Home>Video>Benz: 5 Fund Types I'd Like to See More Of

Benz: 5 Fund Types I'd Like to See More Of

Mon, 6 Oct 2014

The mutual fund and ETF industry is awash with new investment types, but there's a shortage of solution-based funds that address real investors' needs, says Morningstar's Christine Benz.

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Video Transcript

Jason Stipp: I'm Jason Stipp for Morningstar. The mutual fund and ETF industry is constantly cranking out new investment types, and it's safe to say that most investors don't need these funds. But here to offer some ideas for more funds she would like to see 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: So, you tend to like what you would call solution-based funds. These funds would be different than the funds that are trying to capitalize on the latest hot idea, which are so many of the new fund launches that we tend to see. So, what would a solution-based fund do?

Benz: I think the classic example of a solution-based fund is a target-date fund. It's set up to address investors' real needs. And so, when we look at 401(k) plan participants, what do they struggle with? They struggle with coming up with a sensible asset allocation given their timeframe; they struggle with selecting reasonable funds to populate that portfolio; finally, they struggle with keeping that asset-allocation mix up to date as they get closer to retirement. The target-date fund neatly handles all of those tasks in a single fund solution. So, that's what I'm talking about when I'm talking about solution-based investments.

Stipp: And a specific type of target-date fund you would like to see more of is one that is more aware of taxes.

Benz: I've called for this before, and I have yet to see this type of product. But I would love to see some sort of tax-managed target-date fund. The reason being that, for folks who have been maxing out their 401(k)s or have also been investing in IRAs, they can use target-date vehicles within the confines of those tax-sheltered wrappers because target-date funds are set up typically to be embedded in those types of vehicles.

If they are moving into their taxable accounts, if investors want to invest additional assets for retirement in their taxable accounts, the target-date fund probably won't be such a good fit because it's not managed for tax efficiency in any way. So, I'm thinking of just a simple target-date vehicle that might use index funds for equity exposure and municipal bonds for fixed-income exposure. I think that could be a really nice addition to taxable investors' tool kits.

Stipp: A lot of target-date funds have a retirement fund, but you say there is room for improvement for the types of funds you might invest in in retirement, if you are using one of these solutions.

Benz: That's right. This is an area of the market that we've seen evolving very, very quickly as we've seen more and more baby boomers retiring. Fund companies know that they need to come out with some better solutions for this group of individuals who are retiring without pensions. They need to extract cash flows from their portfolios. How do we make this less complicated for retirees?

And so, I think a solution for them would be some sort of a managed-payout vehicle--Vanguard has one--where you are not relying strictly on income-producing securities to deliver that cash flow. You are opportunistic about where you go for those cash flow distributions. Maybe you are using rebalancing proceeds in some years to deliver that cash flow. In years when interest rates are higher, maybe you are taking some income from the portfolio. But I like the idea of managed-payout funds, retirement-income funds that do have that level of opportunism and flexibility embedded in them.

Stipp: For investors who maybe aren't interested in the full automation of a target-date fund but want to keep it simple, you say it would be great if they had more options among global index funds.

Benz: That's right. And there are some global index funds on the market, but typically they are higher cost than buying a separate U.S.-equity index fund and a separate foreign-stock index fund. I think if we were to see more assets flow into these fund types, if more of these fund types hit the market, you could see a strong appetite for them, particularly among younger investors who are accumulators who just want to let the chips fall where they may and let the market do its work in terms of deciding which companies and countries deserve to have the biggest value in the total global stock market capitalization.

So, I think a global market index is a great idea for people who are just starting out or for people who are in their middle accumulation years. Having that much foreign-stock exposure may not make sense for people getting close to retirement because you do get a lot of foreign-currency fluctuations that will affect how your portfolio behaves. But I think it's a good idea for younger investors who are in accumulation mode.

Stipp: Investors who are familiar with the Morningstar Style Box know there are large-cap, mid-cap, and small-cap areas of that box. And you say it'd be great if there were more funds that crossed the frontier between the small- and the mid-cap boxes.

Benz: That's right. And there are certainly some funds that do that. But one reason I like that vehicle type is because it gives the investor fewer moving parts to deal with. So, when you think about small- and mid-cap stocks, they take up somewhat less than 30% of the total global market capitalization. So, I think it makes sense for investors to try to hit the small- and mid-cap squares with perhaps a single fund.

I also think that it gives active managers--to the extent that you own an active manager in this space--a little more flexibility. If you own maybe a fund that is primarily small cap oriented, you are giving the manager latitude to own mid-cap stocks. And it can also reduce tax and transaction costs incurred by that portfolio if the manager isn't having to periodically sell securities because they have outgrown his or her market-cap parameters. Or, maybe they have gotten too small to fall within the market-cap parameters. This type of fund, I think, could ease those sorts of costs and those needs to trade.

Stipp: The last category of investments that you think investors could use some more options in are inflation fighters.

Benz: That's right. There are some of these funds on the market right now, and the idea is that you are embedding a lot of different inflation-fighting instruments under the hood of a single investment fund. So, maybe you've got Treasury Inflation-Protected Securities (TIPS) in the mix; you've got commodities there; you might have real estate investment trusts (REITs)--a lot of different vehicles that we know have some inflation-fighting attributes embedded in a single fund type.

The reason why I think this is a really attractive concept is because it will keep the investor from having to manage a lot of different parts. Some investors really struggle with this idea of, "Well, how much should I allocate to TIPS? How much should I allocate to commodities and all of these other inflation-fighting investment types?" It simplifies that inflation-fighting piece of the portfolio.

Stipp: Well, Christine, we hope the fund industry is listening today to these great ideas. We want to see more of these kinds of funds. Thanks for joining me.

Benz: Thank you, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.

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