said Rohr. Morningstar's equity analysts focus on whether management is a good allocator of capital, is a company's capital structure appropriate, and is the dividend policy suitable.

Another topic that has gained traction during the past 20 years: total wealth. Ratner defined total wealth as encompassing everything ranging from long-term goals, an investor's human capital, his or her housing wealth, and so on. While the total-wealth concept isn't necessarily new, technology allows investors and advisors to design investment strategies that "take into account as much relevant information as possible," said Ratner.

Two decades ago, investors and advisors were concerned about finding great funds. Today, the focus is more on how to best use a fund, and how to close the behavior gap and achieve better results. Kinnel noted that the gap between stated returns and investors returns over a 10-year period is about 100 to 150 basis points. In the least-risky quartiles, the gap is smaller; in the highest-risk quartile, there is more than a 200-basis-point gap in returns. Where Morningstar has found the narrowest gap: target-date funds. "These are really boring funds that rarely inspire fear or greed," said Kinnel.

Morningstar's research team has also been monitoring and evaluating the proliferation of strategic beta funds--an unheard-of concept 20 years ago. "Obviously, they're oversold," noted Kinnel. But he added that he likes that strategic beta funds land somewhere between active and passive, and "that raises the bar for everyone. Strategic beta funds make active managers have to justify their fees against these funds," he said.

The panel also touched on the state of the equity market today. "When we roll up all individual-company valuations, we see a slightly overvalued market," said Rohr. Most sectors are overvalued, except for energy. Lutton concurs: Most of the equity managers she speaks with are having difficulty finding value in the market. Ratner acknowledges that the market appears to be richly valued, but adds, "I'm not quite as apocalyptic as Mr. Grantham."