Thoughts From the Morningstar Investment Conference

Within five minutes of walking in the door, I spied Mario Gabelli, who runs--among many other funds--the Gabelli Equity Trust GAB, which I cover with a full report and to which I recently awarded a Morningstar Analyst Rating of Gold. Having spoken with him on the phone during the due diligence report process, I wanted to introduce myself in person. I know from scuttlebutt that some people are put off by his renowned marketing prowess. What struck me in our brief chat was not only how gracious he is in person, but also how he could instantly recall pertinent details of GAB. It's remarkable if only because he manages 26 other funds as well. That type of recall has obviously served him--and GAB's investors--well over the years.

Two minutes later, I was talking to Lewis C., an avid reader of our research who attends conferences far and wide, seemingly as a personal hobby. An individual investor, Lewis always asks good, pertinent questions, and this time was no different, as he handed me a note--already written in anticipation that he might see me--about a fund he is interested in. So, within 10 minutes, I had spoken with two very different types of investors and walked away impressed by both. That's one of the benefits of our conference: You never know who you're going to meet but you're certain they'll be serious-minded investors.

The vendors, too, have plenty to offer. They range from global investment advisors, such as Aberdeen Asset Management, to more specialized firms, like RiverNorth Capital. It seems that everyone sends his or her best and brightest salespeople to work the booths at this conference. Although we're quite familiar with Aberdeen's investment team, it was nice to meet and chat with the sales representatives about their open-end lineup. RiverNorth, which is based here in Chicago, runs the closed-to-new-investors RiverNorth Core Opportunity RNCOX and RiverNorth DoubleLine Strategic Income RNSIX, where they're teamed up with Jeffrey Gundlach, and it's always good to catch up on their investment strategies.

Every year, during the week of the conference, we have written a similar article, capturing our thoughts about closed-end funds from comments people have made at the conference. In 2010, I wrote about trust, which was from the keynote address of Bill McNabb III, Vanguard's chairman and CEO. Last year, Cara Esser wrote about income generation, which she noticed as a theme in many presentations.

Pay Attention to the Forest, Not Just the Trees
At the Fund Research Roundtable, Morningstar's Scott Burns (my boss' boss, for full disclosure) pointed out that as investors, we often make our own meltdowns--independent of market movements--by choosing the wrong investments at the wrong time. Ironically, as Morningstar's data can point out, investors typically make the right decisions at the fund selection level. Their mistakes come at the higher level: the asset class decision. Portfolio construction is key to long-term wealth creation.

As many studies have pointed out, the bulk of a portfolio's investment returns can be attributed not to the securities owned but to the asset class they are in. For instance, while you may experience a marginal difference in total returns depending on whether you're invested in the SPDR S&P 500 SPY or in the Gabelli Equity Trust GAB, the significant total returns will be determined by the U.S. equity markets, which both funds are highly correlated with.

Let's take a step back. At Morningstar, we believe that investors should start with mapping out their investment objectives and risk tolerances. The second step is to match those with an appropriate asset-allocation strategy. Finally, investors should choose funds--hopefully the best funds--that match that asset-allocation strategy. Our tools and our research are largely built around helping investors make sense of all of the funds and investment opportunities out there. This seems like common sense, but it's not. If you think this is common sense, consider yourself an enlightened investor.

A few weeks ago, I met an individual investor who was clearly quite knowledgeable about individual funds, specifically closed-end funds. He asked me why he should be invested in Aberdeen Asia-Pacific Income FAX that has a distribution rate of about 5.5% at its current share price, when he can get close to 9% from a royalty trust tied to the Toronto Stock Exchange. Well, I never give such explicit investment advice, but here I was dumbfounded. The Aberdeen fund derives its income from Australian and Asian fixed-income securities, whereas the other fund would derive its income from Canadian equities (and with a 9% distribution rate, there’s something puzzling going on there as well). To me, this would be like asking, Should I buy a 60-inch television or an iPhone--both have screens and can show movies? When I pointed out how different the funds were and how they derived their income, he said he didn't care--he just wants the income. Yikes.

Without getting into the whole buy-and-hold debate, I believe every portfolio benefits from sound asset-allocation discipline, revisiting allocations to funds, and rebalancing where necessary. If you desire more income from your portfolio, then consider that in your asset-allocation and fund-selection decisions. Closed-end funds for the past five to 10 years have typically been created to deliver income to investors. This gentleman, again clearly educated about how to derive income from closed-end funds and trusts, had missed the forest for the trees.

Risk--Time to Rethink What That Means
Franklin Templeton's global fixed-income guru Michael Hasenstab delivered the conference’s opening keynote address. The overall topic was whether Europe presents a true reason to panic. His seeming conclusion was that there is reason to be optimistic about the outcome of the current European crisis, but at the same time investors should step back and reassess risk. He pointed out, like Aberdeen's Donald Amstad has time and again (here), that countries in the Asia-Pacific region have healthier economies and fiscal balances than in the developed world. Most interestingly, he underlined that U.S. Treasuries--which many investors still consider a safe haven--are paying only 1.5% when our country has one of the weakest fiscal positions on earth. Most investors are, of course, aware that the economy is muddling along (at best) and that governmental monetary imbalances are at obscene levels (except perhaps on the state level, where they seem to be slightly improving overall). However, listening to Hasenstab and knowing how much money has flowed into fixed-income funds over the past few years, I was left wondering if there is a disconnect between what investors know and how they are behaving. Hasenstab isn't the first fixed-income manager to warn about the attractiveness of U.S. Treasuries. It may be time for some investors to rethink how their fixed-income holdings align with their overall risk profile and investment objectives.

Also, if Hasenstab is correct about Europe, it may be time to revisit European equity closed-end funds. Though their discounts haven’t gapped out since my article back in May (here), that doesn’t mean that the portfolio’s themselves aren’t undervalued.

On the Cusp of an Equity Bull Market?
Another conference roundtable was entitled "The Quarter-Century Club." Moderated by Morningstar's Don Phillips, who has been analyzing mutual funds for almost 25 years, the panelists were Susan Byrne of Westwood Holdings, Will Danoff of Fidelity, and Brian Rogers of T. Rowe Price. All have been managing money for at least as long as Don has been looking at their funds. I was especially interested to hear what such successful, long-term investors had to say about their experiences and their outlook. You can read the on-the-spot blog post here. There were plenty of interesting take-aways.

However, for me, perhaps the most interesting comment came from T. Rowe Price's Rogers. He said that right now, the mood of equity investors reminds him a lot of when he began in the industry. "Investor sentiment is bad. ... It doesn’t mean that the next ten years will be like the last ten." Despite the differences in the interest-rate environment, he said that "today looks a lot like 1982." Let's hope so.

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