Speaker of the Month: Don Phillips

The conscience of Morningstar tells why the June M

Morningstar, Inc., will hold its 15th Investment Conference in Chicago on June 25-27. Don Phillips, managing director of Morningstar and the inventor of the company's style box system, will kick off the annual event with a preconference practice management session on June 25 titled "The Next Step in Holdings-Based Analysis." Among the mutual fund industry luminaries scheduled to appear are John P. Calamos of Calamos Investments, Jean-Marie Eveillard of First Eagle Funds, Ralph Wanger of Liberty Wanger Asset Management, Mario Gabelli of Gabelli Asset Management, and Marty Whitman of Third Avenue Management. Phillips spoke about the conference and the challenges that face advisors today.

How's the conference shaping up?

Very nicely. Last year attendance was actually up over the year before, which is amazing in this market when so many conferences are dropping out.

It's been great to see the conference grow; this is the 15th one we've done. The first time we had maybe 70-75 people show up, but everyone who did was incredibly supportive, telling us we had to keep doing this.

Our conference, unlike the ICI conference, which for years preceded ours by a week or so [though not this year; ICI was held May 21-23], was all about the investing side of the [mutual fund] equation, not the operations side. It's geared around financial advisors, and the people who want to talk about investing. As analysts at Morningstar, you have a phenomenal job: You get on the phone and pick the brains of some of the best investment people in the world. We thought the conference would be a good way to share this with more people: Get some of the best fund managers and advisors who have clients and thus have real-world questions, and bring these parties together.

And the presenters are not just from one fund company or family, which happens at many conferences.

We've made a real move over the years to get away from being very scripted. Early on, we let managers give canned presentations, which at first went over relatively well. But as advisors saw more of them, we started getting weaker and weaker marks from attendees for those managers who simply got up and said "Here's the historical price range for growth stocks versus value stocks, and this shows you why this is exactly the right time to buy my fund" And of course the next manager would have a slide to prove the exact opposite. Over time, those managers who had really slick sales presentations got poor marks from the audience, and those who spoke from the heart, who were more candid and forthcoming, got high marks. So we got rid of the canned presentations, and we give the Morningstar analysts more of a role in the moderation: You cut to the chase and get down to a real discussion of investments, not just a sales presentation. And the audience really appreciates it.

That's why somebody like Marty Whitman (of Third Avenue Value Fund fame) would fit right in?

Marty couldn't give a slick sales presentation to save his life. [He's much more likely to say]: "This stock's a dog, and people who are buying this are nuts."

One thing I learned early on, when I started calling up fund managers, is that there are very few absolute truths in this business. I used to think that they were out there, that if you just figured out who the smart people were, then they'd know all the right things.

At Fidelity, for instance, they'd say the real key is having one manager for one fund, so there's real accountability. And you'd say, "Yes, that's absolutely the right way to manage money." Then you'd talk to American Funds, and they'd say, "No, we believe in this team concept and multiple portfolio counselors." And you'd think again, "Yes, that's the right way to do it." But there isn't one right way to do it; there are ways that work for certain organizations and there are certain styles that work in some places that don't in others.

And that's the interesting thing about the conference, that you'll hear very different things from different people. I remember a few years ago we had David Dreman [of Forbes and Dreman Value Management] speak about AOL. He said the stock is so ridiculously overpriced [because] it assumes that everyone on this planet will subscribe to AOL as well as all the people on other planets yet to be discovered. Later that day we had Bill Miller of Legg Mason doing a "Stocks 501" session where he was walking through [the process of] why you own a certain stock and how it illustrates your investment process, and he had chosen--weeks in advance--AOL to be the stock he'd walk you through and why it was a compelling buy.

It's that kind of debate that makes for markets, and what makes this business so interesting. The conference has become a nice way to showcase that, and to let advisors debate on the matters, not just sit through canned presentations, and to hear a lot of managers at once to get that perspective.

What about advisors, what do you think the challenges are for them these days? For example, some recent surveys we've reported on, including our own--see http://www.investmentadvisor.com/sub_id_sector2/iamag_article.asp?mid=1631 and http://www.investmentadvisor.com/sub_id_sector2/iamag_article.asp?mid=1624 or www.advisorproducts.com/iasurvey/--seem to indicate that there's a broader interest among advisors in exploring alternatives to traditional mutual funds, bonds, and equities. Do you agree?

Sure, you can see why advisors are grappling with that. If they've got a client who needs a 9% [return] a year, and they've got a plan that's based on compounding money at that amount, and an intelligent advisor looks at the equity market and says, "I might expect to get 7% from equities and 4% from bonds, so how do I divide money into these two piles and hope to get 9%?" It's natural that they're looking for alternative asset classes. But a lot of them are very hesitant to get into an untested vehicle, and there's an awful lot that they like about mutual funds. For many advisors, mutual funds replaced limited partnerships. They feel that with mutual funds, they get a fair shake. Morningstar's played a role in that, but we're only one of many factors. The mutual fund industry operates on a clean, well-lit playing field. You couldn't say that about limited partnerships in the 1970s and you can't say that about hedge funds today. That's a real concern advisors have. "I'd like to learn more about these, I'm interested in bringing something into my client's portfolios that's not correlated with these other asset classes and has the potential for higher returns, but I'm hesitant to do so if it means getting into territory where I can't convince myself, or my client, that I'm doing my level best to protect their interest."

So advisors look at hedge funds and say: "What are the things that I know for certain? A) I know I'll pay more; B) I'll be asked to make a decision based on less independent information, I won't be able to open up a newspaper every day and find out what the price of the hedge fund the way I can with a mutual fund; and C) I'll have less liquidity. If something goes wrong, I may have to wait until the end of the quarter, or the end of the year, to be able to move monies out of the hedge fund.

I think there are some operational concerns, but advisors are inquisitive people and it makes sense they'd look at these things. There's also competitive pressure to add things like separately managed accounts or alternative assets simply because so many advisors have seen their practices grow so they're now serving very affluent clients. Their competition is no longer the financial planner down the street, or even the wirehouses. It's increasingly something like U.S. Trust or Northern Trust.

Some advisors say retail funds are not priced appropriately for them, that if you're an individual investor who's buying a mutual fund with a 1% to 1.5% expense ratio through Schwab, that's a fairly good deal and you can put together a very diverse portfolio with moderate cost. But if an advisor is doing that and then adding 1%, meaning there's now a 2% to 2.5% embedded cost for their clients, and they're competing against Northern Trust in the institutional arena where a 1% all-inclusive fee is more the standard, then there are real issues. The nature of the competition has changed considerably over the last decade for advisors.

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