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Investing Insights: IRA Picks, Kraft Heinz, and Wells Fargo

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Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. With the April 15 deadline to fund a 2018 IRA fast approaching, many investors might be wondering what types of investments they should put inside this wrapper. I'm here with Christine Benz--she is our director of personal finance--with three ideas.

Christine, thanks for joining me.

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

Glaser: The first category of investments that are good for IRAs are high-dividend-paying stocks. Why is this?

Benz: I think investors might be a little confused by this, but dividends are currently taxed the same as long-term capital gains. You might say, well, why do you make such a big deal about putting the dividend payer inside of an IRA. The key reason is that if you own a dividend-paying company or if you own some sort of a fund that focuses on dividend-paying companies, you get those dividends year in and year out regardless of anything that you might do to try to control the receipt of those distributions. If you do like dividend-paying securities and you have room in your tax-sheltered accounts, I would prioritize them there rather than putting them in a taxable account. Taxable account is great for that plain-vanilla index fund that might happen to have some dividends. But if you are prioritizing a high-dividend-payer, I would house it inside of a tax-deferred account.

Glaser: If you were looking for a dividend fund for this year, what would be a good choice?

Benz: One that our team likes is called Schwab Dividend Equity, the ETF. The ticker is SCHD. This is a fund that is neither extremely high-dividend-focused nor focused exclusively on dividend growth, which tends to lead to a lower dividend payout. It's somewhere in between. It's a very low-cost product. We think it's a really nice option for investors who do want to receive some sort of regular income from their products.

Glaser: The second category to think about are Treasury Inflation-Protected Securities, or TIPS. Why would these be a good choice for an IRA versus other bonds?

Benz: Generally speaking, other bonds are also a good fit for an IRA. Anything that's kicking off high levels of current income in the neighborhood of 3.5%, 4%, that's a security type that you want to think about housing inside some sort of tax-sheltered accounts. TIPS, in particular, I think, are worth a look inside an IRA. For one thing, they tend to not frequently be found on 401(k) menus. This might be a slot that you have open because you are not fulfilling it through your 401(k). The other key reason relates to the taxation of TIPS. When you own a TIPS bond, you own tax on not just the coupon payout but also the inflation adjustment. TIPS are generally a security type that you want to house inside of a tax-sheltered account.

Glaser: Your third category is also in fixed income and that's those higher-yielding bonds will be more aggressive bond funds?

Benz: That's right. The interesting thing is, Jeremy, I was just doing a little prep for a presentation a couple of weeks ago, and I saw that yields have really popped up on some of the lower-quality stuff. I hadn't been paying close attention. But you don't have to stretch for a high-yield bond fund that is yielding 6% today. Same with emerging-markets bonds. We've seen yields pop up quite significantly over the past six months. To the extent that you have some of these higher-income--some of the lower-quality bond types--the yields are significant, especially these days and so, you want to make sure that to the extent that you own them, you are housing them inside a tax-deferred account.

Glaser: If you are looking for a TIPS fund or a higher-yield bond fund, what would be some of your top choices?

Benz: When it comes to TIPS, our analysts have concluded that keeping things really plain-vanilla is a good way to go. They generally find that the index products are very effective and active managers have a hard time adding value.

The funds that I recommend again and again would be Vanguard Short-Term Inflation-Protected Securities. It's one I've got in my model portfolios. Vanguard Inflation-Protected Securities--it has more interest-rate sensitivity, but it's also another good option. In terms of higher-yielding products, one fund I often recommend because it bundles together a lot of different lower-quality fixed-income types is Loomis Sayles Bond. It will hold lower-quality junk bonds. It will hold emerging-markets bonds. It sometimes holds a little bit of equity exposure. It's definitely not for the faint of heart. You'd want to have a nice long holding period for it. But that's a product I like because it keeps you from having to hold a lot of 3% or 4% or 5% positions. It lets you bundle those types together.

Glaser: Christine, thank you.

Benz: Thank you, Jeremy.

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


Eric Compton: Wide-moat-rated Wells Fargo is still trading within a 4-star range, and the bank boasts one of the top dividend yields among our coverage, at roughly 3.8%. Unfortunately, the Wells Fargo name has become synonymous with "scandal," and the bank is now in year three of "surely we will fix this soon," resulting in years of disappointments for shareholders. 

The bank does face real issues, including current and future potential impairments to its brand, which is already making it difficult to stem the loss of future business, such as from advisors or retail customers who have lost faith in the bank, and the bank will likely remain under its asset cap through the end of 2019. 

Initially, the bank had found ways to maneuver the balance sheet to make the asset cap sting as little as possible, but with those efforts already largely completed, the bank will face a higher cost from being unable to grow. The constant focus on defense has also robbed the bank of an ability to be more aggressive on offense during a time when the banking industry is arguably changing faster than ever. 

While the negatives are obvious, they are also being priced into the stock to some degree, giving investors, particularly those searching for yield, a potentially attractive opportunity.

We will highlight that Wells is still very profitable, yielding a return on average tangible equity of over 15% in the most recent quarterly results. With an inability to invest in balance sheet growth, the bank will be more focused on share repurchases and dividend growth than most of its peers. Further, with a current CET1 ratio of 11.7%, compared to an internal target of 10%, the bank also has more excess capital than most peers. The combination of the asset cap and excess capital should lead to healthy dividend and share repurchases in 2019. 

While the asset cap will eventually be lifted, we think when that does happen, and if Wells can maintain or even improve their current returns, shareholders should eventually be rewarded with share price appreciation. 

In the meantime, the bank may be able to repurchase roughly 6% of shares in 2019 and roughly 5% of shares in 2020, subject to regulatory approvals, and with the share counts declining, we forecast the bank could support dividend growth in the double-digit range over the next several years, even with limited top-line revenue growth. This should provide some cushion for shares as the bank continues to navigate the real risks and issues it faces over the next several years.


Beth Foos: Wells Fargo Intermediate Tax/AMT-Free Fund is backed by a stable, well-resourced team that's delivered solid returns. That, along with the fund's attractive fees on most of its share classes, supports a Morningstar Analyst Rating of Bronze. 

Managers Robert Miller and Lyle Fitterer have been comanaging this fund for over a decade. Miller came to Wells Fargo from American Century in 2008 and takes the lead here. Fitterer leads the firm's tax-exempt fixed-income team and also serves as the co-head of its global fixed-income platform. The two managers tap a variety of tools to build this portfolio, including moderate adjustments to duration and yield-curve positioning. While this fund's duration typically stays close to that of its index, Miller is more adventurous when it comes to credit risk. He relies on a talented group of credit analysts to uncover undervalued securities and will invest in out-of-favor sectors when he believes there's value there. For example, he generally favors midquality bonds over AAA-rated bonds prevalent in the fund's benchmark.

Investors should note, though, that although the fund's credit-sensitive style can boost returns when muni markets are strong, they can also sting when markets get rocky. That said, the team has shown restraint and seems to be willing to lighten up on credit risk when valuations aren't compelling. That approach has generated solid results over the long haul, with the fund's 10-year annualized gain topping roughly two thirds of category rivals.


While no-moat Kraft Heinz boasted its second-consecutive period of more than 2% organic sales growth in the last quarter of 2018, this was overshadowed by a rash of unfavorable headlines surrounding profit contraction, an SEC investigation into its procurement accounting, and a reduction in its quarterly dividend. Despite this, we view shares as undervalued today.

In the quarter, adjusted operating margins contracted. We do expect this pressure to persist, but we view the firm's emphasis on ratcheting up spend behind its brands and capabilities favorably. More specifically, research, development, and marketing spending at Kraft Heinz has hovered in the low-single digits of sales the past few years--lagging their peers--but we expect investments will expand this number to a mid-single-digit range annually over our 10-year forecast.

In light of profit headwinds, we intend to edge down our $60 fair value estimate by a mid-single-digit rate, but we still view shares as undervalued given the pronounced pullback the last few months.


Christine Benz: Hi, I'm Christine Benz for Investors have until April 15 to make a contribution to an IRA for the 2018 tax year and they may be mulling what to invest in. Joining me to share three exchange-traded fund ideas for an IRA is Alex Bryan, he is with Morningstar research services.

Alex, your first fund idea, your first exchange-traded fund idea is just to keep things very plain-vanilla to invest in a total stock market index fund like Vanguard Total Stock Market Index. Why do you think it's a good core pick for an IRA?

Alex Bryan: I think this is a great core pick  across the board for anyone who wants exposure to U.S. stocks. This particular fund basically owns all U.S. stocks that have decent liquidity, and it weights them based on their market value. Effectively, what this does is it replicates the composition of the U.S. market, effectively harnessing investors' collective wisdom about the relative value of each security.

Now, the market has been very difficult to beat over the very long term. There's a few reasons for that. One, it's very difficult for a lot of active managers to overcome their fees and to earn those back. This particular fund keeps fees low. It keeps fees at 4 basis points, which is $4 for every $10,000 that you invest. That's, I think, the biggest advantage. But this fund is also advantageous because it provides really strong diversification across both individual names as well as sectors. You are not putting all of your eggs in one basket here. I think that's really important, especially if you are an investor who doesn't necessarily have the view on a particular area of the market or a particular stock. This is one way that you can just buy a single fund for your entire exposure to the U.S. market and kind of be done with it.

Benz: Investors sometimes hear "Total Stock Market Index" and think, well, that's a perfect taxable holding. But you are saying it would also work well in an IRA?

Bryan: Yes, absolutely. I think there's a couple of advantages to holding this type of holding in an IRA. One, U.S. stocks right now pay dividends about 2% or so. And if you hold that in a taxable account, you are going to have to pay taxes every time you receive those dividend payments. In a tax-deferred account, you don't have to pay those taxes right away. That's one of the advantages. But more importantly, I think, it's really important to think about the diversification across asset classes. Even though stocks are generally more tax-efficient than bonds, I think it's important for investors who are saving up for retirement to have access to both asset classes, and I think this is a really good way of getting exposure to U.S. stocks.

Benz: Another fund you like is iShares Edge MSCI Minimum Volatility USA. The ticker is USMV. You like the category of minimum volatility funds in general. Let's talk about the thesis there and then this fund in particular.

Bryan: The idea behind minimum volatility strategies is that these are strategies that are designed to reduce the risk of investing in stocks. Now, they still have stocklike risk. They are definitely riskier than bonds are. If the stock market is down, these will also likely lose money. But the idea is that these are designed to provide a smoother ride, so deliver lower volatility than the overall market, provide better downside protection. If the market is down 10%, hopefully, these will be down something less than that, maybe like 7% or 8%. You give up a little bit on the upside. During a strong market rally, these types of funds will tend to lag a bit. But if you are risk-averse and you are OK with that trade-off, I think these are really attractive strategies. They have tended to provide better risk-adjusted performance over the long term. Even though you give up some on the upside, the downside protection more than offsets that. Over the very long term, these types of strategies have provided marketlike returns with lower risk, and I think that's a pretty attractive trade-off that will likely continue going forward.

Benz: You can buy different flavors of these minimum volatility funds. One is like a foreign stock ETF that would target that particular subuniverse?

Brian: That's right. There's various iterations of this strategy, but there is an international version of this. The ticker is EFAV, the iShares Edge MSCI EAFE Minimum Volatility Fund. But this fund, the U.S. version of it, the way that this works is it basically starts with all stocks that are listed in the MSCI USA index and then it uses a pretty complicated algorithm to try to construct the least volatile portfolio possible looking at two things: one, the volatility of individual stocks, and two, the correlations across the stocks. It's trying to not necessarily own the least volatile stocks, but it's looking at stocks that in combination will provide the lowest overall volatility. It's looking at diversification as well as the individual defensive characteristics of each stock. 

I think that's an important thing for a core holding because it's not going to load up on just utilities or just consumer defensive stocks. It's still going to own some tech stocks, still going to own some energy stocks. In fact, it actually anchors its sector weightings to that of the broader market, limits itself to within 5%. So, you get a pretty well-diversified portfolio here. But I think this is a portfolio that will provide better downside protection than the overall market, and I think that's really attractive for more risk-averse investors.

Benz: Another fund that is a really interesting idea is Vanguard High Dividend Yield. The ticker is VYM. It's Silver-rated, it's a large-cap value fund. Let's talk about the thesis for holding dividend-payers inside of an IRA, because I think some investors might look at that and say, well, dividends are taxed just like long-term capital gains. So, why should I house a dividend-focused fund inside of an IRA. Let's talk about that to start.

Bryan: When a company pays the dividend, that creates an immediate taxable event. You have to pay taxes on that when you receive the money from …

Benz: If you hold it in a taxable account?

Bryan: If you hold it in a taxable account. So, the benefit of holding this in an IRA or a tax-sheltered account is that you get to defer those taxes, and that allows you to keep more of your money to earn a higher rate of return before you ultimately pay those taxes. I think that's a really attractive place to hold income-producing securities, whether it's bonds or dividend-paying stocks. IRAs are particularly attractive for that. 

More broadly, aside from the tax considerations, I think there's a lot to like about dividend-paying companies. One, dividends impose discipline on managers. It prevents them from hoarding cash and makes it harder for them to invest in low-return pet projects and things like that. But also dividends allow investors the fortitude to stay invested through the markets' rough patches. A lot of these companies tend to have a bit more stable cash flows than nondividend-payers out there. Yes, during market downturns, these stocks will go down, but you will still be able to collect the dividend payments. For a lot of investors, that can give them the fortitude to stick with these investments through thick and thin, and it can be easier than holding nondividend-payers.

Benz: A thoughtful group of funds. Thank you so much for being here to discuss them with us.

Bryan: Thank you for having me.

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


Jaime Katz: Wide-moat companies Home Depot and Lowe's both reported their fourth-quarter results this week, delivering same-store sales that were a bit lighter than we had forecast, spoiled by a wet winter and a difficult comparison to 2017's hurricane season. 

However, the outlook for the year ahead, with Home Depot calling for 5% and Lowe's predicting 3% same-store sales growth in 2019 implies the slowing improvement of the housing market hasn't hindered the ability for the market leaders to grow their top lines. 

With housing turnover slowing as lower-priced homes remain scarce and interest rates remain off their lows, there are some caution signs for these businesses. However, still rising home prices and the aging housing stock are mitigating factors that continue to help offset these headwinds.

At this time we view both Home Depot and Lowe's shares as fairly valued. We have slower growth embedded in both models ahead, given where we are in the current economic cycle are the market share gains the businesses have already captured. Our $170 fair value on Home Depot is contingent on 3.5% sales growth and 20 basis points of operating margin expansion, on average, while our $98 fair value at Lowe's incorporates 2.5% sales increases and 20 basis points of operating margin improvement annually. We expect both companies to maintain their market leadership positions and generate solid ROICs, supporting our wide moat ratings.