From the August 2006 issue of Research Magazine • Subscribe!

August 1, 2006

Volatility, Global Outlook Are Main Focus at Forum

(Chicago) On the heels of some significant market volatility and in anticipation of news from the Fed on interest rates, Morningstar hosted its 2006 Investment Conference June 28-30 in Chicago. Speakers highlighted global investing and long-term strategies and also shared their short-term outlook on specific stocks, sectors and economic patterns. The conference drew some 1,300 advisors and other financial professionals.

"There's been some performance chasing and associated turmoil recently," said Dan Lefkovitz, a Morningstar fund analyst and moderator. "But investors want their portfolios to reflect the global reality." And they're looking for the best global valuations, analysts say.

During the session moderated by Lefkovitz, Institutional Capital CEO and CIO Robert Lyon outlined the latest thinking behind his shop's large-cap approach. "We're attracted to growth and see opportunities for older, mainstream European firms to take advantage of via their deep, colonial roots," Lyon said. "Some [European firms] are better positioned in commodities" than rivals based in other parts of the world, he said, giving examples such as BP (BP), Total (TOT) and Rio Tinto (RTP). He also pointed to European banking giants UBS (UBS), Deutsche Bank (DB) and Credit Suisse (CSR) as being very well positioned in the global financial marketplace.

Dodge and Cox International Stock Fund portfolio manager Diana Strandberg agreed. Long-term investors should have multinational companies based outside the United States in their portfolios. And David Antonelli, CIO of non-U.S. and global equity investments for MFS Investment Management said, "There are great companies and franchises overseas."

Many overseas companies are not priced where they "should be," Lyon said, because there are not hundreds of equity analysts following them.

In terms of emerging-market conditions, Antonelli says to expect more volatility, risk and growth potential in the short- and medium-term. Long term, he maintained, returns should be "handsome," but investors should "keep an eye on valuations."

"We were drawn into the emerging markets one company at a time," Strandberg said, through share purchases of companies like Petroleo Brasileiro (PBR) and LG.Philips LCD (LPL). And Antonelli gave the example of MFS Investment's stake in Samsung Electronics. "It's not where a company is domiciled but who is in charge," he explained, adding that MFS has been targeting shares of Korean banks lately.

The mutual fund executives said they are bullish on Japan, given the dramatic restructuring efforts many companies have made there. "There's been an increased focus on improving returns," said Strandberg.

As for the recent run-up in the small-cap sector, Antonelli explained, "There are always new companies and things happening. There are always opportunities to look for." Still, he cautioned that many of these stocks are now trading at "a premium" and, hence, aren't worth the risk. Long term, he views this sector as "in uncharted territory as an asset class."

In terms of correlation, Lyon said, the divergence of U.S. and foreign stocks is on the decline. The world's different monetary authorities operate more in sync than ever, he added. With the U.S. trade deficit at record levels, Lyon described, the U.S. dollar should continue to decline -- making international returns more attractive.

When asked about whether investors should get into more emerging-market holdings or European franchises (like Nestle), the fund executives urged consideration of corporate valuations. Lyon also stressed that it's a good time to look at the banking sector in both regions.

Despite the global push by the panelists, several advisors polled by Morningstar during the conference said they see investment opportunities in the U.S. as being good or better than those overseas.

During a separate talk, Eileen Rominger -- who heads the value-equity team at Goldman Sachs -- underscored a common conference theme: expect rising volatility and look more closely at large-cap stocks, especially those with attractive valuations.

Rominger's top picks are:

o Ambac Financial (ABK)

o Cisco Systems (CSCO)

o EOG Resources (EOG)

o Motorola (MOT)

o Oracle (ORCL)

o Time Warner (TWX)

Bill Nygren, portfolio manager of the Oakmark Fund and Oakmark Select Fund, explained his investment style: closely track "fallen growth stocks." He agreed with some other speakers that today's market presents investors with "good buying opportunities," pointing to:

o Citigroup (C)

o Dell (DELL)

o Harley-Davidson (HDI)

o Hewlett-Packard (HPQ)

o Home Depot (HD)

o Kohl's Corp. (KSS)

o Texas Instruments (TXN)

o Time Warner (TWX)

o Tyco International (TYC)

o Wal-Mart Stores (WMT)

Activism on the part of fund managers, Nygren said, "can hurt management and be a disservice." If he has an issue with a company that Oakmark invests in, he'll pick up the phone, but not get confrontational.

In one of the event's livelier speeches, Pimco economist Paul McCulley gave attendees his take on the expected sources of increasing market volatility. The world economy has been in a state of "stable disequilibrium" for the past five years, thanks largely to a de facto monetary union between the U.S., China, Japan and Europe. As this pact comes to an end, the next five years should see a rise in instability.

Monetary tightening across the globe, McCulley said, will "penalize excessive risk taking." The associated "global soft landing," he said, should entail a pullback in the U.S. economy -- now heavily skewed toward over-consumption. The rest of the world would need to compensate, and that's "no sure thing."

His advice? Move out of small-cap growth and into large-cap value.

The most over-arching advice for financial advisors, though, came during the opening address given by Michael Mauboussin. The chief investment strategist of Legg Mason Capital Management spoke of the dangers of investor "short-termism," which is driven by psychology, incentives and expectations (or PIE).

While the S&P 500 had average yearly returns of 12.8 percent from 1983 to 2003, the average domestic-equity mutual fund returned about 10 percent, according to Mauboussin. Meanwhile, the average investor had returns of 6.3 percent -- because of what he termed "recency bias," a focus on short-term concerns.

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Morningstar at a Glance

Who Works with Morningstar?

185,000 financial advisors o 750 institutions o 4.9 million individuals

Who Goes to Morningtar's Conference?

1,327 people: 966 attendees o 296 exhibitors o 65 press reps

Where Do the Attendees Work?

58% are independent financial planners o 16% are independent BD reps o 9% are insurance reps o 8% are bank reps o 5% are CPAs o 3% are captive BD reps o 4% other

Who Works for Morningstar?

1,250 people in 13 countries tracking 145,000+ investment products. Includes staff with Ibbotson Associates, an asset-allocation research firm. Set to include the equity research firm Aspect Huntley of Australia with 65 employees

What's Morningstar Up To?

The Chicago-based investment research group hosting the event has trailing-12-months sales of nearly $250 million and derives about one-third of total revenue from its Advisor Workstation products and related offerings.

"We are proud to partner with the advisor community," said Morningstar Chairman and CEO Joe Monsueto. He told conference attendees that the company is adding hedge fund data to its Web-based Advisor Workstation product line, and is putting information on some 3,000 hedge funds on its website for individual investors.

Other introductions in '06 include retirement-income and suitability-management tools, along with asset-allocation research from Ibbotson Associates.

Morningstar also intends to further expand its international products and services to tap into the global independent FA marketplace, which includes some 715,000 professionals, according to Monsueto.

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