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Ep 10: Morningstar's new boss
257 Plays1 year ago
Kunal Kapoor has just taken over as CEO of Morningstar from the company’s billionaire founder Joe Mansueto. It’s one of the biggest jobs in global investing; Morningstar enjoys huge influence among investment professionals, advisers, journalists and end investors, employing more than 4,200 people around the world. Whatever happens in the investing industry over the next 20 years, Kunal Kapoor is likely to be one of the movers and shakers.
Kapoor’s background is in analysing and rating actively managed funds and, as you would expect, his views on the value of active management differ from my own. I was, however, encouraged to hear that he does share a very similar perspective to TEBI’s on such critical issues as fees and charges, the rôle of financial advice and the importance of putting the interests of consumers first.
Whatever your views on those topics, I think you’ll find this a fascinating and insightful interview.
Recommended
Transcript
Introduction
00:00:05
Speaker
Hello and welcome to the Tebbe podcast from The Evidence-Based Investor, brought to you by Regis Media, connecting advisors with clients. I'm Robin Powell.
Leadership Transition at Morningstar
00:00:16
Speaker
Kunal Kapoor recently took one of the biggest jobs in the investing industry as Chief Executive Officer of Morningstar, the global investment research and investment management firm headquartered in Chicago. He replaced Joe Mansueto, the billionaire who founded Morningstar in 1984. So who is Kunal Kapoor?
00:00:37
Speaker
Well, although he's still only in his early 40s, he's been at Morningstar for 20 years. He originally joined the firm as a data analyst in 1997. He's served as head of global products and client solutions and in a variety of other leadership roles. He's been president of the company since October 2015.
00:00:58
Speaker
So, what are his thoughts on the industry and where it's heading?
Morningstar's Mission and Critique of Hedge Funds
00:01:03
Speaker
Last week I had the privilege of interviewing Kunal Kapoor at Morningstar's Game Changers Investment Summit in Brussels. I started by asking him about Morningstar's place in the value chain. Apart from continuing to be a successful business, what is it actually trying to do?
00:01:22
Speaker
We've always had at the core of our mission the idea of helping investors achieve the outcomes that they are aiming to. And when you look at the finance industry, there's very few firms that have such a clearly articulated focus on the individual.
00:01:41
Speaker
And then we've linked that to an independent, long-term, somewhat contrarian approach to investing and building portfolios. Historically, we've been advocates for things such as low expenses, building diversified portfolios, picking funds and stocks when others might be running away from them, investing and building diversified portfolios that do more than just
00:02:09
Speaker
reflect your home market and sort of the biases that we have with our home markets. So I think we've got a relatively unique position and relationship both with financial advisors and individual investors. And when I think about where we are in the value chain, I think we're a trusted partner because of that clarity of purpose and that independence.
00:02:31
Speaker
As anyone with the remotest interest in the investing industry knows, we're living in very interesting times. In the United States in particular, investors are deserting high-fee actively managed funds in their droves. 2016 was a particularly disastrous year for hedge funds, many of which closed down. Colonel Kapoor for one won't be shedding
00:02:54
Speaker
I think in general it's not a bad thing. So now let me put some nuance to my answer. First of all on hedge funds, in general hedge funds are a bad deal for investors. I think there's very few hedge funds that one can look at and say that in the long run they are going to provide the type of outperformance that at least up until a few years ago people thought
00:03:23
Speaker
they were going to provide. The only people who got rich off of hedge funds were the managers. So I think it's a good thing that people have woken up to that reality. Having said that, I will say that if you go back to the foundation of the hedge fund industry, it really was about trying to diversify away some types of risk. And you're seeing some of that now show up in the mutual fund area through the use of alternatives and kind of a growth in the alternative area. And I think that that's worth watching, although there, too, you have to keep an eye on expenses.
Cost Debate in Investment Funds
00:03:53
Speaker
Now, I wasn't expecting to see eye to eye with Kunal Kapoor on the active versus passive issue. Morningstar, after all, earns much of its income from rating actively managed funds. But we're actually not as far apart on this subject as I thought we might be. I tend to look at things a little bit differently, and I don't think it's an active versus passive debate. I actually think it's a high cost versus low cost debate.
00:04:18
Speaker
And globally, the losers have been the high cost index huggers that call themselves active funds. And I think we can all agree that we're all probably better off that those are out of existence. They were among the worst rated funds. They were high cost. Our analysts tended to hate them and rarely recommended them. Now, what's left of the active bunch, I think you're seeing funds that are going to be truly active.
00:04:48
Speaker
And we'll see if they're able to earn their fee and beat the indexes. But what I will say is a few things have happened that make me believe that it won't be as one-sided as it's been. One is costs have come down across the board.
00:05:04
Speaker
And so I think that actually plays very much in favor of the active funds now starting to be more competitive in that regard. Secondly, you've seen, even as there's been outflows at the aggregate level, you've seen a lot of good active managers with low costs stabilize on their flows in the last few years. And so I don't think the bottom is going to keep falling out. And then the final thing I'll just point out
00:05:30
Speaker
To the extent that you want to focus on active versus passive and not just high-cost versus low-cost, it's true that some of the active money has moved into the ETF area, and it's fair to say that it has moved into a lot of nonsense. So if I think back to the mutual fund arena 15, 20 years ago,
00:05:49
Speaker
You used to have a lot of strategies that were very niche and not that useful or relevant for investors. They usually bought them after they'd done well and they immediately sold them as soon as they started to do poorly. A lot of those types of strategies have shown up in the ETF area.
00:06:06
Speaker
And I would say that indexing is a good strategy when it's simple and relatively straightforward. But I think we're starting to stretch the bounds again on the ETF side in the way that we did on the mutual fund side with really narrow investment ideas that are being indexed, apparently. And I think that that's somewhat risky and worth keeping an eye on.
00:06:26
Speaker
Of course, one of the big investing stories in the United States just now is the uncertainty surrounding the fiduciary rule.
Fiduciary Rule and Industry Shift
00:06:33
Speaker
The rule was introduced by the Obama administration to try to protect consumers from conflicted financial advice. It's still not clear what will happen to it, but it seems likely at the very least that President Trump will try to limit the impact of the fiduciary rule on Wall Street.
00:06:52
Speaker
Pinal Kapoor's view, surprisingly, is that the rule is actually irrelevant. Irrelevant is a strong word, but what I mean is the market is already spoken. And so if you look at many markets globally, whether that's the UK, whether that's Canada, whether it's Australia, whether it's India or now the US, you're fundamentally seeing a shift
00:07:14
Speaker
to low-cost investments, a shift to fee-based advice, a shift to outcome or goal-based portfolios, and that's not going away.
00:07:24
Speaker
So the rules that have popped up in different parts of the world, whether it's a DOL, fiduciary rule in the US, or RDR in the UK, or Mifit 2 here, or FOFA in Australia, they are all ultimately just hastening a market trend that's occurring anyway. And so you could scrap the rule tomorrow, which, by the way, I think is entirely unlikely.
00:07:50
Speaker
But the reality is, this is part of a larger trend where the investor is winning. And the market has moved in a way to support the investor's outcomes. And no rule is going to stop or start that, regardless of what an administration may do or not.
00:08:07
Speaker
You're listening to the Tebbe podcast. In a moment, we're going to find out what the new bot of Morningstar has to say about the changing nature of financial advice. But first, here's a message from our sponsor, Regis Media.
00:08:21
Speaker
Hi, it's Will. I'm a producer from Regis Media. We know running a financial advisory firm is hard work, but we also know the value of high-quality, regular content and marketing. And that's where we come in.
Marketing Support for Advisors
00:08:34
Speaker
We support firms by helping them attract and retain clients through a mixture of video content, social marketing and written articles. To find out more, visit our website RegisMedia.com.
00:08:47
Speaker
Welcome back. I'm Robin Powell and I've been interviewing Kunal Kapoor, the newly installed CEO of Morningstar. One subject I was especially keen to hear his views on is financial advice. How is the role of the advisor changing? How do advisors add value?
Advisors' Value Beyond Investment Selection
00:09:08
Speaker
and how important is investment selection compared to the bigger picture? A few years ago, we did a research paper on the concept that we call Gamma at Morningstar, and Gamma is the value of financial advice. And we show that advisors are actually adding value in multiple ways beyond investment selection. So traditionally, the whole notion of whether you're adding value or not is just based on under or out performance.
00:09:35
Speaker
And certainly, that's an important part of it, always has been, always will be. But if you're an advisor, there's many other activities you need to be doing with your client where you are adding value. It could be something as simple as ensuring that your client stays invested in a portfolio at the worst possible time because the client's behavioral biases are maybe urging them to do something other than what is in their best long-term interest.
00:10:04
Speaker
Now, most people may not qualify that as the advisor adding value, but I will submit to you that if an advisor kept their client in a portfolio during the last bear market, then they did a huge service and added a tremendous amount of value. And so to me, the debate is less about, will the way they work change or not? Of course it will. There's more technology. You have younger folks.
00:10:26
Speaker
who maybe want to be interacted with differently. So some of that will happen. But the core of this is trying to answer the question of where is the value added, and then actually measuring it, and then doing so over and above just the investment piece, which while important, is not the only thing the advisor is doing.
00:10:44
Speaker
So we've heard his views on hedge funds, on active versus passive, and on financial advice. But Kunal Kapoor's predictions for the future of investing have a common denominator.
Future Focus on Investor Returns
00:10:56
Speaker
In the past, he believes there's been far too much emphasis on the industry itself. The future is all about the end investor. The firms that do best will be the ones that really take that on board.
00:11:11
Speaker
I think we were early in terms of having a focus on the investor and advocating for that. I think if you look at all the winners today globally, you cited Vanguard earlier on, and they're one of the winners because they focused on the investor. And everything they did, that was driven by the notion of how do you let the investor capture more of the return by driving down expenses even lower.
00:11:36
Speaker
I think the industry is actually in a strong position because costs are lower. Some of the investment strategies that have persisted are among the very best that are available. And at the core, what the mutual fund industry does is a good thing. It helps people build portfolios without needing a ton of money. And I don't think we should lose sight of that.
00:11:57
Speaker
And so the purpose of the industry at the core is a good one. As is always the case, there are people who take advantage of the situation. And if you look back over the last two decades, certainly you can call out funds that should not have existed and expenses that were too high. And I'm proud of the fact that we constantly do that. But I think a lot of that has been shaken out. And so it's a great time to be an investor. And I think if you are a firm serving the investor,
00:12:25
Speaker
your future can be bright if you figure out that alignment with the investor gets you a good long-term outcome. It's when you conflate short-term incentives in the way that you want to grow your business with how you want to serve an investor that becomes problematic.
00:12:42
Speaker
core has been in trying to ensure that investors' interests are well aligned with those who are managing their money. And I think we live in a world where that's going to be more and more likely and prevalent.
00:12:57
Speaker
And that brings to a close this latest Tebi podcast brought to you by the evidence-based investor in conjunction with Regis Media, connecting advisors with clients. Thank you to Kunal Kapoor and to you for listening. Until next time, goodbye.