October 2021 IssueLong scroll reading

A Leap of Faith – MICUS Chicago 2021

By Charles Boccadoro

The Welcome
Last week Morningstar’s CEO Kunal Kapoor welcomed 700 in-person attendees to Chicago and the Morningstar Investment Conference [MICUS 2021, the “US” short for United States]. This was the first such in-person event since before COVID. Another 1400 attended virtually. This hybrid approach to conferencing likely signals the way forward.

While many 2021 events were being rescheduled or canceled because of the unexpected Delta variant surge, Morningstar pressed on. And it was so welcomed! [Literally, attendees could watch the sunrise over Lake Michigan from the Lakeside Center venue of McCormick Place.] Last year’s all-virtual conference attempt was noble, but nothing beats in-person attendance.

As he superbly does, Kapoor articulated today’s options investment and landscape. “Many of the barriers that have existed for people to become investors have melted away.” There are customized fractional shares [comprised of stock slices set by investor discretion], social impact funds, global databases, access to private markets, and zero trading and holding fees. “The face of the investor is changing … it’s changed!” He noted that on Morningstar.com “we’ve seen a nearly 50% uptick in visits of 18-24 year olds in the past 12 months alone.”

Can you believe that? After GFC [Global Financial Crisis], having watched their parents deal with massive drawdowns in lifetime savings twice in a decade, Millennials [aka Gen Y] wanted nothing to do with financial markets! The interests of today’s younger investors are much different than those of the baby boomers, who up till now have been the focus of advisors. This situation mandates more personalized portfolios.

Similarly, while introducing a new “Risk Ecosystem” product, Kapoor described the current equity environment as “one of the greatest bull markets.” I was again struck by the change in sentiment: It took 10 years [and ignoring the intra-month drawdowns of late March 2020], but this bull market, which started in March of 2009, has gone from “most hated” to “one of the greatest.”

He also announced the Morningstar 2021 winners for investing excellence: Joel Tillinghast of Fidelity is named Outstanding Portfolio Manager; Sonali Pier of Pimco awarded Rising Talent; and Dodge & Cox is recognized for Exemplary Stewardship. Seeing this recognition was also welcomed!

David has long admired Joel Tillinghast [aka “Mr. T”], as evidenced in his piece Three Tales of the Faithful. Tillinghast’s Fidelity Low-Priced Stock Fund [FLPSX] has rewarded investors with 13.6% annualized returns over the past 32 years, or about 3000% more than its peers or benchmark, cumulatively. FLPSX remains today an MFO Great Owl.

And for Dodge & Cox: It only took 20 years, but recognition for their style of investing and stewardship is back. The table below from our MultiSearch tool summarizes lifetime [or back to 1960] risk and return metrics of D&C’s current fund line-up, listed by largest assets under management [AUM]. APR is annualized return [or absolute return for young DODEX]. An APR Rating of 5 [blue] is top quintile.

PIMCO’s Sonali Pier is a team member on five Allianz PIMCO products, all worthy of fixed-income investor attention:

• Diversified Income Inst [PDIIX, Multi-Sector Income]
• Dynamic Income Opportunities [PDO, Global Income]
• Enhanced Low Duration Active Exchange-Traded [LDUR, Short Investment Grade Debt]
• High Yield Inst [PHIYX, High Yield]
• High Yield Spectrum Inst [PHSIX, Global High Yield]

The City
MICUS was welcomed not just by the pandemic weary and Zoom-fatigued investment community, but by the city itself. In 2020 and continuing today, Chicago has experienced a serious spike in violence, including lootings and gun-related homicides, driven by social unrest, pandemic-driven layoffs, store-front closures, and the attendant loss of tax base. One Uber driver lamented: “Chicago is beautiful on the outside, but inside … not so much.”

Many of its current problems started before the pandemic: A ballooning structural deficit and underfunded pension programs. Declining brick-and-mortar retail, like Macy’s exit from Water Tower Place. The tension between police and mayor. Morningstar, which was founded in Chicago in 1984 and incorporated in 2005, maintains its headquarters there, providing a note of hope.

Of my visits to MICUS in years past [2019, 2017, 2016], I called out Chicago’s vibrancy: Millennial Park, Art Institute, bustling food-courts inside McCormick Place, and restaurant row on Randolph Street. The 1871 entrepreneurial project. The future south-side location of the Obama Presidential Center, which just broke ground. The Riverwalk and breathtaking skyline. It certainly felt different this time.

The city seems to be recovering, but slowly. The Intelligentsia coffee bar at 53 West Jackson Blvd finally re-opened but to restricted hours. Fewer people are taking public transportation, exacerbating traffic as more employees return to the office place. Lake Shore Drive traffic during rush hour: “A nightmare.”

Uber rides cost a lot more. What used to be a $10 fare from my hotel, now costs $20-30, depending on time. I rarely saw a traditional cab visit McCormick Place, which is only about 3 miles outside the city center but feels more remote.

During a Friday walk along Magnificent Mile, which is not appearing so magnificent right now, I did delight in finding the outdoor café at Millennial Park open and busy. Lots of folks, including the four-legged kind, were relishing the blue skies and autumnal weather. The night before, I enjoyed the best late-night ham sandwich ever at a young and innovative new restaurant called Oriole. Fortunately, deep-dish Giordano’s remains a mainstay.

The Business
If attendance at Morningstar The Conference was down this year, it does not reflect the success of Morningstar The Business, in spite of COVID or perhaps helped by it. Since Kapoor took over CEO in 2017, employees have doubled, as have MORN’s valuations. The company’s market cap has nearly quadrupled.

Adding to its acquisition of private equity tracker Pitchbook, the company acquired credit rating firm DBRS in 2019 and ESG rating firm Sustainalytics in 2020.

Since most people probably think of Morningstar as just the “Good Housekeeping” of the fund industry, it’s probably worth listing all their current products:

DBRS Morningstar – Independent rating services and …
Morningstar Advisor Workstation – Investment research, financial planning, client reporting …
Morningstar Data – Global equity, managed investments, and market data …
Morningstar Direct – Advanced portfolio analytics and performance reporting …
PitchBook – Data, analysis, industry news, and in-depth reports on the private and public markets …
ESG Investing Solutions – Assessments of ESG risks and opportunities across asset classes …
Financial Planning Solutions – Web-based financial planning tools for advisors
Sustainalytics – Sustainable investment strategies and security-level ESG research and ratings …
Morningstar Office – Web-based portfolio and practice management …
Morningstar Research – Independent, comprehensive evaluations on equities, funds …
Morningstar Annuity Intelligence – Annuity research for professional investors
Morningstar ByAllAccounts – Account-aggregation and financial-management tools…
Morningstar Commodities and Energy – Research and data in the commodities and energy sectors …
Morningstar Credit Information and Analytics – Credit tools and research …
Morningstar Enterprise Components – Configurable, ready-to-integrate enterprise software …
Morningstar Essentials – Investment statistics and ratings for institutional marketing professionals
Goal Bridge – Goal-setting and investment planning for financial advisors
Morningstar Investment Research Center – Comprehensive investment resources for library patrons
Morningstar Reporting Solutions – Marketing materials, regulatory documents, and other custom …
Manager Selection Services – Manager selection and investment analysis for financial advisors
Morningstar Total Rebalance Expert – Tax-aware rebalancing for financial advisors
Morningstar Indexes – Product benchmarking and creation for financial institutions and asset managers
Managed Portfolios – Mutual fund, stock, and exchange-traded fund portfolios …
Morningstar Retirement Manager – Workplace retirement account service for plan sponsors
Advisor Managed Accounts – Managed accounts for registered investment advisors
Morningstar Fiduciary Services – Investment selection, portfolio monitoring, and portfolio reporting …
Morningstar Plan Advantage – Comprehensive retirement-plan management …
Target-Date Solutions – Target-date funds for plan sponsors
Morningstar Premium – Analysis of stocks, funds, and markets, plus tools …
Morningstar Investor Newsletters – Investment strategies and in-depth analysis …

Morningstar’s founder and chairman, Joe Mansueto, retains about 45% of outstanding shares, representing a current value of about $5 billion. If there is someone vested in Chicago’s recovery, it would be him. He purchased the historic Wrigley Building in 2018 and most recently the Waldorf Astoria Chicago. He owns Major League Soccer’s Chicago Fire. He remains a large donor to the University of Chicago, his alma mater.

One of the businesses Morningstar entered just under three years ago was their own brand of mutual funds, which replaced other funds in its Managed Portfolios business. The nine funds have accumulated $5.3B in AUM, or about $44M in additional fees for Morningstar.

At the time, it seemed awkward to us [here’s David’s Take] and it remains awkward for Morningstar to offer its own competing funds. What’s worse is that so far they have performed unremarkably, as can be seen in the table below. As a fiduciary, I would be hard-pressed to defend why these funds were chosen over others recommended by Morningstar’s own research teams. None of the funds will qualify for Morningstar’s “5 Star” rating when they soon reach the 3-year mark. Morningstar is also a sub-advisor of five other funds for ALPS. These five ETF asset-allocation portfolios suffer even worse performance; in fact, Morningstar itself ranks the ALPS family “Below Average.”

The Showdown
Perhaps the most anticipated session of the conference was entitled, “Gloom or Boom? Two Wildly Different Perspectives on Equity Valuations.” It showcased Research Affiliates’ Rob Arnott – “a diversified contrarian, value-oriented manager” – and ARK Investment Management’s Catherine Wood – “a disruptive, technology-focused, growth-oriented investor.”

Catherine Wood’s flagship ARK Innovation ETF [ARKK] has delivered eye-watering returns for investors for the past 7 years … 7 years! In the calendar year 2017, it returned 87.4%, and in 2020, 152.5%. Over this time, AUM across her eight funds grew to $44B.

Rob Arnott’s flagship Allianz PIMCO All Asset [PAAIX], a tactical allocation fund, has beaten its peers by 2.5% annualized for the past 20 years, included tempered drawdown during GFC. His RAE [Research Affiliates Equity] funds have also beaten their peers for the past 6 years, if modestly.

Arnott defends his investing style by deferring to Wood: “I’m not a growth investor. To be a growth investor, you need to be able to predict the future better than the market, which is very hard to do.” He’s more a believer in regression to the mean. While he acknowledges the explosive potential of “disruptive innovation,” he warns that the “disrupter can be disrupted” [Palm, Blackberry, Cisco] and it’s hard to know in advance which ones will come out on top [Amazon]. “Apple was on brink of ruin.” He believes markets can get ahead of themselves and for assets [Tesla, which he considers a bubble] get priced to perfection and to persist “the narrative must exceed expectations.” He believes that the disparity in growth vs value valuations will result in very satisfactory returns for value investors in the future.

Wood counters that Tesla is not a bubble and predicts TSLA will reach $3000 per share in 5 years. She never calls Tesla a car maker … “it’s a robot maker.” It poses four barriers of entry to competitors: lower battery costs, AI chip, miles driven, and software updates over the air. It represents the convergence of technologies that started 20 years ago: DNA engineering/robots/AI/energy storage/crypto. The attendant cost of these technologies continues to sink, creating enormous potential, as described in Wright’s Law. She predicts that Bitcoin will climb to $500,000. [Matt Hougan, an early champion of ETFs and now cryptocurrency, articulated in another session that “investing in cryptocurrency today is like investing in the internet in the early 1990s.”] She credits her dedicated analysts for ARK’s success. When does ARK exit a position? It trims positions when 5-year growth projections drop below 15% annualized and exit when below single digits.

In the end, they agreed on little, except perhaps that the finance sector was ripe for disruption through FinTech and DeFi. “Millions do not wish to go into a brick-and-mortar bank. The future bank branch is in your pocket.”

Wood has attracted lots of detractors or “haters.” Probably because of FOMO. Fear of missing out. Or, perhaps more literally, fear that they already missed out. Probably the same reason why “one of the greatest bull markets” was once one of the most hated. And probably the same for crytocurrency.

Morningstar published a portion of the showdown: The Tesla ‘Bubble Or Not’ Debate.

The Disruption
Similar to Arnott and Wood, the session “The Disruptors, the Disrupted, and How to Value Them” contrasted the different investing styles of two long-time successful managers: Dennis Lynch, Head of Counterpoint Global, Morgan Stanley Investment Management, and Bill Nygren, Portfolio Manager, Natxis Oakmark Funds. It was the best session of the conference.

Bill Nygren has been a value manager of the Oakmark Select Fund [OAKLX] since 1996, Oakmark Fund [OAKMX] since 2000, and the Oakmark Global Select Fund [OAKWX] since 2006. Dennis Lynch has led the Counterpoint Global team since 2002, focused on growth: Inception Portfolio I [MSSGX], Discovery Portfolio I [MPEGX], Growth Portfolio I [MSEQX], Advantage Portfolio I [MPAIX], Insight I [CPODX]. Both have received Morningstar’s Domestic Stock Manager of the Year, Nygren in 2001, and Lynch in 2013.

The table below summarizes their risk and return records for the past 12 years, plus more recent calendar year performance. Both managers have beaten their peers by healthy margins, but Lynch’s growth approach was better positioned to benefit from 2020, when four of his five funds joined the “100 Club” [delivered 100% or more].

They share several common views. For example, neither wants to be characterized as a trend chaser or appreciated being labeled. Nygren argues that disruption has always been part of the market, remembering “when newspaper used to be considered safe.” Lynch feels themes are traps, like “the tail wagging the dog.” Both feel that for companies to be successful the end user must benefit and unit economies achieved. Both are skeptical Tesla will maintain its lead in the automotive sector. Unlike Wood, they see Tesla as a car company.

One of their starkest differences was about cryptocurrency. Nygren wants no part of it because he doesn’t understand it, though he has tried. “We’re happy opting out. We don’t know enough to make an investment.” Oakmark cannot assign a value or margin of safety. Lynch sees crypto as “a bet on adoption and a bet on an alternative standard for how you think about value in relation to things like fiat currency, which also don’t necessarily have intrinsic value.” He recognizes the opposing camps [Warren Buffett considers it “rat poison.” Marc Andreessen is extraordinarily bullish.] He acknowledges it is speculative and sizes his bet accordingly. But it has persisted despite its critics claiming it will die since 2008. Lynch describes crypto as “anti-fragile” … it benefits from disorder.

Nygren tends to shy away from disruptive companies, in order to maintain his “skeptical hat.” He also believes that investors tend to underestimate the amount of change that established leaders can make … the disruption from within. Lynch likes the following contrarian guidance: “It’s always different this time; it’s just a matter of degree.” It’s a play on the old adage but helps avoid being dismissive. He was initially dismissive of Amazon in 2002. “Sounded like the worst idea of all time.”

The Rest

  • Jennifer Grancio, CEO of Engine No. 1. One of the founding partners of Blackrock’s hugely successful iShares, she led the activist movement to put three outside directors on Exxon’s board. An extraordinary accomplishment, but especially for a new ETF [VOTE]. It just reached $200M AUM. She presses companies to 1) incorporate tangible value on the environmental, social and governance actions, and 2) make decisions according to what will create long-term value for all stakeholders. Engine No. 1 works hard to assign that tangible value. She called Exxon the perfect test case.

  • Tyrone Ross, Jr., CEO of Onramp Invest. “Crypto is a godsend to those that are underserved. Fifty percent of the people in South Bronx are unbanked. That is the quintessential use case. It is digital social justice.” He argues that Bitcoin itself could go to zero tomorrow, but it’s the technology that will bring financial services closer to people that have never had it, because of financial red-lining.

  • Mike Green, Portfolio Manager and Chief Strategist, Simplify. He believes the massive success of passive index investing and its attendant massive inflows are distorting underlying risks in markets. There is no price discovery anymore. It just re-enforces momentum characteristics. [The five young ETFs he is mentioned as managing are all top quintile performers in Refinitiv’s Options Arbitrage/Strategies category of 130 funds: SPD, SPUC, SPYC, QQC and QQD.]

  • Megan Greene, Global Economist, Harvard Kennedy School. She believes the best of the recovery is behind us in macro. [Macro does not equal Markets!] Does not believe inflation will spiral, because it needs increasing wages to support it and continued productivity growth will mitigate it. Labor market has a ways to go, but “shortage of workers is not new.” COVID exacerbated inequality with high wage employment [>$60K per year] up 10% and low wage employment [<$27K per year] down 21%. “The rich save more and spend less.” This dynamic helps explain why we currently have a savings glut. She does not believe Evergrande will be China’s Lehman Moment. Nor does she worry about US debt: “The US can carry debt because 1) it’s the reserve currency, and 2) T-Bills are the most liquid and deepest asset class in the world.” EM will suffer as rates normalize. She predicts growth sector will continue to outperform value. Lastly, she sees opportunities in Europe … “I rarely say this!” Asked what’s it like working for Larry Summers, she said “It’s great.”

  • Morningstar’s US Equity Research Team: David Sekera, Seth Goldstein, Karen Andersen, Preston Caldwell, and Erin Stafford. Each gave an outstanding summary of their area of expertise, detailing where they saw opportunities to invest. EV is the future, but not for 15 years when the current supply of internal combustion cars starts to end. Until then, don’t discount traditional energy companies. There remains $4T of debt in commercial real estate. Brick and mortar malls will need to change or be plowed under and the land redeveloped. COVID broke records on vaccine discovery and development time. Many innovates product in pipeline, especially those based on mRNA [messenger ribonucleic acid]. US GDP should recover strongly and most workers will return to office. The US market is about 7% overvalued.

The Coverage
Here’s a link to Morningstar’s coverage of the conference.

The March
After MICUS, many of us had planned to participate in March for the Fallen [MFTF], as we have previously. But our group event was canceled due to COVID. Fortunately, Morningstar’s Ben Johnson, Director of Global ETF and Passive Strategies Research, organized a local “virtual” event at the Waterfall Glen Trail. The trail is located about 26 miles from downtown and completely surrounds Argonne National Laboratory. It was a glorious cool autumn day, perfect for us to enjoy in honor of the fallen.

“But we in it shall be remembered —

We few, we happy few, we band of brothers …”

Shakespeare

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About Charles Boccadoro

Charles Boccadoro, BS (MIT), Post Graduate Diploma (von Karman Institute, BELGIUM). Associate editor, data wizard. Described by Popular Science as “enthusiastic, voluble and nattily-dressed,” Charles describes himself as “a recently retired aerospace engineer.” He doesn’t brag about a 30 year career that included managing Northrop Grumman’s Quiet Supersonic Platform and Future Strike Systems projects, working with NASA and receiving a host of industry accolades. Charles is renowned for thoughtful, data-rich analyses and is the driving force behind the Observer’s fund ratings and fund screeners.