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Investing Insights: Fund Upgrades, Roth IRAs, and Allergan

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Susan Dziubinski: Hi, I'm Susan Dziubinski for Morningstar regularly re-evaluates the fund Analyst Ratings on the funds under analyst coverage. Here are three funds whose Analyst Ratings have been upgraded during the past few months. These funds are now among our Morningstar Medalists.

Miriam Sjoblom: We've recently upgraded PIMCO Dynamic Bond's Morningstar Analyst Rating to Bronze from Neutral. This fund used to be called PIMCO Unconstrained Bond, and it had a rough period from 2013 through 2015. It had four different lead managers during that period in quick succession. And when the current lead manager, Marc Seidner, came aboard, he had a pretty rough stretch in 2015 just right out of the gate. There are a few reasons driving the upgrade for the fund at this time. The first is that PIMCO, a little more than a year ago, cut fees on the fund. The fund is not exactly cheap, but it's no longer prohibitively expensive. So, that should help its chances going forward. Also, the team has stabilized quite a bit. Marc Seidner has now been the lead manager here for four years. And more importantly, Seidner has also made some key improvements to the process. This strategy has a wide latitude to invest in a lot of the bond markets' riskier sectors, which means mistakes can be costly. Seidner has been focused more on risk management and making sure that any individual bets or risk factors aren't driving the fund's returns. So, the fund has done pretty well with this more circumspect approach through a variety of markets in the last couple of years and that gives us confidence that what we saw from the fund in 2015 is going to be more of the exception than the rule. That, plus the wealth of resources at PIMCO, should help this fund be one of the better performers in the nontraditional bond category from here.

Jason Kephart: inherit; text-align: left; font-family: inherit;">To kick off the new year, AQR put a new spin on its Risk Parity Fund. The fund is now called AQR Multi-Asset, and we recently upgraded its Morningstar Analyst Rating to Bronze. The fund is still pretty balanced across risk, kind of like Risk Parity. It has a lot of exposure to equities, interest rates, and commodities, and, unlike 60-40 funds that are predominantly driven by the equity exposure, this fund should be driven equally by risks to equities, interest rates, and commodities. As a part of the makeover, AQR switched out its equity exposure from market-cap-weighted indices to its stock-selection model. And the stock-selection model is one we have high confidence in. It picks stocks based on tried and true factors like value and momentum. True, in 2018, the model did struggle when value had a really poor year, and it should struggle when factors aren't doing that well, but overall, we think it's a good long-term strategy. The fund also has its large exposures to commodities and interest rates, which make it look really different than peers and it should perform really differently. So, it could be hard to hold on to this fund if you don't know what to expect. But we think over the long term it has all the components to be a strong diversifying fund for most portfolios.

Emory Zink: Improved resources across the Capital Group American Fund's fixed-income efforts--including improved analytical tools, sharpened quantitative risk models, as well as more coordinated macroeconomic guidance across the fixed-income suite--have all strengthened the process at American Funds Short-Term Bond Fund of America. The addition of a third portfolio manager with a focus on securitized fare as well as the existing principal investment officer and a rates-focused comanager all provide extra oomph to this process. These process enhancements should assist this fund with its goal of providing ballast when markets turn volatile, and for this reason it receives a Morningstar Analyst Rating upgrade to Bronze from Neutral.


Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm joined today by Christine Benz. She is our director of personal finance. We're going to look at four lesser-known reasons that investors may want to prefer Roth IRAs.

Christine, thanks for joining me.

Christine Benz: Jeremy, it's great to be here.

Glaser: The benefits of Roth IRAs are pretty well-known. You put in aftertax dollars and those grow tax-free for your lifetime. But beyond that, there's some other attributes of the account that could be pretty attractive. What's one of the lesser-known features of these accounts?

Benz: It's well-known among people who are getting close to retirement. But one, perhaps, less well-known feature to people who are young accumulators is this idea of not having to take required distributions later in life. I hear so much from retirees where they are withdrawing most of their living expenses from traditional IRAs, which are subject to ordinary income tax, and they also represent the RMDs, required minimum distributions, represent a little bit of a loss of control over your tax picture that you had earlier on in retirement. So, being able to avoid required minimum distributions, which you are able to do with Roth IRAs, is a huge selling point in my opinion.

Glaser: The second is that there's a lot of flexibility here.

Benz: There is, and this is one of the main reasons why when I talk to young savers who aren't sure where to start saving, I often recommend a Roth IRA because you have so much flexibility in terms of those withdrawals. So, you can withdraw your contributions at any time and for any reason without any taxes or penalties. That's one reason why I recommend a Roth IRA as a good emergency fund vehicle. Even if you have the best of intentions and you plan to leave in the money in there until your retirement, you can save within the confines of a Roth IRA, presumably in something a little bit safer, and build up critical mass in safe assets before you start saving in long-term assets.

Glaser: If I go on to the IRS website, it's going to say that I have an income limit about who can contribute to a Roth IRA. But it might be a little bit less well-known that there is a way around that?

Benz: That's right. So, there are income limits on contributions to Roth IRAs. What there aren't income limits on are conversions from traditional IRA assets to Roth. And so, back in 2010, I believe, this idea of a backdoor Roth IRA contribution was born. And the basic idea is that you fund a traditional IRA, it's a nondeductible contribution, because if you earn too much to make a Roth IRA contribution, you automatically earn too much to deduct your contribution. But you make that nondeductible traditional IRA contribution and then you convert those assets to Roth assets. So, this strategy won't make sense in every situation. One profile who needs to be especially careful would be the person who has significant traditional IRA assets elsewhere apart from this little starter IRA that they are doing. So, get some tax help before embarking on a backdoor Roth IRA maneuver. But it is a way for high-income folks to get some money into an IRA and in particular into a Roth IRA.

Glaser: And Roths could be a good way to get more money into a tax-advantaged account as well?

Benz: I think this is something that's not discussed so much. But as you said, Jeremy, at the top, you are making contributions of money that has already been taxed and yet, these contribution limits are identical, whether you are doing a traditional or a Roth contribution. And so, in my mind, one of the virtues of the Roth is that if you are, say, a higher income person and you are in a position to make the full IRA contribution of $6,000 if you are under 50 or $7,000 if you are over 50, well, effectively you are putting that much more in from the get-go because you are putting in aftertax dollars.

Glaser: But the Roth isn't right for everybody?

Benz: It's not. That's a great point, Jeremy. There are profiles for whom a traditional IRA is going to be preferable. One of the key categories that I would point to would be the person who is a later career saver who thinks, well, I haven't really saved that much for retirement. It may be that my income tax bracket is higher than it will be when I'm pulling the money out in retirement. For people like that who can get a deduction on their IRA contribution, they may well be better doing the traditional deductible IRA contribution and skipping the Roth.

Glaser: Christine, thank you.

Benz: Thank you, Jeremy.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.


Kenneth Oshodi: Despite a pending manager departure, we believe that its strong team, steady process, and relatively cheap fees make T. Rowe Price High Yield a solid choice.

Following more than two decades as lead manager, Mark Vaselkiv plans to step away from day-to-day portfolio management responsibilities effective Jan. 1, 2020. With plans to take the helm following Vaselkiv's departure, Rodney Rayburn was appointed to the fund as a comanager on Jan. 14, 2019. He joined T. Rowe in 2014 and has served as portfolio manager of T. Rowe Price Credit Opportunities since July 2015. The team also includes 14 credit analysts and two associate analysts. After Vaselkiv's departure, the group plans to continue to implement the same value-driven process. It seeks bonds with compelling valuations that are issued by firms primed for a turnaround. Accordingly, many of the fund's holdings have split ratings. Non-U.S. high-yield bonds and out-of-benchmark holdings, including equities and bank loans, also figure prominently here.

The fund's long-term record is strong versus peers and owes much to deft moves by Vaselkiv. Most recently, his decision to avoid the high-yield market’s most-distressed names helped the fund to hold up better than 60% of distinct peers when high-yield fare struggled during 2018's fourth quarter. And overall, the fund's 6.6% annualized return landed among the best-performing quartile of its Morningstar cohort over the 15-year stretch ended January 2019.

This fund's overall experienced and robust team, consistent process, and affordable expenses support its Morningstar Analyst Rating of Bronze.


Michael Waterhouse: Despite looming generic competition on a few key products like Restasis, we still believe wide-moat Allergan's current stock price still reflects too much pessimism for the company's outlook. While the market is preoccupied with the upcoming launch of a new aesthetic neurotoxins in the U.S. market and the effect of the new class of CGRP monoclonal antibodies in chronic migraine on Botox's therapeutic sales, we still expect limited market share losses and pricing pressure for Botox in this high-barrier-to-entry and limited-competition market. 

Besides injection differences among products, Botox retains the most diverse set of approved indications that should help preserve high market share. These competitive issues make 2019 a transition year for Allergan, but we think the optics on the horizon are improving as Allergan advances a number of key pipeline products through late stage clinical trials, including ubrogepant and atogepant for migraine, abiciapar for macular degeneration, rapastinel for major depressive disorder, CVC for NASH, and relamorelin for gastroparesis. 

For patient, long-term investors, we think Allergan's future looks more promising than the current stock price at 8 times adjusted 2019 earnings would suggest.


Christine Benz: Hi, I'm Christine Benz for Even if you own an index fund or ETF, that doesn't mean that there's not some active decision-making going on behind the scenes. Joining me to discuss that topic is Ben Johnson. He is director of Morningstar's global ETF research.

Ben, thank you so much for being here.

Ben Johnson: Thanks for having me, Christine.

Benz: Ben, you wrote a recent piece about the evolution of indexes. Let's talk about that because I think index fund investors might not appreciate that indexes didn't start out as something to invest in.

Johnson: That's absolutely right. I think most investors when they think of indexes, they think of a means of measurement, no different really than, say, the metric system. But different from the metric system, whereby once we decided a meter is a meter and a kilogram is a kilogram and will be now and forever, indexes are living, breathing organisms. They continue to grow, they continue to evolve, and over the years they have evolved in very meaningful ways. 

At first, they were designed to be measures to try to give us a sense of where markets are going, where they have been. More recently, they have evolved into being targets. They are the underpinnings of investable funds, most notably with the launch of the first retail index mutual fund in the mid-1970s by Jack Bogle and Vanguard.

Fast forward to today, and the latest stage of their evolution has been marked by kind of a metamorphoses into, in many cases, a form of active management. Indexes have become in many instances exactly what they were originally designed to measure. These newer forms of indexes fit into the bucket that we've defined as strategic beta, what others will call smart beta or factor indexes. Indexes, I think, far from being just simple measures, have become subsequently targets and now active management in many cases.

Benz: Let's talk about how even very vanilla products actually have some active decision-making going on behind the scenes. I think the S&P 500 is a great example of that. Let's talk about how some discretion factors into how that index gets put together.

Johnson: The S&P 500 is a great example, and it's an exclusive club. There is a small group of individuals who decide who gets into that club when individuals are kicked out of that club. If you look at a recent example. whereby PG&E has been removed from the S&P 500 index, that group of individuals that is part of a committee at S&P Dow Jones indices, decides what's the next that will be voted up into that exclusive club.

Benz: And how do they look at that?

Johnson: They look at a number of different criteria. Obviously, size is important, the quality of the business is important. There are certain, sort of, more concrete measures that they can take into account. But nonetheless, there is going to be an element of discretion that will be involved in deciding which stocks get voted up to replace those as they graduate through that family of benchmarks as others are removed by virtue of bankruptcy or mergers and acquisitions activity, you name it. And it drives that sort of chain reaction, that event, that ultimately the discretion lies with a committee, a group of individuals.

Benz: That's discretion related to the construction of an index itself. But there is also discretion at the provider level, where the provider can choose which index a product tracks. Let's talk about that piece of it.

Johnson: That discretion, which is ultimately what most directly affects investors, it can be exercised, and it resides along a continuum in terms of the level of impact. We've seen index changes in recent years whereby some funds, notably, many Vanguard funds, have gone from standard versions of their target benchmarks to more expansive at the margin versions of those same target benchmarks. Generally speaking, adding small and even microcap stocks into the mix--in some cases, because those funds have grown tremendously in recent years--they need a wider berth and they can afford a wider berth because they have more money to invest in those smaller names without incurring huge amounts of costs, without taking away from what their core objective is, which is to deliver high fidelity tracking of that index.

Benz: The provider wants to track the index as closely as possible, and the way to do that is to maybe bring in some of the smaller names that heretofore not but included?

Johnson: That's right. To build a portfolio that represents the market in its broadest sense for investors. Now, that's one end of the spectrum, and that doesn't really ultimately move the needle a ton for the end investor. Now, at the other end of the continuum are some extreme examples, one of which being an ETF that had, up until fairly recently, been a Latin American real estate ETF that had a lobotomy of sorts and woke up one morning and was a marijuana ETF. So, a wholesale shift in the underlying index, the underlying strategy, you name it …

Benz: And not at all what investors necessarily were bargaining for when they bought the thing in the first place?

Johnson: Not at all what they signed up for in the place. What you see between those two extremes on the continuum are a variety of different shades, a variety of gradients where either they are outright index changes in some cases; in other cases, there might be changes to index methodologies. All of these are important for investors to understand to decide whether or not, in some cases, is this still what I signed up for originally; in other cases, how might this affect the risk, the return profile of the portfolio that I own.

Benz: Some due diligence on an ongoing basis from me as an investor is crucial. How do I stack the deck in my favor to ensure that the discretion to the extent that it's happening is on my side, that these decisions are being made with my best interest at heart, not necessarily with the provider's interest at heart?

Johnson: I think investors can protect themselves, can sleep well at night if they invest in the most broad-based, the most well-diversified, the lowest-cost index products that are out there on the marketplace. Those are the ones similar to the example I described that at the margin are growing ever larger, can expand that opportunity set that they are investing in directly for investors. By virtue of doing that because they have such a large scale are offering those portfolios at the lowest possible costs, in some cases, for next to nothing. If not, after accounting for just good portfolio management in all intents and purposes, for nothing. Those are the ones that I think at the margin are going to continue to evolve and evolve in a way that takes into account their impact on markets and evolve in a way that will be ultimately friendly to investors. Those are the ones that I think investors are best served by today and will be tomorrow and as far as we can see down the road.

Benz: Ben. Always great to get your insights. Thank you so much for being here.

Johnson: Thanks for having me.

Benz: Thanks for watching. I'm Christine Benz for