Morningstar expects passive fund managers — like Vanguard and BlackRock/iShares, which are the two largest providers of exchange-traded funds — to continue to garner much of the attention in the next decade, according to a new research report.
However, the report — by Laura Lutton, director of North American manager research, and senior equity analyst Greggory Warren — finds that there’s plenty of room for active asset managers that have scale, established brands, solid long-term performance and reasonable fees.
Lutton and Warren presented their research during the annual Morningstar Investment Conference in Chicago.
To be especially successful in the coming decade, though, Morningstar believes that asset managers will be best served by differentiating themselves from the competition, offering low-cost funds with repeatable investment strategies and prudently adapting to the changing competitive landscape.
Based on these qualifications, the report finds these nine firms are deemed as promising partners for the next decade:
According to Morningstar, Vanguard is among the best-positioned industry leaders because its business model is differentiated and formidable.
The firm’s mutual ownership allows it to offer investments at cost, and that, along with a robust lineup of straightforward active and passive investments, has made it the largest retail money manager.
“With $3.4 trillion of assets under management, though, the law of large numbers will eventually catch up with Vanguard,” Lutton and Warren write in the report. “Indexing could also suffer during a major market correction, with the combination of market losses and outflows reducing the company’s assets under management.”
Even so, Morningstar has issued forward-looking, qualitative Morningstar Analyst Ratings to 84 Vanguard funds and ETFs – 79 of which are rated Gold, Silver or Bronze – indicating that it thinks these funds will outperform their benchmarks and typical peers over a full market cycle.
One reason BlackRock will have staying power is it’s known for its scale through its passive iShares ETFs, as well as its investment scale among institutional accounts.
Beyond passive investing, BlackRock also has a strong reputation for active fixed income investing, with many of its active bond funds earning medalist ratings.
Its fixed-income data platform, Aladdin, is another differentiator that should contribute to this firm’s staying power.
“We also believe that an expansion of BlackRock’s Aladdin enterprise investment system into Provider Aladdin (which supports asset servicers and custodians), Aladdin for Wealth (which should allow broker-dealers and advisors to focus on greater levels of risk analytics and oversight in a post-Department of Labor fiduciary rule environment), and Aladdin Portfolio Builder (which has helped broker-dealers and advisors to manage their clients’ portfolios by building a multitude of different portfolio scenarios) should contribute to the firm’s staying power and industry influence in the years to come,” Lutton and Warren write.
BlackRock’s vulnerabilities include its active equity fund lineup, which is undergoing a makeover, as well as prolonged underperformance of index funds. Even with those risks, Morningstar has issued BlackRock’s (BLK) stock a wide moat rating, indicating its relative competitive advantage among publicly traded asset managers.
3. T. Rowe Price
T. Rowe Price stands out among the large firms for its consistent and repeatable investment process, according to the report.
“This firm is a leader at succession planning, doing more than most competitors to eliminate generational-transfer risk, which occurs when one manager retires and hands the reigns to another,” the report says.
T. Rowe Price also has been mindful on the cost side. More than 60% of share classes were below average fee levels for their categories at the end of last year, according to the report.
“While many active competitors are now realizing that their higher fees have been a disservice, T. Rowe Price has been cost-conscious all along and will be under less pressure to cut fees, making their profit margins and earnings more stable and predictable going forward,” Lutton and Warren write.
Like BlackRock, T. Rowe Price’s (TROW) stock carries a wide moat rating. And Morningstar’s manager research analysts are bullish on T. Rowe’s funds, with 38 of the firm’s funds rated Gold, Silver or Bronze.
4. American Funds
Another strong partner for the next decade is Capital Group’s American Funds, according to the report.
This firm’s funds have suffered redemptions over the previous decade, largely falling victim to the flight to passive in recent years. Even so, the firm’s returns are competitive on a risk-adjusted basis, primarily because American Funds’ approach to managing assets in sleeves across multiple independent managers has been effective.
“There’s no succession risk with these funds,” Lutton and Warren say.
The firm also has an edge when it comes to low fees. Morningstar rates more than 92% of American Funds’ assets across 23 funds as Gold, Silver or Bronze.
“American Funds does have some vulnerabilities on the fixed income side as it is working to increase the level of sophistication of its bond offerings, but overall we think that its funds are strong long-term investments,” according to the report.
5. Dodge & Cox
Dodge & Cox has a team-based investment process that is “tested, consistent and well-supported,” according to the report.
That bodes well for the firm’s six funds going forward — Dodge & Cox Stock, Dodge & Cox International Stock, Dodge & Cox Income, Dodge & Cox Balanced, Dodge & Cox Global Stock and Dodge & Cox Global Bond. Low fees also give the firm another competitive advantage.
Morningstar has Gold ratings on five of the firm’s older funds, which accounts for nearly 100% of firmwide assets.
However, the report does point out that “this traditional active shop uses a low-turnover value strategy that can run hot — as it has recently — or cold — as it did during the financial crisis.”
6. Primecap Odyssey
Primecap Odyssey is another firm with a “strong, team-based approach” to active equity investing, according to the report.
The firm subadvises two funds for Vanguard and offers just three active equity strategies on its own, all rated Gold.
Performance across the lineup has been strong, which the report says is a rarity in active equity. Also, expense ratios on the funds are low relative to the competition.
“This firm actively avoids the spotlight and is unlikely to pivot if its approach falls out of favor,” the report says. “Those potential drawbacks seem relatively slim; we think this firm will be a good partner for investors and the advisors that serve them going forward.”
According to the report, Parnassus is another firm that’s been growing quickly with strong-performing, actively managed investments.
It’s also riding another growth wave: ESG investing. The firm uses environmental, social and governance criteria for its stock-picking, and an increasing number of investors are including ESG funds in their portfolios.
“We expect ESG investing to grow in popularity over the next decade, particularly since wealth is growing among women and millennials – two demographics of investors who say they seek ESG investments,” Lutton and Warren write in the report.
The pair also think this firm has a sound investment process – three of its six funds are medalists. Although, this firm could be humbled should its funds hit a performance snag that triggers outflows.
8. Dimensional Fund Advisors
Over the previous decade, Dimensional Fund Advisors has demonstrated the power of asset-gathering that can come from strategic-beta strategies, according to the report.
All of the firm’s strategies are grounded in an “unwavering belief” in market efficiency and transaction cost management, according to Lutton and Warren.
The pair also believe that DFA’s cost advantage comes from its quantitative, repeatable strategic-beta strategies, and its 10% three-year annualized organic growth has made it a top-10 industry player.
“We think DFA has staying power, with all 21 of the firm’s funds we rate earning medals, which is a strong endorsement of the investment process at this firm,” Lutton and Warren write in the report. “To be sure, the strategic beta landscape gets more competitive each day, but DFA’s business model and investing approach give it a sustainable edge, in our view.”
Lutton and Warren highlight Schwab for its more recent arrival to the passive scene.
“Its launch of plain-vanilla ETFs with very competitive prices is a strong example of a firm adapting its approach to the changing competitive landscape,” the pair write.
Inflows to the ETFs have boosted Schwab’s market share and have attracted and kept investors on the firm’s brokerage platform, according to Morningstar.
“That low-cost approach and access to distribution through Schwab’s retail and advisory platforms will fuel further growth in the coming decade,” according to the report.
On the manager research side, Morningstar has assigned Medalist ratings to 18 of this firm’s funds. And on the equity side, Morningstar Research Services assigns a wide Economic Moat Rating to Charles Schwab (SCHW), indicating a strong competitive advantage.
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