Tue, 3 Mar 2015
Morningstar's Christine Benz recommends these tried-and-true value-leaning stock funds, still-open foreign-stock favorites, and TIPS funds for investors who want to tilt against the grain.
Jason Stipp: I'm Jason Stipp for Morningstar. Investors have until April 15 to fund an IRA for the 2014 tax year. Here with some ideas on what you might want to invest in is Morningstar's Christine Benz, our director of personal finance.
Christine, thanks for being here.
Christine Benz: Jason, it's great to be here.
Stipp: Investors do have until April 15 for funding IRAs for 2014 or they might be getting an early start on 2015--both great ideas. But before we talk about specific ideas for today's market, let's just talk generally: If I'm a strategic, long-term investor, what kinds of things should I have in my IRA?
Benz: Well, I think you really want to think about your life stage and what sorts of core holdings make sense for you, given your life stage. I think the starting point for figuring out what to put in your IRA is to take a look at all of your assets together. I think our X-Ray tool does a great job of helping you see what that looks like in terms of your asset-class exposures. Just see whether you are on track relative to, say, a target-date fund geared toward someone in your age range or the allocations in our Lifetime Allocation Indexes. Just do that first read, and then I think it makes a lot of sense if you determine that you're probably light on bonds relative to where you need to be, that you might look at using your IRA to add to those holdings where you are light. But start with that--look at your overall asset-class exposure and then use that to determine where you go next.
Stipp: And then within that asset class, you may want to tilt one way or the other and maybe be a little contrarian--go against the grain and maybe do a little bit better than the market. Maybe not outsized bets, but just making small bets and tilting. You have a few ideas on how you might want to do that. So, let's say I've looked at my portfolio and I need to add a little bit to equities. How would I be contrarian in doing that? The market for equities has been pretty good.
Benz: It has been. One easy way to ensure that you are not overpaying--or at least to help insulate against overpaying--is to steer your portfolio toward the value side of the [Morningstar] Style Box. If you are a value-oriented stock-picker, you could look for companies with high star ratings, meaning that they look pretty cheap in our scoring system, currently. Or you could simply look for value-leaning diversified stock funds--that would be another way to go. A couple of tried-and-true names that we often recommend would be Dodge & Cox Stock (DODGX)--a very large fund, but one that has scaled up very capably. Oakmark Select (OAKLX) would be another idea. Oakmark Fund (OAKMX) is another idea. [These funds are] just good, sturdy, core value-leaning holdings. I think Oakmark Fund may actually land in the blend column, but we think of it as one of our favorite value-oriented funds.
Stipp: And Morningstar analysts also have opinions about areas of the market to look over- or undervalued. If you're looking at our research, what might that suggest about where there could be some value?
Benz: The one pocket of extreme value, when you look at the overall coverage universe on a sector basis, is the energy space. Of course, there are risks in that area as well; but certainly, investors who want to be contrarian who are individual-stock investors could take a look. I would [suggest looking] for those companies that rate 4 or 5 stars, currently--again, meaning that they look cheap to us. And I also typically layer on some sort of a moat rating; you want to look for those companies that have some sort of a sustainable competitive advantage. I did a quick screen. We currently have 11 companies that have wide moats and star ratings of 4 or 5 stars, meaning that our analysts think that they are inexpensive.
So, you could look there. You could look to a sector-specific fund: Vanguard Energy (VGENX) is one of our favorites run by the team at Wellington Management. It's been typically one of the best-performing energy funds in our database over long periods of time--and of course, it's nice and cheap. Or you could take the chicken way of playing energy stocks and look to a diversified value leaning-fund that has been buying there recently.
I did a quick screen for those: Longleaf Partners (LLPFX) is one that hit my screen; Artisan Value (ARTLX) was another fund that met those parameters; Tweedy, Browne Value (TWEBX)--not to be confused with Tweedy, Browne Global Value (TBGVX)--was another value-leaning fund that's currently emphasizing the energy sector.
Stipp: And as with any contrarian bet, you have to buy into these undervalued areas with like good deal of patience as well. Nobody knows exactly when some of these things will turn around.
Benz: The turnaround will not necessarily be imminent. Anytime you are holding any sort of stock fund, I would say at a minimum you want to have a time horizon of, say, seven to 10 years--ideally, even longer than that.
Stipp: Another area where investors may actually see that they have underexposure just because of market performance is foreign stocks. That's a sign that you might want to be a little contrarian and put some money to work in overseas markets. What are your ideas there?
Benz: I think you are absolutely right, Jason. A lot of investors do tend to be underweight foreign stocks relative to where they should be. And this tends to be kind of an ongoing issue where you see a lot of investors with very strong home-country bias. But then, you factor in the fact that foreign stocks--especially foreign-stock funds, for reasons I'll explain later--have really underperformed U.S. over the past several years. In fact, the typical large-blend fund has double the return of the typical foreign large-blend fund over the past five years. So, most investors--if they've done nothing in terms of making any reallocations in their portfolio, they've not done any rebalancing--they'll be pretty underweight foreign stocks.
The problem here is that a lot of the really good value-oriented foreign-stock funds--ones that we've tended to recommend over and over again--are currently not accepting new investments. Oakmark International (OAKIX) is one; Dodge & Cox International (DODFX) recently closed its doors to new shareholders. So, the biggest funds that we had most often recommended over the years are not open currently. One I would recommend--and, in fact, one that I own in my own IRA--is Vanguard International Value (VTRIX). It's a multimanager value-leaning fund; of course, it's nice and cheap. And one thing I like about it: When you look at the most-unloved pocket of foreign markets, it tends to be emerging markets--they have underperformed developed foreign markets over the past several years. I like that this Vanguard fund has an emphasis on emerging markets. I think that investors who want to be contrarian should probably look for their core foreign-stock fund to have at least something [in emerging markets]--ideally 10% or more.
Stipp: And anytime you're looking overseas, currencies are another issue that you have to think about, and there have been certain strong currency trends happening recently. So, as I'm thinking about deploying money, how should I account for currencies?
Benz: It's interesting. Our colleague, Kevin McDevitt, wrote a great piece talking about how much of the performance discrepancy between U.S. stock funds and foreign-stock funds really owes to the fact that foreign currencies have depreciated relative to the dollar. We've seen foreign markets actually go up at a time that foreign currencies have depreciated. So, I think for investors who want to be contrarian, they probably want to think about making sure that, if they are investing in a foreign-stock fund, that it's one of the unhedged funds--that it's one that's fully exposed to the fluctuations in foreign currency. Sometimes, that will work against you, as it has recently; but I think if you believe in reversion to the mean, that's probably not a bad way to position your portfolio, with at least some exposure to foreign currencies.
Stipp: Let's talk about another asset class that has been troublesome for investors in recent times, and that's fixed income. If I want to be contrarian there, what should be on my radar?
Benz: This is a tough spot because, by and large, most of the bond categories have performed pretty well. Even as stocks have outperformed, bonds have really done quite well for investors, too. One area I would say that contrarians might look at--and I highlighted this in a column I wrote a couple of months ago--would be the Treasury Inflation-Protected Securities space. This has been a category that a lot of investors have been fleeing, and it's easy to see why [because we] have low inflation. So, there's not a lot of imminent need to have inflation protection in your portfolio. Then, when we look at core TIPS products, what we see is quite a bit of interest-rate sensitivity.
So, investors are not worried about inflation, which the funds are designed to protect against, and [the funds] are, in many cases, fully exposed to interest-rate hikes. So, this is a deeply unloved category; we have been seeing outflows. But I think it's worth considering, because when you look at TIPS today, the so-called break-even rate for a TIPS bond is about 1.7%. That means that investors are assuming that inflation will run in that ballpark. If it runs higher, though--and historically, over long periods of time, it has--the purchaser of a TIPS bond or a TIPS fund will be the winner. So, I think that it's an area to consider, particularly if you are someone who is getting close to drawdown of your portfolio. If you are getting close to retirement, you are going to be pulling from that portfolio for your living expenses.
I think you want to think about adding inflation-protected securities, and I have a couple of ideas of funds that I like. One that I like for shorter-term income needs would be Vanguard Short-Term Inflation-Protected Securities (VTIPX). It's an index-tracking fund, but I think it's kind of a neat fund in that it provides a little bit of inflation insulation without all of the interest-rate-related noise that comes along with the intermediate- and long-duration TIPS products. But for investors who have slightly longer time horizons, I think it's reasonable to consider a core-type TIPS product--and there, again, Vanguard Inflation-Protected Securities (VIPSX) is one that we like. Harbor Real Return (HARRX) is another one we've often recommended, and also American Century Inflation-Adjusted Bond (ACITX). Those are all funds that are highly rated by our analyst team.
Stipp: Tilting into the unloved can be a great strategy for investors in the long term. Christine, thanks for joining me and for those ideas.
Benz: Jason, thank you.
Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.
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