Morningstar Files to Launch Its Own Mutual Funds for Advisors

The subadvised funds will replace current third-party funds comprising Morningstar Managed Portfolios

Workers at a Morningstar conference. Workers at a Morningstar conference.

Morningstar has filed with the Securities and Exchange Commission to launch its own its open-end investment company known as Morningstar Funds Trust, which will consist initially of nine subadvised mutual funds that will be available for financial advisors only, not for the retail public, through Morningstar Managed Portfolios.

The new funds will replace third-party funds currently held in Managed Portfolios, but still use use outside fund managers, known as subadvisors.

“Instead of investing in third-party funds, the portfolios will invest in the Morningstar funds, which, in turn, will invest their assets in individual stocks, bonds and other securities that have been selected by third-party managers,” according to the SEC filing.

Morningstar says it is making the change to save costs “by removing a layer of costs embedded in the current fee structure,” to simplify the portfolios and how they’re managed – there will be nine funds instead of the current 15 to 25 – and to gain flexibility. It says it will be able to reduce the number of funds because each fund will have multiple managers.

"The impetus for launching the Morningstar funds is to lower the overall fees that these clients pay," according to a Q&A statement that accompanied the SEC filing. It expects net fees will decline about 20% and hopes the funds will launch in the fourth quarter of this year.

Morningstar managers will be able “to express investment ideas and adjust positions as circumstances warrant,” according to the filing, which explains that Morningstar will be able to move money around more easily between subadvisors and invest in firms that don’t offer mutual funds.

The filing also notes that many of the funds available to advisors are expected to change but the underlying investment exposures should basically remain the same. Only those Managed Portfolios that use active mutual funds will be affected: Active/Passive Asset Allocation, Reitrement Income, Multi-Asset Income and Absolute Return. Those portfolios that invest exclusively in ETFs or in individual stocks or securities will not be affected.

Morningstar Funds Trust will initially consist of nine funds: an unconstrained allocation fund, a defensive bond fund, total return bond fund and multi-sector bond fund plus funds covering these asset classes: U.S. equity and international equity, global income, alternative investments and municipal bonds.

Jon L. Ten Haagen, founder and principal of the Ten Haagen Financial Group in Huntington, New York, says he’s “concerned” about how Morningstar will “promote its own fund family while being the overseeing body to run manager groups within other fund companies.

“How can they do both? Also, how will they be perceived by other fund companies when they offer up their ratings for 'competitors?”

Todd Rosenbluth, director of ETF and mutual fund research at CFRA, an independent research firm that competes with Morningstar, tells ThinkAdvisor that Morningstar’s move should give advisors pause and require greater scrutiny on their part.

“There are potential conflicts because … it’s hard to be objective when your own products are available in the same system” [that researches mutual funds] …We believe advisors need to believe that the star methodology that Morningstar uses has no conflicts of interest.”

A Morningstar spokeswoman initiallydeclined to comment because of the “quiet period” in place while the SEC reviews its registration filings but did provide some clarification following its publication.

She wrote that the Morningstar funds will not receive a Morningstar Analyst Rating, which is a qualitative rating that the firm’s analysts assign based on their assessment of five pillars (process, people, parent, performance, and price), but they will be eligible for a Morningstar Rating, known as the “star rating”, a quantitative measure based on a fund’s trailing risk-adjusted returns versus category peers after three years of performance history.

She also noted that Morningstar will “continue to maintain a separation between the manager research analysts and the investment professionals in Morningstar Investment Management (MIM).”

The firm's Q&A statement notes that the funds will be governed by a board of trustees—at least 75% of them independent members—and that Morningstar itself plans to disclose the company's relationship to Morningstar funds in products and on Global Fund Reports.

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