Investing Insights: Fed Hike, Retirement Date, and Mondelez
Our analysts discuss Coke and Pepsi dividends, sustainable investing, and a fund to watch on this week's episode.
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As expected, the Federal Open Market Committee voted to raise its target rate range on Wednesday.
The vote was unanimous as economic data remains positive for the U.S., with unemployment remaining quite low, household spending and business investment remaining constructive, and real GDP growth expected to be above 3% for 2018.
Notably, the committee removed language from the statement about the stance of monetary policy being accommodative. This suggests to us that the Fed is getting closer to what it views as a neutral rate in the current environment. Still, the market is expecting another hike at the December meeting and two more next year.
In terms of the impact on the banking sector, the most rate-sensitive names we cover are Comerica and M&T, but we believe the market largely understands this and view the names as fairly valued.
Instead, we still see value in Wells Fargo, given the pessimism and poor headlines continuing to plague the bank. Further, with banks in general simply treading water for 2018, we are beginning to see our broader coverage universe as more fairly valued than we did at the start of the year.
Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Many investors plan to retire at a very specific date, but that might not be ideal. Joining me to share some research on that topic is David Blanchett. He is head of retirement research for Morningstar Investment Management.
David, thank you so much for being here.
David Blanchett: Thanks for having me.
Benz: David, you recently wrote a research paper where you looked at retirement dates and how setting a very specific retirement date might not be an optimal way to approach it. But let's start by talking about why delaying retirement can be such an attractive fallback plan, because increasingly people have heard if you wait a few years even, that can be really impactful in terms of the sustainability of your plan. What's the appeal from a financial standpoint of waiting?
Blanchett: As you made a point, delaying retirement is like the best thing you can do to improve your retirement outcomes. It does four things. It gives you one more year to save for retirement, one more year for your assets to grow, one less year to plan for retirement, and one more year to delay claiming Social Security. And the problem is, the reverse is also true. If you retire early, it can really negatively affect your retirement outcome.
Benz: That's the thing. That's one thing that you looked at in this research is that people might feel that they have some level of control over when they retire, but they might not have as much control as they think. What kinds of things can get in the way of someone retiring at a specific date?
Blanchett: You name it. I think like the big ones are things like healthcare and layoffs. When I looked at this, I was looking at someone who is, say, 10 years away from retirement. They make their forecast, I'm going to retire at age 65. Then things happen. For the most part though, when things happen, they require someone to retire early, and maybe two or three years early on average. That really affects their outcome. Because if you are planning to age 65 and you're retiring at 62, retirement becomes a lot more expensive.
Benz: Right. You looked at some research. Where did you find this research about how retirees' desired retirement dates can be in conflict with their actual retirement dates?
Blanchett: There's a great data set called the Health and Retirement Study, and it tracks people over time. Because what you actually need is someone to say if they are 55 years old, I'm going to retire in 10 years, and then come back 10 years from now and see when they actually retire. Because what you don't want to do is look at data after someone has already retired, because adjust their expectations over time, things happen. What you want is someone to kind of give you that estimate and then check back in the future to see how that actually panned out.
Benz: One thing that you looked at in the research was you attempted to identify whether there were any commonalities as to what might cause someone to retire earlier. What did you find there? Did you find any predictors?
Blanchett: I found a few things. I looked at 20 different variables. This is at, say, age 55. So, I'm 55 years old, I'm making a guess 10 years into the future. There were a few things we looked at, like, job stress, physical labor, income, total household assets and I thought …
Benz: Gender is always one.
Blanchett: Gender, all these different variables. But the thing that got me was that the expected age of retirement was the number-one driver, hands-down. Other stuff mattered a little bit. But when you expect to retire is the predominant driver of when you actually end up retiring.
Benz: Though if I'm not supposed to hinge my whole retirement plan on this desired retirement date--say I say 67 is really when I plan to hang it up--what should I do instead? If creating my whole retirement plan around a very specific date isn't a great idea, what are my alternatives?
Blanchett: I think you have to pick an age. What I found in the research is that the people who target age 61, retire at age 61. Those that retire or target retirement before 61 retire a little bit later. If I was talking about retiring at 59, I retire at 60. What gets interesting though is past age 61, you retire earlier and earlier and earlier, about half a year for every one year past age 61. The average person that said age 69 is their retirement age, retired at 65. You still have to target an age for retirement. The key though is saying, well, what if? Maybe I say, I'm going to retire at age 67. What happens if it's 64? How does that impact your overall retirement plan?
Benz: Make sure that your plan includes a contingency plan, and in the paper you argue that planning to save more is one way to potentially be a contingency plan?
Blanchett: A lot of advisors run what's called a Monte Carlo analysis, and they treat returns as random. They say that returns can go up by 20%, down by 20%. Retirement age is kind of random as well. One thing you can do is look at different ages and, to your point, the one kind of solution here is to save more for retirement. A lot of folks don't want to do that.
Benz: Or hear that, right?
Blanchett: Or hear that. But that's really all you can do to prepare for that possibility.
Benz: Interesting research, David. Thank you so much for being here to discuss it with us.
Blanchett: Thank you.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.
Sonia Vora: Coca-Cola and Pepsi pay some of the most attractive dividends in the beverage space, yielding north of 3%. Both companies have an impressive track record of returning cash to shareholders, as evidenced by a dividend increase each year for more than 40 years.
Longer term, we expect both firms to post average dividend growth around 7%. This implies a roughly 65% payout ratio for Pepsi and 75% payout ratio for Coca-Cola. Further, despite the fact that both firms made sizble acquisitions in August, with Pepsi acquiring Sodastream and Coca-Cola acquiring Costa, we expect them to remain committed to their dividend and continue to view their capital allocation policies as prudent.
We think Pepsi and Coca-Cola have secured wide economic moats, thanks to their brand-intangible assets and a cost advantage over their peer set, which should ensure that their returns on invested capital remain strong. Pepsi has 22 billion-dollar brands in the beverage and snack categories, which have helped it form entrenched relationships with retailers that rely on leading brands to drive inventory turnover. Similarly, Coca-Cola possesses substantial brand equity and an unparalleled distribution network distribution as its trademark offering is one of the most recognizable global beverage brands.
In addition to the attractive dividend yield, we view shares of both names as slightly undervalued, which could provide an attractive entry point for investors. Shares of Coca-Cola trade at a 6% discount to our valuation, while shares of Pepsi trade at a 7% discount.
Connor Young: American Beacon SGA Global Growth features a seasoned management team and is on our radar. Comanagers George Fraise, Gordon Marchand, and Rob Rohn of subadvisor Sustainable Growth Advisors focus on established large-cap firms they believe have strong levels of cash flow available to shareholders--a conservative variant of free cash flow.
The three have overseen this fund since its December 2010 inception, and they've built a solid long-term record deploying similar stock-picking techniques at John Hancock U.S. Global Leaders Growth. The managers here invest with conviction, typically stashing one third of the portfolio's assets in its top 10 holdings. They pay little attention to the MSCI ACWI Index; notably, the fund tends to have a heavy emerging-markets stake.
Since its inception, through August 2018, the fund beat the index by more than 3 percentage points annually. Its above-average emerging markets exposure has resulted in higher volatility than the bogey, but the fund has still outperformed on a risk-adjusted basis due to management's quality focus. Fees are above average relative to peers but have come down as assets have grown. We think the fund is worth watching.
Erin Lash: After nine months at the helm, Mondelez's new CEO, Dirk Van de Put, has finally provided clarity as to the direction the firm is slated to embark upon and the gains he believes are likely to ensue from these plans. As we've surmised, the firm's top priority hinges on igniting its sales trajectory, but the means by which it intends to do so are multifaceted, with management looking to extend the distribution of its fare into untapped regions and channels, while also focusing investments behind its core brands, which have been posting outsize growth. Based on these initiatives, management aims to post 3%-plus sales growth longer term, which aligns with our forecast.
But we never believed Van de Put and his team would opt to reignite its top line at any cost. Rather, based on his tenure at privately held McCain Foods and his recent rhetoric, we suspected he would opt to put the firm on a path to drive sustained, profitable growth. While management was reluctant to quantify its cost-savings objectives, we see an additional $1 billion in excess costs that it could remove on top of the $1.5 billion realized over the past several years, primarily by extracting further complexity from its operations (including rationalizing its suppliers, parting ways with unprofitable brands, and continuing to upgrade its manufacturing facilities). And in line with our thinking, management stressed that a portion of any savings realized would fuel additional spending behind its brand mix (in the form of both R&D as well as marketing), supporting the intangible asset that underlies its wide economic moat, which we view as prudent.
We expect Mondelez is on a course to drive accelerating sales growth while also posting margin gains over the next several years and think that investors should feast on shares, which trade at around a 15% discount to our $52 fair value estimate and the high-teens to low 20s price/earnings multiple of its wide-moat peers.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Today, I'm joined by Jon Hale, he is the director of sustainable investing research here at Morningstar. He recently had the chance to attend a few conferences on sustainable investing, and he had a few big takeaways.
Jon, thanks for joining me.
Jon Hale: My pleasure.
Glaser: Let's start with the way that advisors talk to their clients about sustainability. We've discussed in the past how this is growing in importance to many clients, but sometimes advisors don't quite know how to grapple with that. What did you learn about the way that sustainability should be talked about?
Hale: I was at the Sustainable Investing Conference at the U.N. last week. It was a very interesting conference because it was at capacity--600 advisors; there's so much interest out there among advisors in how to incorporate this into their investment process. What we heard at that conference, we heard from Morgan Stanley, who was saying that in their surveys of individual investors they are getting a huge number, 75%, 80% of investors saying I would be interested in sustainable investing, but advisors are saying I'm not hearing that necessarily from all that many clients--most of them are saying more are asking about than in the past--but I'm not getting this overwhelming response.
One of the takeaways from the discussion there was that what advisors might need to do is bring it up themselves, because a lot of investors who may be interested may not be so interested and especially so well-informed about it that they feel like it's something they can bring up with an advisor. If an advisor can elicit that support for sustainable investing by bringing it up themselves, then they are starting to forge a link between themselves and their client. It potentially can make the client a better investor themselves because it's a more meaningful set of things that they are doing with their investments, and it's all for the good. But to expect that 75%, 80% of investors are going to just proactively bring it up is probably not realistic.
Glaser: Another takeaway is more on the asset manager side in that we are seeing a lot more of mainstream asset managers be more interested in ESG investing.
Hale: It was very interesting. We saw at Principles for Responsible Investing, an organization originally U.N.-backed, started 12 years ago and now has 2,000 signatories, asset managers, and institutional investors. Their annual global conference in San Francisco last week--oversubscribed, record number of attendees. The thing you notice there was that there were so many asset managers we would consider to be conventional asset managers. One of the main sponsors was MFS, lead sponsor; PIMCO was all over the conference. What these conventional investors have done basically is, they have incorporated ESG into their investment processes. It's very interesting to see the various ways in which they are doing that. They are not necessarily relabeling strategies as ESG, outcome-oriented strategies, but they are routinely incorporating it into what they do.
Then in addition to that, they are increasingly interested in what we call impact investing. A PIMCO--Scott Mather was there on a couple of panels--really saying, here, we're over a $1 trillion asset manager; what is the overall impact of the investments that we make on some of these broader issues. The U.N. two years ago backed a series of what they call sustainable development goals that really are starting to serve as a framework for investors who want to better evaluate what the impact is on their investments. We are seeing a lot of asset managers move in that direction.
Glaser: Do you think that impact piece will eventually become bigger than thinking about ESG--environment, social, governance--into being that granular, and people will think in that bigger picture? How do you see that playing out?
Hale: I think it's another dimension of sustainable investing. One is, focusing your investment process on using ESG criteria to help you be a better investor on the one hand. But then also this idea of impact is very resonant with investors of all stripes. Because when you think about it all investments have some kind of impact. On the whole if you can orient your investments toward a more positive outcome, then not only do you have success financially with your investments, but you are actually helping literally make the world a better place. That's something we are going to see more of going forward.
Glaser: Jon, thanks for the report.
Hale: Thank you.
Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.
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