Christine Benz: Hi, I'm Christine Benz from Morningstar.com. Morningstar's director of manager research, Russ Kinnel, is a long-time observer and researcher of mutual funds. He's here with me today to share some of the holdings in his own portfolio.
Russ, thank you so much for being here.
Russ Kinnel: Glad to be here.
Benz: Russ, I feel a little like I am getting a look at what's in Bobby Flay's cupboard or something like that. It's great that you are willing to share some of your own personal portfolio holdings. Before we get into them I'd like to talk about what qualities generally speaking you look for when selecting mutual funds.
Kinnel: I look for low cost, great management, great strategy, ideally something that can be a core holding for a long time in my portfolio. Really a lot of the things we look for in a Gold-rated fund are what I look for. To be a top holding in my portfolio naturally has to be something you can really depend on, something I really have a high opinion of.
Benz: Where do you come down on the passively managed versus actively managed question when it comes to your own portfolio?
Kinnel: I think they are both great. I have mostly active funds in my portfolio, but I do have some passive as we'll discuss. I think they are both great. We have Gold-rated funds from both categories. I think most people should probably own some of each, I think it just makes a lot of sense--each can do a good job and it also depends, how much effort you want to put into the research obviously. Active requires a little more effort than the passive.
Benz: Good point. Before we get into some of your specific holdings, for each of them I am hoping you can say where you hold them--whether you hold them in 401(k), IRA, taxable account, or so forth. Let's start with American Funds New World. Talk about where you hold it and then I'd like to get into why you like it.
Kinnel: I have got this one in my 401(k), it's in Morningstar's 401(k). I just like the fact that it's a nice conservative emerging-markets fund. We have institutional share class of the fund, so very low cost, very dependable fund.
Benz: For people who aren’t familiar with this particular fund. It's really different from most other pure emerging-markets equity funds. Let's talk about that and how it's construction sets it apart and makes it more conservative.
Kinnel: That’s right. It's got some of your typical emerging-markets equities. But it also has some in developed market equities from businesses that do a lot of business in emerging markets. It's kind of taking a more holistic approach to that, and what that means is that it's less volatile, but it also means you are giving up a little. When emerging markets really rally this fund's going to lag. I think it makes a lot of sense, that there are a lot of different ways to get that exposure. To me, it makes a lot of sense, but it's not going to be the highest potential returner in the EM space.
Benz: Right. So, in a year like 2017 when EM is going strong this fund will perhaps tend to not perform quite as well.
Kinnel: That’s right, but I think its useful for investors because these more cautious EM funds are the kind that people will hold through the downturn, because when emerging markets get hit they get hit really hard. You lose 50% or 60% of your investment. If you can minimize that loss or reduce it a bit that’s going to help people stick through to the good side.
Benz: Really good point. Let's look at another international fund, this is Dodge & Cox International Stock. Let's talk about where you own it first and why you own it.
Kinnel: Sure. I have got this one actually in my 401(k) and in a taxable account. I initially brought in a taxable account before it was available in our 401(k), later added it to our 401(k), so I own it in both places.
Benz: In terms of it's appeal it lands in our foreign large blend category it's a Gold-rated fund. Really time-tested process on display in this fund.
Kinnel: Dodge & Cox is an old school value investing firm. But to me maybe the most important thing is just the stability of people, that their analysts and managers tend to make a career of it there. You've got team-managed approach here, and so one person, retiring doesn't throw off the fund in the least. Really a great group of analysts and managers there. When I talk about a fund you can own and forget about, Dodge & Cox is really almost like an index fund in that you can buy their funds and they are pretty much going to be the same fund in five or 10 years.
Now this one does obviously have some risks. It got burned in '08, it had too much in financials, but I really believe in the fund, obviously, I owned it before that time and I held through. So, I am a true believer.
Benz: Dodge & Cox funds are really low cost.
Kinnel: Very low cost. Again, we talk about active versus passive, and I think whether you are active or passive, you want low costs. When you have a low-cost active fund like this one, they only have a small hurdle to catch up with a passive fund.
Benz: Now, let's look at another fund that you hold. This is Vanguard Primecap Core. Let's talk about where you hold it and why you like it. By the way, this is one I own, too.
Kinnel: This one is closed to new investors. I hold it in a taxable account. There are Primecap Odyssey funds that are still open, so you can get pretty similar fund. But low cost, the best growth investors out there. I just really believe in them. You have a team approach here where each manager picks stocks separately from the other managers, but they all have the same input of their analysts. They are just very good fundamental growth investors. You put that together with Vanguard, and its really low cost. This one I have in a taxable account. I have Vanguard Capital Opportunity in an IRA, and I have Primecap Odyssey Aggressive Growth in a 401(k). So, I am a big fan.
Benz: It is one of the firms, when we ask our analysts, what's your highest conviction active shop, Primecap usually bubbles close to the top.
Kinnel: They are outstanding.
Benz: Let's talk about the last fund, also a Vanguard fund, this is Tax-Managed Capital Appreciation. Based on its name, I'm assuming you hold it in a taxable account, you better.
Kinnel: Good guess.
Benz: Let's talk about that. I think that these tax-managed funds, you and I both like them, but they are kind of under-recognized among investors, especially as many investors have gravitated toward ETFs for tax efficiency. Tax-managed funds, though, are still worth a look.
Kinnel: Yeah, they are. Jack Bogle once joked about the words "tax managed" being the best way to scare investors away, and it seems to continue to work. You put "tax" in the name and people think it's boring, you are sacrificing returns. It's really just essentially the Russell 1000 with a couple of tilts. One, they tilted slightly away from dividend payers, because dividends sometimes get taxed more than capital appreciation. The other thing is they actively harvest losses in order to offset gains. The upshot is on an aftertax basis you should do really well, and in fact it has done really well. It's actually beaten the Russell 1000, the S&P 500 on a pretax basis. I don't know that I would necessarily that going forward. That may just be a little bit of luck. But the more important thing is on a aftertax basis, this fund should continue to deliver. It really is good at avoiding capital gains distributions.
Benz: It gives you very broad diversification almost indexlike exposure but with a little bit more tightness around the tax efficiency.
Kinnel: That’s right, and it's super cheap and of course when these funds came out there were not many ETFs out there. Now it's maybe less of a standalone draw compared with ETFs because now there is lots of ETFs with good tax advantages. But it still keeps on chugging, it's really low cost, and it does a great job.
Benz: The other thing that I like about it is that it can adjust to the tax regime. If tax laws change, and as you suggested dividends could be at some point taxable as ordinary income again, the fund would be able to adjust its strategy a little bit.
Kinnel: That's right. Because it's not actually an index fund, it's passive more or less, it does have some flexibility to adjust that. It is nice because the tax laws change every few years.
Benz: Russ, thank you so much for giving us a peek into your own portfolio, really helpful.
Kinnel: You are welcome.
Benz: Thanks for watching. I'm Christine Benz from Morningstar.com.