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Portfolio > Economy & Markets > Fixed Income

Morningstar Highlights Fund Stewardship, Retirement, Fixed Income and Smart Beta

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Morningstar announced the winners of its Awards for Investing Excellence during the research firm’s annual investment conference held recently in Chicago: Dan Fuss of Loomis Sayles was named Outstanding Portfolio Manager.

“Our 2019 winners have been great drivers of investor success,” said Laura Pavlenko Lutton, Morningstar’s director of manager research, North America. “The managers and firm selected all have one thing in common: they are investing and operating for the long haul by maintaining value-oriented strategies that stay true to client interests instead of their own.”

A pioneer in the area, Fuss was first in the benchmark-agnostic, multi-sector approach to fixed income, which has defined its flagship Loomis Sayles Bond (LSBRX) since 1991, according to the research firm. He has demonstrated a “value-driven, often contrarian, and aggressive strategy that continues to have an impressive long-term record for the fund and its siblings,” it said.

Other award winners were the Vanguard Group, recognized for Exemplary Stewardship, and James Marchetti noted for Rising Talent as head of Primecap’s Odyssey Aggressive Growth Fund (POAGX).

Retirement Focus Advisors helping clients plan for retirement should focus both on accumulating assets and on projected liabilities, according to David Blanchett, head of retirement research at Morningstar. “Think about assets and liabilities separately,” said Blanchett, during the Chicago gathering. “What will assets earn and what are the liabilities, spending needs, over 30 to 40 years.”

The traditional 4% withdrawal rule from retirement funds may not be appropriate for future retirees, said Blanchett, noting that the rule is based on historical returns for U.S. stock and bond markets, not future return projections, and assumes a constant income increased for inflation over 30 years, which is “not reality.”

U.S. large caps, for example, are not likely to return the 10% average annual gains that have prevailed since 1926 and the 10-year Treasury is unlikely to maintain its historical 5.5% annual yield.

“We have to adjust our expectations,” he said. A reasonable annual return for U.S. large caps over the next 10 years is 0.95%; for international equities, Morningstar’s projection is 5.4% annually, while for small caps it is 2.88%.

Retirees most affected by these relatively low expected returns will be those closest to retirement, either five years ahead of or five years into retirement, according to Blanchett. “You have to incorporate lower returns” in retirement plans today. “The 4% rule is not as safe as the historical data shows.”

On the spending side in retirement planning — the liabilities — he suggested that advisors focus on realistic expectations. The assumption that investors will spend more as they age, above the inflation rate, is wrong.

“Retiree spending doesn’t rise above inflation because spending evolves,” Blanchett said. They will spend more on health care as they age, but less on travel and other activities and items as they slow down, including wealthy retirees as well. “The average retiree spending $100,000 a year at 65 spends $75,000 by age 95,” he explained.

Another major consideration in retirement planning is longevity risk, whether retirees will outlive their assets. Here, too, Blanchett warned against using conventional analysis of average life expectancy, which have been rising: “Your clients are not average. Consider the unique risks today for wealthy Americans.”

Males in the top 1% today will live to about 90 on average vs 80 for the remaining 99%. Plus, longevity for the top 50% of earners is rising much faster than the longevity of the bottom half, he explained. “Where are your clients on this spectrum?”

As for guaranteed income, Blanchett said only annuities can provide that, with Social Security being the best example. He also reminded the audience that in the worst case scenario, when retirees appear to be running out of money, they can usually adjust their discretionary spending.

Fixed-Income, Pimco Update On stage at the Morningstar conference, Pimco CEO Emmanuel “Manny” Roman was unapologetic for focusing on fixed income and fixed income only. “We do fixed income at a fair price, and we do it well,” he said. “It’s a unique strategy that focuses on one side of the market.”

Nor does he think focusing on fixed income puts Pimco at a disadvantage — and the $1.7 trillion bond shop has no plans to expand into other markets. “It doesn’t matter how much we manage,” he said. “All that matters is our long-term performance. [Even] in the last quarter of 2018, all our funds were up.”

He added that “one of the things you need to decide is what business you want to be in.” For example, Vanguard focuses on bringing indexes that are inexpensive to the public.

“That’s a business model. At the other extreme is us … where we do everything from the mortgage world to the fixed income world to the muni world to the private credit world.

And we do one thing well,” Roman explained. “We’re never going to be the biggest, but we do very well for clients, and that’s perfectly fine for us.”

Asset managers can get into trouble when they “try to do a lot of different things,” he said. “It has consequences. If you try to do too many things, you’ll always do one badly. You’ll always have risk you haven’t carefully thought about … and cost structure that explodes when you don’t invest in the right place.”

Pimco, which has been in fixed income for 47 years and appears to have successfully navigated the rocky exit of former co-founder and Chief Investment Officer Bill Gross in 2014, insists it isn’t sitting on its laurels. For example, it has hired 360 people in recent years and acquired Gurtin Municipal Fund Management in January, which is “great” in the world of municipals in separately management accounts, Roman said.

“They had a technology which we thought was pretty unique to SMAs and would benefit all our businesses. Very quickly, we thought this was a very easy niche we could do, so it that worked for everybody,” he added.

Why the SMA business? One reason is to utilize municipals — which Gurtin has wide coverage of — for clients who live in high tax areas like California and New York. “And, given what’s happening in terms of U.S. politics, municipals are attractive, and there’s a tactical trade as far as owning municipals,” according to Roman.

Another reason is that “more people want SMAs,” he said. He doesn’t see it replacing the mutual fund business, “but it’s a nice thing to have, and for some clients it makes sense.”

Will passive management overtake active? On the fixed income side, Pimco has been able to beat the benchmark by 1.5%, Roman said. Also, passive for fixed income “makes no sense.”

First, fixed income passive indexes have a turnover of 40%. If managers try to replicate the benchmark, they end up churning the portfolio. Second, he explained, an advantage of active management in fixed income is that there are non-economic agents. “Think of the central bank,” he said. Bottom line, “all that matters to anyone in this room is if we can deliver, net of fees, long-term alpha consistently.”

Strategic Beta Update Strategic beta has a long way to go, admits Marc Zeitoun of Columbia Threadneedle Investments, who heads up the strategic beta group that just released results of its new study on advisor awareness in the area. “One of our biggest problems is that people don’t understand what they are investing in,” Zeitoun said at the Morningstar gathering. “What I would like people to react to is, who is managing the money?”

The quantitative online study of nearly 300 advisors took place in April, and some of its key findings surprised Zeitoun. First, 98% of the respondents said they have “some level of familiarity with strategic beta investing,” he explained. “That means almost everyone knows about it. But [we found] only 36% are confident in implementing it into their portfolios.”

A second “problematic” finding is that only 18% of advisors know the names of the portfolio managers of strategic beta funds they are working. Another unexpected finding is tied to the primary reason advisors invest in strategic beta solutions: 38% stated it is to enhance portfolio diversification, while 23% said it is to incorporate factor-based investing; just 4% said it is to lower fees. “Lower fees should be the answer,” according to Zeitoun.

Bernice Napach can be reached at [email protected]. Ginger Szala is executive managing editor of Investment Advisor. She can be reached at [email protected].


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