Morningstar strategy brings positives and negatives

As muchas US advisers would love exclusive rights to the financial intermediary needs of all Americans, the reality is that with a fast-growing and profitable customer base, a monopoly is out of the question. Hence, the thousands of lawyers, accountants, brokers and bankers clamouring for a piece of the action.

Likewise, many service providers, once dedicated almost exclusively to financial planners, have cultivated new relationships, both directly with customers and new entrants into the advice business.

Some advisers still feel burned by giant discount broker/dealer Charles Schwab, for instance, following the launch two years ago of the firm’s proprietary investment management operation.

They accuse Schwab, which administers the bulk of assets for independent financial planners in the US, of sending materials to their clients encouraging them to switch to direct accounts.

The latest, and one of the most significant, firm to blur its relationship with the advisory community is Morning-star. The Chicago-based fund tracker last month launched Morningstar Managed Port-folios, a set of fund-of-funds, or pre-allocated portfolios, for distribution only through intermediaries.

Morningstar has no intention of selling the funds direct to mums and dads, explains head of the newly-created subsidiary Morning-star Investment Services, Tom Florence. Nevertheless, advisers, which account for about three-quarters of Morningstar’s revenues — thanks largely to the firm’s popular research — are not necessarily happy.

“I was a little surprised to see them come out with this. I felt it was an encroachment into what I do,” argues New Hampshire-based CFP, Samuel Hull, who has been using Morningstar as a “primary tool” for 10 years.

“I’m a great believer in outsourcing things periphery to the core, but this is at the core of what I do. Maybe they’re ruffling the feathers of the golden goose the wrong way” he says.

“If what I’m doing is taking your assets and investing it in a pre-selected portfolio, why do you need me?” adds CFP and vice-president of Massachusetts-based New England Schooner, Vincent Rinaldi, another veteran Morningstar user.

Rinaldi is also annoyed that the users of the new service, which will cost 15 to 35 basis points and require a minimum outlay of US$100,000, will primarily be the accountants and lawyers with limited investment experience against which he is competing.

Morningstar makes no apologies. The business case is a no-brainer. Boston-based consultant Cerulli Associates predicts that US$50 billion of new assets will flow into the “asset allocation space” in the US this year alone. And as Florence explains: “There’s always room for great portfolios.”

“It’s an expansion by Morningstar to meet the needs of a different set of advisers,” he says. So-called separate accounts, or discretely managed portfolios, are next on the firm’s agenda.

Morningstar is unlikely to lose the support of existing clients. Hull says he will stay with the firm regardless. And even though Rinaldi confirms he knows of three advisers that pulled assets from Charles Schwab in disgust, Morningstar is not competing directly with intermediaries.

There is another risk, however. Credibility in its research business. Like most independent ratings agencies, Morningstar will succeed or fail based on perceptions of its objectivity.

Some advisers are wondering if Morningstar’s analysis of mutual funds in its own portfolios won’t be jeopardised.

“They have always said they are independent. [Well] they are getting close to creating a conflict of interest,” Hull argues.

Florence dismisses the worries, noting that Morningstar’s research and investment units will be separate, and questions the motives for bias when mutual fund performance is so thoroughly reported.

One senior executive at a rival firm likened Morning-star’s strategy to Frank Russell’s transformation over the last decade from pension fund consultant to fund-of-funds manager. Frank Russell manages ANZ’s Gateway program in Australia.

Interestingly, Russell’s transformation has been accepted by clients. Morningstar’s “natural extension” into managed portfolios, as Florence describes it, will also likely be tolerated.

Certainly, Morningstar is shedding light on a number of key trends. These include the shift to holistic advice and, as some say, the “commoditisation” of investments.

According to Florence, the needs of individual clients are becoming much more holistic.

“Investment advice is just one small piece of an overall financial planning strategy. Today, planners are so consumed with understanding an overall financial picture. It’s very demanding,” he says.