Investing Insights: Tips for Sustainable Investing and Inflation Protection

please stay tuned for important disclosure information at the conclusion of this episode welcome to the investing insights podcast from morningstar in this week's podcast david blanchett helps retirees prepare their portfolios for inflation christine benz walks us through the ins and outs of building a sustainable portfolio jason kephart fills us in on a relatively new area of research and ben johnson shares his findings from the semi-annual active passive barometer report let's get started here are david blanchett from morningstar investment management and christine benz from morningstar inc hi i'm christine benz for morningstar low inflation has provided an invisible helping hand to retirees over the past decade but should retirees be on their guard for higher prices joining me to discuss the role of inflation in retirement planning is david blanchett he's head of retirement research for morningstar david thank you so much for being here excitedly david let's start with a broad question how does inflation affect retirees and why is it potentially even more worrisome for retirees than it is for the broad population so and you know inflation is is an interesting consideration right if you actually look at retiree fears you know inflation risk is actually up there with like health care and not living their resources and you know to some extent you know i think inflation risk is is somewhat overblown for retirees and i'll i'll explain why um you know retirees almost every retiree out there gets social security and that's that's indexed to inflation and most retiree spinning actually tends to decline with inflation over time but the one kind of you know great unknown is health care expenses those are the one piece of spending that tend to rise over time there's actually different definitions of inflation there's the cpiu the cpiw the cpie and when those are built using different what are called consumption baskets so what does the average person spend money on and the the older version of um inflation the cpie um it tenant arise by more than base inflation because of health care expenses so i don't really worry as much about the other pieces of inflation as i do health care i'm thinking about you know the impact possible of inflation for retirees okay we'll want to touch on another aspect of that um cpi calculation the role of housing if you look at the cpi for the elderly as well as the cpiu housing is a big chunk of it like close to 50 for the cpie but some retirees might say well i own my home so i am not really subject to inflation in that category how should retirees think about that so here's so it's really interesting you know for those of you out there that love to look at data um you can go to the the bureau of labor statistics website you can actually get like very detailed information on retirement expenditures and it's it's totally true that that you know you know by age 90 a lot of folks own their home and people are often like well why why do these older people that own their homes spend more on housing it's because they're not mowing their yards anymore and so what happens actually it's it's interesting effect where um the older that you are as as housing the less you're going to be spending on on um mortgage payments the more you're going to be spending on things like maintenance that that you just can't do yourself now to your point though housing you know to some extent does become less of an issue if you own your home but it's all the things that are involved in in in you know operating a house that older americans become less and less likely to be able to do themselves okay and not to get too in the in the weeds but how does it handle the fact that someone might be living in some sort of an assisted living facility where costs can run really high and be a big portion or maybe all of someone's expenses well and and in that instance you could actually have like the double whammy you could be paying for a house and being paying for health care so like that would be usually under under health care expenses and the one thing that you know i don't really love a lot of the research that talks about like health care is gonna cost you like four hundred thousand dollars or what you know you got to say because that's actually not like the the the unknown expenses right like like the shock that people incur when it comes to health care is really that that that nursing home care stay and i mean to be honest that isn't a big expenditure for most households the problem is it is significant for some and it's just so hard to plan for so um you know housing housing as is like normal housing isn't necessarily a big concern my kind of you know the thing that i really can't answer at all is is how do you plan for that kind of end-of-life you know nursing home care stay and and you know the answer could be well david buy long-term care insurance well a lot of folks that want it can't get it it's very expensive and so i just don't know what the best answer to that question is yeah and that's kind of a detour from our main topic on inflation getting back to inflation if someone is thinking about their retirement plan perhaps they haven't yet embarked on retirement and they're trying to figure out what is a reasonable inflation assumption that i should incorporate into my plan how should retirees think about that because inflation has been really low over the past decade i guess the question is will that carry forward and we really don't know right we and so historically in the u.s the average inflation rate has been like three percent um now to be fair that includes like the 80s when interest rates were like 12 to 15 percent so like it you know right now a great estimate of inflation would be like like the cleveland federal reserve like has an estimate to say hey what do we expect inflation to be for the next say 10 years and it's usually you know two percent-ish or less um one really important kind of thing to be aware of though and and i've researched this and others have as well is that retiree spending does not tend to increase by inflation every year so i think it's important to incorporate potentially an inflation estimate in a projection the issue is that you know solution cream of its already already indexed to inflation those will rise with inflation every year and for a lot of retirees that's about the only increase that they need and so you know one concern that i have is that is that you know if you assume that that retiree spending increases every year by inflation say two percent a year that's actually not going to capture what the average retiree does in terms of increases in spending um throughout retirement okay switching over to the portfolio if i'm building a retirement portfolio and i want to ensure that it helps defend against inflation over time what are the key categories that i want to think about incorporating into that portfolio so you know it's not it's not an investment but social security retirement benefits would be an excellent hedge because they're they're linked to inflation right and they're a very good deal in terms of the cost of the quote-unquote guaranteed income um the other most obvious asset is any kind of government bond that's explicitly linked to inflation these are called tips um the problem is is that the yields on these are are pretty pretty atrocious right now it's they're negative it's like a negative you know 0.6 ish percent return and so i think that you know like that's one possibility you know others are you know what people would call like real assets like you know real estate or possibly commodities the problem is is that while these can be a decent hedge for inflation they're not great so once you kind of move away from investments that are directly linked to inflation like social security or tips um it becomes of a lot more loose relationship equities though potentially at least out earn inflation well so that so yeah that's a great point so equities have equities aren't really a great inflation hedge but to your point equities have done a great job beating inflation historically so i wouldn't i wouldn't necessarily describe equities as an inflation hedge but i would describe them as a way to say hey equities have done a fantastic job historically of beating inflation when inflation's higher that would be one way to say hey i'm worried about inflation equities would be one way to kind of say i'm going to you know minimize the risk of inflation on a portfolio okay david super helpful discussion thank you so much for being here sure thing thanks for watching i'm christine benz for morningstar expand your investing horizons and look to the long term with morningstar's podcast the longview join hosts christine benz and jeff patak as they talk to influential leaders in investing advice and personal finance search for and subscribe to the longview today [Music] now christine benz discusses esg portfolio tips with susan jabinski from morningstar inc hi i'm susan jabinski with morningstar interest in mutual funds and etfs that focus on environmental social and governance issues has exploded and so have the choices joining me today to talk about the things you should keep in mind as you're building an esg portfolio is christine benz christine's morningstar's director of personal finance hi christine thanks for joining us today hi susan it's great to be here so let's start off by talking about the esg model portfolios that you've built on morningstar.com how many of them are there and how are they different from each other well there are 12 all together and there are six what we call bucket portfolios those are geared toward people who are in retirement so who are actively drawing upon their portfolios within those bucket portfolios we have three etf exchange traded fund portfolios and three mutual fund portfolios and then there are six portfolios that are geared for toward people who are still in the accumulation phase of their retirement careers so they're saving for retirement and there again we have three etf portfolios and three mutual fund portfolios but the basic idea was to showcase what we think are sound asset allocation structures for portfolios as well as some of our favorite esg funds and etfs now if an investor does want to assemble a portfolio of esg focused mutual funds and etfs what's the first step i think the first step is just thinking about how deeply you want to get into this so for some investors it might be as simple as just adding one esg fund kind of dipping a toe into the esg landscape for other investors they might look at this and say this is a an idea that i really want to embrace wholeheartedly i would like all of my holdings or as closely as as closely to that as i can get to be esg funds um so do some soul searching around that there's no one right answer and you may be limited if for example most of your assets are within your 401k plan and there is no esg fund well then you're limited in terms of how esge your portfolio can get you may have to do your esg investing through an ira so just give a little bit of thought to that i see that as the starting point and then you also say that before building a portfolio of esg funds or etfs you should think about the type of esg focus that you're really interested in talk a little bit about that right you know it's interesting this landscape has evolved so rapidly susan where 20 years ago the esg landscape was mainly made up of funds that excluded various industries whether energy companies or gun makers or you know alcohol companies whatever it might be now we have just a really broad gradation of esg fun types and i would rate them as on kind of a spectrum where you have some that are what i would call sort of esg light where they're looking to own very broad sector diversification they're looking to behave a lot like the broad market except excluding some of the more objectionable sorts of companies and then on the other end of the spectrum you would have companies that are much more esg forward where that is front and center in their process and it very much affects the makeup of the portfolio where the portfolio might have more significant tracking error relative to the broad market in exchange for a heavier esg emphasis a more pure esg emphasis so give some thought to where you want to land on the spectrum are you okay with owning sort of the companies that are in every industry but are the least objectionable companies in those industries or are you looking for more of a pure esg portfolio and there are holdings that you can use with either approach now a key consideration when building any portfolio esg or otherwise is to take into account your goal and then matching that an asset allocation that's appropriate for that goal how does an investor do that right and this is not an esg part of the process this would correspond or would relate to anyone who is building any type of portfolio but i think that that's the main way to think about how to put together a portfolio is thinking about your proximity to spending that money for whatever goal that you're saving for so obviously if you are saving for goals that are close at hand you want to have more safe investments in that portfolio and you'd want to gradually tip into safer investments as that goal date draws near if you are a 30 year old saving for retirement well obviously you have a lot more room to tolerate fluctuations in the portfolio you want a more aggressive asset mix most likely because you want to try to reach for the highest return potential that you can get so i think that that's a key starting point when investors are thinking about building a portfolio composed of esg funds or any type of funds think about your time horizon and that in turn can inform how much safety you need in that portfolio and christine the the esg landscape has really exploded in the past several years as as you pointed out earlier are there still pockets of the market where there maybe aren't great esg options there are potentially a few susan but there has been such a rapid rollout of products in this space that really it's possible to cover the major asset classes with very good quality esg funds so within fixed income within international equity obviously u.s equity for u.s investors that's where you will find the most choices today and you'll be able to really pick and choose we talked about that gradation you'll have a lot of latitude to choose the right type of product for you there are some types of funds though that you will not find an esg representative of so for example metals commodities you probably wouldn't expect to see esg choices there and indeed there aren't but i would say for the most part where people cannot find esg choices those are niche categories that you wouldn't want to use in any sort of size within a portfolio in any case well christine sounds like there's a lot of good news out there for esg investors and for those looking to dip a toe in esg waters for the first time lots of choices thank you for your time today christine we appreciate it thank you so much susan i'm susan jabinski with morningstar thank you for tuning in six days a week we deliver the latest news for investors just say alexa enable the morningstar skill or visit morningstar.com alexa next we have jason kephart from morningstar research services and tom lorisella for morningstar inc welcome i'm tom lauricella editor for professional audiences at morningstar and i'm speaking today with jason kephart strategist at morningstar about our model portfolio research jason thanks for being here today thanks for having me so let's start with an overview of model portfolio research this is a relatively new area morningstar it's a relatively new area in its current form for the industry for advisors so as just a starting point how does our research and how does the process for model portfolio research compare or contrast with traditional mutual fund research yeah that's a great question so the vehicle the model portfolio is a little bit new but for the most part we're evaluating the same with them the same way we would evaluate any asset allocation mutual fund or target date fund we're looking for things like the quality of the underlying investments looking at how well they fit together the portfolio construction part is really important to us and we're also looking at if the managers are trying to add any tactical trades over time you know what that process is and if we're confident it could add value over time now there is one really big difference between model portfolios and mutual funds which is that we don't have actual performance numbers for these right these these are hypothetical essentially right um based on the strategies that the that the asset managers lay out we don't have real actual day-to-day performance numbers based on a portfolio the way we do with the mutual fund what sort of challenges does that present for advisors trying to assess which strategies have been doing well or not doing well yeah i think it creates an extra layer of due diligence for the advisor or anyone trying to research model portfolios i think you really want to get comfortable with whether or not the returns that are reported match up to what the portfolios reported are if you see a long string of returns without portfolios to kind of match them up to i would treat that as kind of a bit of a yellow flag and be you know wouldn't put too much weight on that performance track record um you can still evaluate like the um you know the quality the underlying and how well they fit together but i think in terms of evaluating past performance you really have to have that portfolio along with the returns to make sure that they're within reason and they're not just really out of whack because obviously you know there's always the chance that you know someone could have you know be reporting back tested returns that might not be really realistic going forward so you want to really be comfortable with when that you know track record really began and you could really do that with portfolios and there's another element here which is that ultimately the returns that a client gets is based on the advisors how the advisor actually puts these strategies to work how they actually implement them in terms of trading and decision making right yes so that's kind of the key difference i guess between a model portfolio and a mutual fund in the model portfolio an asset manager or an etf strategist is giving you recommended underlying funds recommended at recommended asset allocations and recommended trades but it's on the advisor to either do those trades themselves or find some kind of technology to help them like an auto rebalancer um the yeah the asset manager is not going to be doing the trading for the advisors and that's kind of kind of the key differentiator that the advisors at the end of the day retaining discretion over the underlying funds as we were speaking earlier before we did this interview you were mentioning that another aspect of this is that perhaps if an asset manager was implementing these some of these strategies in-house they might use more sophisticated vehicles to implement them derivatives other other aspects of it that that that might uh translate into some different kinds of performance or different characteristics can you just talk through that a little bit yeah so in model portfolios i think one of the goals asset managers have is to make them kind of simple and straightforward and easy for an advisor to manage given that the advisor is the one that's to implement them so you know it whereas uh like t rail price is a good example in their asset allocation mutual funds which are managed by the same team that oversees their asset allocation models you know they have a much broader line of underlying funds it's around 14 or 15 they also use derivatives like equity futures or interest rate swaps to kind of alter the portfolio's exposures but in the models they did they're obviously not going to tell an advisor to go buy out and buy an s p 500 future so they're kind of have a more slimmed down lineup it's like more like eight funds so it's more manageable but then the tactical tilts like if they like emerging market equities you have to overweight the emerging market equity fund rather than just using a derivative to kind of get that exposure in a quicker faster way but that's kind of it's kind of one of the trade-offs with um having the advisor be the one that retains the ultimate discretion sure so let's talk about uh how this translates into some ratings for different managers so we'll start with two of our gold rated model portfolios let's start off with uh vanguard they're the most simple ones out there right yeah simple and very cheap the expense ratio for the vanguard core models that we rate gold range from about four to eight basis points and for that low cost you're getting broad exposure to global stocks and bonds in a very reasonably put together portfolio um the stocks and bonds tend to complement complement each other very well um they're very high quality bonds so when equity markets don't do well the bonds provide a very reliable ballast so we think it'll give investors a very smooth ride over time um and given that they're just so cheap it's just hard to hard to find a real uh deficiency in them you know they're probably never going to be the optimal portfolio but they're always going to be a very good starting point and should be very durable over the long haul and another gold rated uh set of strategies comes from blackrock uh they're kind of the opposite end of the spectrum right yeah they're a bit more active they're still using um low-cost etfs but uh rather than just trying to get you broad exposure they're being a bit more thoughtful about it they take more granular views they'll make sector overweights in the beginning of 2020 we saw them add esg as a strategic weight to the portfolios and they're not trying to make the whole portfolio as esg intentional but they just saw an opportunity there to kind of diversify the portfolio by adding companies that have lower esg related risks um think like less energy less oil sensitivity so they're they added them to the portfolio um for those reasons and i think they just like they just take a bit more thoughtful approach to building each portfolio on its own you know we see in a lot of firms is they'll take one portfolio make a 60 40 fund this scale it up or down blackrock's actually going um you know they're actually looking at the conservative portfolio and building a portfolio that makes the most sense for that and they're doing it for the moderate they're doing it for the aggressive so i think it's just uh you know we really appreciate the thoughtfulness that goes into it we think they're gonna serve investors well too great and then one more uh set of portfolios to talk about it's american funds we rate them as silver um what do we like about them yeah american funds kind of falls in the middle in a sense between the vanguard and blackrock models um they are using active funds but they're not doing a lot of tweaking at the uh top at the top down level they're not going to tell you to like overweight american funds growth of america this month or american funds new world this month but there are a lot of there's a lot of activity going on underneath the funds so you are going to get some tactical tilts um through the portfolios but they're going to be driven by the underlying managers which we think makes a lot of sense and it also makes a lot easier to use for an advisor because you're getting a lot of active exposures but the advisor really doesn't have to be too active themselves to get the benefit of that fantastic we look forward to more research on this base jason thanks very much for being here today thanks for having me and lastly ben johnson from morningstar research services tells susan jabinski how active funds fared in 2020 hi i'm susan jabinski with morningstar morningstar recently published its semi-annual active passive barometer report so how did the performance of active funds stack up against the pat their passive counterparts in the volatile year that was 2020. joining me today to discuss key takeaways from the report is ben johnson ben is morningstar's director of global etf research hi ben thanks for being here today hi susan thanks for having me so let's start out broadly how in general did active funds performance stack up relative to the performance of passive investments well what we saw in 2020 susan was that at year's end just shy of half so 49 of the 3 500 or so actively managed funds that we include in our analysis managed to both survive and outperform the average of their passive peers during the 2020 calendar year now that's what we would define as success in the context of this report surviving over a given period and outperforming that that average peer which which is our index which is about a coin flip and is about what you would expect all else equal over a long period of time from actively managed funds that half would probably outperform half would underperform you know why this is is a bit eye-opening is that for a long period of time there's been this prevailing narrative that in conditions such as those that we experienced in the markets in 2020 active managers might actually do markedly better than their indexed peers which are destined to just mirror the markets and have no real ability by definition to either outer underperform the markets so what was notable about the fact that just 49 of them managed to outperform their average peer was that they were given the opportunity to to do much better in what was an unprecedented market environment in in many of our lifetimes and now to be fair it was also unprecedented because the violence the the speed at which markets drew down and then subsequently recovered was also unprecedented even famous investors like warren buffett lamented the fact that they simply couldn't move quickly enough that the opportunities weren't present for long enough uh for them to really be able to exploit them which speaks to the fact that we saw another sort of intervention without precedent which was the speed and sort of magnitude with which the federal reserve intervened to backstop markets to support them to help right the ship when it was down in you know going down in a big way in a fast way uh in the first quarter of 2020. so what what is this performance saying sort of in general about how actively managed funds really do handle market volatility relative to passive investments well i think what it says is that there's really only so much that managers can do in in how their portfolios respond how they respond to market volatility depends in in large part upon their strategy and what i would say in what we've seen now for the years that we've been publishing this report is that success rates among active funds over the very short term and i include not just the one year look back in the short term but even in some cases three and five years are very noisy i think they say more about the tendencies of of active managers about some of the biases in the indexes that underpin their passive peers then they contain any like real useful signal any real useful information for investors where the signal kicks in is over longer look back periods looking back 10 and 15 and 20 years and that's where some of the more useful information that we've been able uh to to divine to suss out from this analysis over the years uh starts to ring through all of that noise that we see over shorter time frames so in 2020 were there any particular parts of the equity market where actively managed funds were able to outperform well what was notable in in 2020 was that despite the fact that value stocks had a terrible horrible no good bad year the morningstar us value index was down 2 in 2020 the morningstar u.s growth index was up over 44 so what we saw actually which might be counter-intuitive for some was that success rates among actively managed value funds across the large mid and small cap value morningstar categories actually spiked materially higher 14 percentage point uh increase in success rates among those funds versus 2019 and what that speaks to and first is some of the noise that i mentioned before and and also uh speaks to kind of the influence of something that's called duns law which is a concept that argues that when a particular strategy either performs quite well or quite poorly actively managed funds active managers that adhere to that particular strategy that fit in that particular style box are either going to have a difficult time keeping up when that strategy performs well or going to do relatively well as we saw with value last year when it performs poorly that's because the indexes that represent value stocks or growth stocks or all stocks they're the purest expression of that strategy and what we see is that most managers aren't necessarily that style pure they tend to color outside the lines so a large cap value manager might own some mid cap stocks they might own some small stocks they might own some blend stocks and they might even own some growth stocks so when value does really badly as it did last year it actually lowers the bar for managers in that space and we've seen actually the flip side has been true for managers in growth categories growth is a style obviously has been performing tremendously well over recent years and that's really squeezed success rates across the board when you think about that right hand column of the morningstar style box which is the neighborhood of large mid and small growth managers let's pivot over to fixed income are there you know certain bond categories where perhaps active management was able to do a little bit better last year than passive yeah so i think the last year in even over the longer term what we've seen is that across the fixed income categories that we include in our analysis which are three they include the intermediate core bond category the corporate bond category and the high yield bond category success rates amongst active bond portfolio managers have actually been systematically higher than what we've seen among stock pickers and that speaks to a number of different factors i think one of the factors in play there is that the indexes are inherently encumbered in those cases the indexes that underpin passive funds mutual funds and etfs relative to their active peers so they have a very strict definition of what they can invest in this bonds that they select for their indexed portfolios and how they weight them so taking uh for example the bloomberg barclays aggregate bond index which underpins most of the largest bond index funds that by definition is limited to investing in bonds that are of investment grade credit ratings now what we've seen over the years is that many active bond managers are able to add value by either overweighting um you know lower uh lower rated investment grade corporate bonds or other investment grade rated credits or crossing the line a bit and dabbling in some high yield bonds which over longer periods of time is has helped them to generate excess returns relative to they're more limited they're more constricted passive peers so especially if you're to focus in those fixed income categories on the least costly funds what we've seen is that success rates among those active managers have been materially higher than what we tended to see in the u.s stock space now over the long term you know across the categories that we've looked at and studied we have found that in most categories passive funds do have a pretty significant performance edge over actively managed counterparts so what should investors take away from that well i think going back to what i was alluding to earlier susan some of the key signals that we see in that longer term data is first and foremost one of the biggest factors that causes active funds to fail is that they fail to survive and they fail to survive oftentimes because they fail to outperform either their indexes or a relevant benchmark so survivorship is is a big factor in long-term success rates for active funds as well as many passive funds there are certain categories where any number of index funds have come and gone over the years as well so survivorship isn't a uniquely uh active fund story it applies to index strategies as well the other signal that comes through loud and clear and should be no surprise to many investors is that costs matter what we see is that long-term success rates among the least costly funds in any given morningstar category tend to be higher than the category at large and tend to be markedly higher than success rates among the most expensive funds in those same morningstar categories so focusing on fees is critical the other signal that is is really clear as i mentioned before with fixed income strategies is that investors should pick their spots there are certain areas of the market that are just inherently more difficult for active managers to add value in and the us stock market has been the most prominent among those but if you move outside of u.s stocks into either bonds or certainly in to foreign stock markets what we've seen is that stock pickers in foreign stock markets and categories like the foreign large blend category diversified emerging markets have had also systematically and materially higher success rates relative to their peers and what we've also seen because we include the measurements of equal and asset weighted returns in our analysis is that in some cases especially in foreign stock markets investors have done better as measured by their asset weighted returns in funds in those groups than they have with index funds so you know all is not lost for active managers i think by focusing on fees and picking their spots and investors can be very well served uh by discretionary portfolio managers across any number of different categories well ben thank you so much for your time today and for the update and we will check back in with you in six months um after morningstar updates this report um for the second time this year we appreciate your time well i'm looking forward to it and thank you for having me susan i'm susan jabinski with morningstar thanks for tuning in that does it for this week's investing insights podcast for morningstar we hope you have enjoyed our program and we welcome your feedback please send your comments and questions to podcast morningstar.com from everyone here at morningstar thanks for listening this recording is for informational purposes only and should not be considered investment advice opinions expressed are as of the date of recording such opinions are subject to change the views and opinions of guests on this program are not necessarily those of morningstar inc and its affiliates morningstar and its affiliates are not affiliated with this guest or his or her business affiliates unless otherwise stated morningstar does not guarantee the accuracy or the completeness of the data presented herein the podcast is for informational purposes only and should not be considered tax advice please consult a tax and or financial professional for advice specific to your individual circumstances morningstar research services llc is a subsidiary of morningstar inc and is registered with and governed by the u.s securities and exchange commission morningstar research services shall not be responsible for any trading decisions damages or other losses resulting from or related to the information data 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Channel: Morningstar, Inc.

Views: 2,718

Rating: 5 out of 5

Keywords: morningstar, investing, stocks, funds, etfs

Id: yHK2GLDAn0Q

Length: 36min 58sec (2218 seconds)

Published: Fri Apr 23 2021