Morningstar's Top Picks for Retirement Portfolios
In this special report, Christine Benz lays out our best investment ideas and how to structure a portfolio in retirement.
Note: This video is part of Morningstar's 7 Days to Retirement Readiness week special report.
Christine Benz: Hi, I'm Christine Benz for Morningstar.com. I'm a big believer in structuring your retirement portfolio by your anticipated spending horizon, which is sometimes called a Bucket strategy. The starting point is figuring out how much you will need to withdraw from your portfolio each year to cover your spending needs. You then need to make sure that your planned withdrawal amount will be sustainable throughout your retirement. Once you know how much you will be withdrawing each year, you can then organize your portfolio by holding assets in investments where you are likely to have a positive return over that spending horizon.
Money that you expect to spend in the first few years of retirement can go into Bucket 1, which holds cash. It won't gain much, but it won't lose anything either. I have typically recommended that retirees hold one to two years' worth of portfolio withdrawals in cash.
Money for which you have a slightly longer spending horizon can go largely into high-quality bonds and bond funds; this is what I call Bucket 2. Bonds are more volatile than cash and you have the potential for losses. But for time horizons of at least five years, they have been quite reliable. I typically recommend that retirees set aside enough money in buckets one and two to cover 10 years' worth of portfolio withdrawals. That way in a worst-case scenario in which stocks fall and stay down for a long time, you wouldn't need to touch your stock portfolio when it's depressed.
I recently asked Sarah Bush, who is director of Morningstar's fixed-income strategies team in manager research, to share some of her favorite bond funds for Bucket 2. Her picks range from very conservative to more aggressive.
Sarah, thank you so much for being here.
Sarah Bush: Thanks for having me.
Benz: Let's talk about money that an investor in retirement might expect to spend within, say, the next anywhere from three to 10 years of retirement. What sorts of assets would be appropriate? A short-term bond fund?
Bush: As you get out just past cash, short-term bonds come to mind. These are funds with relatively short durations. You are not expecting to have a ton of interest-rate risk. And in general, you have to be careful in this space because there are some more aggressive funds. You can also find funds that are pretty conservative when it comes to credit quality, so you are not taking on a huge amount of credit risk.
Benz: One of your favorites in this category is Baird Short-Term Bond. Let's talk about why you like it.
Bush: Baird is just a very straightforward shop, but we like a lot of things about it. It's a long-tenured team. It's been very stable. They are very thoughtful about the risks that they take. They are, again as I mentioned, not taking a lot of credit risk with this fund. They have got good resources to support what they are doing. And for the institutional share class, which is accessible at $25,000, fees are just very, very attractive, which again is important in a short-term bond.
Benz: Right. Let's talk about assets where an investor might have a slightly longer time horizon, so maybe at least a five-year time horizon. It seems like an intermediate-term bond fund might be appropriate there. And there's a gradation of funds that you and the team like ranging from fairly conservative to a little more aggressively positioned. Baird again is a firm that you like in terms of the somewhat conservatively, maybe vanilla types of funds. Let's talk about Baird Aggregate Bond.
Bush: Baird Aggregate Bond is an interesting choice for investors who don't want to take on a huge amount of credit risk. This is a fund that basically doesn't hold high-yield bonds. It's kind of--credit risk profile, it's a little bit more corporate risk maybe than the Vanguard Total Bond Market Index, for example, because they do like corporates. But you are not getting a lot of high-yield in this portfolio. Again, we like the same things about the Baird team. It's the same team that runs this that's running the short-term fund. Again, kind of an attractive price point. You have a very solid plain-vanilla, not a lot of risks; you are going to know what you get with this fund and should be a pretty good performer in a stress market environment, which can be something that people are looking for from their intermediate-term bond funds.
Benz: Right. Now, stepping out a little bit on the risk spectrum, looking at funds that potentially have a little more leeway to maneuver around. One that you and the team like is PIMCO Total Return, a well-known name. It was recently elevated to a Gold rating. Let's talk about what you like there.
Bush: We did recently upgrade PIMCO Total Return to Gold, and we had it at Bronze and Silver following Bill Gross' departure. One thing there, the story there has been that PIMCO has just really handled that transition into the post-Bill Gross era very well. We've seen a lot of stability in the senior management ranks. They have been very thoughtful, as always, about building out quantitative tools to do what they need to do with this fund. What we really like about PIMCO, and this has been true for a long time, is they just have a real depth of resources across any fixed-income sector, basically, on the taxable side that you can think of.
This is a fund with a pretty wide pallet. In addition to the usual, kind of, investment-grade corporates and holding mortgages and Treasuries and the like, they have built stakes in nonagency mortgages, they can hold some nondollar currencies, a little bit of the emerging-markets debt. They are very thoughtful about those risks. Unlike some of the funds in the intermediate-term bond category, some of which we really quite like that consistently lean heavily on credit, this is a fund that really has a broad tool kit and I think they are very thoughtful about how they use those risks. This is really a top-notch choice in the category if you are kind of open to having a little bit more of a wide-ranging approach.
Benz: If I'm a no-load investor, I'm just doing this on my own, would PIMCO Total Return be readily accessible to me?
Bush: You can get it through some of the fund supermarkets. The other option obviously, Harbor Bond …
Benz: Which is a no-load.
Bush: … it's a no-load. That's available. Same strategy there.
Benz: Let's talk about Fidelity Total Bond. That fund has generated a lot of assets over the past several years. I know that you and the team like it a lot. You have it at a Gold rating as well. Let's talk about what's to like there.
Bush: Fidelity Total Bond, Fidelity, again, is a very well-resourced bond shop. So, this is a little bit more plain-vanilla. You are not seeing a lot of nondollar currencies here, for example. But they do have the flexibility in addition to the standard investment-grade, mortgages, and Treasuries, they can go into high yield and they have a bucket of up to 20%, which is actually a pretty high number in high yield. Although, they are pretty thoughtful about how they use it. So, when you see high-yield valuations stretch, they are not going to be at that full 20%. They can hold high yield now. So, typically, hold around 5% in emerging-markets debt. We really like the emerging-markets debt team Fidelity. We really like the high-yield team. We think they have got the depth of credit resources and a really good mortgage team. That's sort of what's standing behind this fund's appeal and then also nice price point for no-load investors.
Benz: Let's talk about inflation protection, making sure that your bond portfolio has some purchasing power protection. You and the team have done some research into this inflation-protected bond space. One conclusion is that if you are going to maintain exposure here, you want to keep things pretty plain-vanilla and certainly keep your costs down. Let's talk about a couple of funds that you and the team like there.
Bush: In this category, we actually have a lot of high ratings on passive funds as you mentioned. One that we really like is this Vanguard Short-Term Inflation-Protected Securities. It's investing just in one to five-year. It's a passive option. Just investing in one to five-year maturity TIPS. And what makes that attractive is that TIPS can actually be very volatile. Even though you have the inflation protection, you can still have a lot of exposure to moves in real interest rates. By focusing on the one- to five-year part of the curve, you are not taking on that same potential volatility and you are getting inflation protection. It's an attractive option.
Vanguard also has--and this is actually an active option but pretty plain vanilla and also very cheap--they have kind of a more wide-ranging Vanguard Inflation-Protected Securities Bond which will give you exposure to the full yield curve in TIPS. But again, very cheap and a good option for investors.
Benz: So, that one has more interest-rate sensitivity. You'd want to have a longer holding period for it presumably than that short-term inflation-protected fund?
Bush: That's absolutely right. Yes.
Benz: Thanks, Sarah.
Of course, you can also take a passive approach to the bond funds you hold in Bucket 2. I talked to Alex Bryan, who is Morningstar's head of passive strategies research in North America, to hear about the analysts' favorite index bond funds.
Alex, thank you so much for being here.
Alex Bryan: Thank you for having me.
Benz: I'm a big believer in retirees organizing their portfolios by their anticipated spending horizon. So, for what I call Bucket 2, I usually think of that as being high-quality bonds. When you're stepping beyond cash, you want to take some risk in an effort to earn a higher return, but you don't want to go all out. The high-quality bonds, I think, are a good place to start. Let's start with a passive fund, an index fund, that focuses on short-term bonds for investors who want to venture beyond cash, but don't want to take a lot of risk.
Bryan: Vanguard Short-Term Bond ETF is one of the better options if you are looking to find a bit of a higher yield than you can get from cash, but don't want to take a lot of risk. This is a fund that basically targets investment-grade U.S.-denominated bonds with between one to five years until maturity. This fund has a bias toward government securities; about 65% of the portfolio is parked in Treasuries. But it does have some exposure to investment-grade corporate debt as well. It's pretty conservative. Most of the risk that comes in the portfolio is from rate risk. But again, since it's focusing on short-term debt, the rate risk is pretty modest. You do get a bit of a yield pickup relative to cash and you don't have a lot of risk in that portfolio.
Benz: For investors who have slightly longer time horizons and maybe want to be in intermediate-term bonds, you think one idea is just to keep it very simple, invest in a low-cost fund that would track the U.S. bond market. Let's talk about a pick there.
Bryan: That's right. Vanguard Total Bond Market ETF I think is a pretty good option if you're looking for a core, passive fixed-income exposure. This fund tracks the Bloomberg Barclays US Aggregate Bond Index, which focuses on the U.S. investment-grade market and it weights its holdings based on market value. What that does is it gives that fund pretty high exposure to U.S. Treasuries because U.S. government is one of the largest debtors in the U.S. It also has a pretty sizable exposure to agency mortgage-backed securities. And both Treasuries and agency mortgage-backed securities have very little credit risk, in fact, almost none. You're not getting a lot of credit risk in that portfolio. Again here, most of the risk comes from rate risk. The yield isn't quite as high as what you might get with a lot of active funds in the Morningstar intermediate-term bond category because a lot of the active funds in the group do take on a bit more credit risk. But it's not such a bad thing to have a conservative bond portfolio because bonds are designed to kind of be the ballast in your portfolio when stocks are …
Benz: For the equity holdings.
Bryan: Exactly. This is a good fund to play defense. If you're looking for a way to diversify away from equity risk, having a conservative bond portfolio like Vanguard Total Bond Market ETF is not a bad way to go.
Benz: How about for investors who want to pick up maybe a little bit extra yield, but still want to focus on intermediate-term bonds? You've got a pick there that has more of a corporate emphasis versus the big emphasis on government bonds.
Bryan: That's right. Vanguard Intermediate-Term Corporate Bond ETF is a good option here. It focuses on investment-grade corporate debt with between five to 10 years until maturity. These bonds are still fairly high-quality. The default risk is low, but they do have some credit risk, more so than the U.S. government. They offer higher yields as compensation for that risk. But the risk is still investment-grade. I think it's still a reasonable way to get exposure to bonds if you're looking for a broadly diversified exposure to the corporate bond space.
Benz: One challenge for the fixed-rate component of investor portfolios in retirement is just making sure that you are preserving the purchasing power from that portion of the portfolio. One way to think about adding that is to add some inflation-protected bonds to the portfolio. Can you talk about what those bonds are, what they do for your portfolio and also, share your pick in that space?
Bryan: Treasury Inflation-Protected Securities, or TIPS, basically offer principal payments that are linked to inflation. When inflation picks up, the value of the bond goes up by a corresponding amount. That's important because if there is an increase in inflation beyond what the market is expecting, you can actually preserve your purchasing power better with TIPS securities than you can with traditional bonds. Traditional bonds basically bake in the market's expectation of what inflation will be in the future, but if the market underestimates what inflation actually is, you end up with a eroded purchasing power, whereas TIPS will preserve that purchasing power if inflation does in fact turn out to be higher than people are expecting.
Now, I think, one of the best options for getting exposure to TIPS is Schwab U.S. TIPS ETF. I think it's in this space really important to keep it simple, keep your costs low. That's the biggest differentiator among the passive funds in this space. This particular fund charges 4 basis points, which makes it one of the cheapest TIPS funds available.
Benz: Bucket 3 is the growth engine of your portfolio, so it's populated with investments with higher return potential, but also higher volatility. For most investors, Bucket 3 will hold stocks, stock mutual funds or exchange-traded funds. I asked Morningstar's director of manager research, Russ Kinnel, to discuss some of his favorite actively-managed equity mutual funds.
Russ, thank you so much for being here.
Russ Kinnel: Glad to be here.
Benz: Let's talk about that commonalities among the funds that you are going to recommend. When I look down the list, they are not necessarily the most conservative funds, but yet, you think they are appropriate for retirees because they are well-managed. Let's talk about some of the key features that come up again and again throughout these picks.
Kinnel: They are not low-risk as you say. I think they are low maintenance and low cost, and you'll see all of these are from firms with outstanding parent grades. These are firms you can really trust to keep the fund on a good footing. You don't have to worry very much about a subpar manager taking over. In that way they fit nicely. Retirees don't necessarily want to watch their portfolio day in and day out. They fit nicely that I think these are dependable predictable funds.
Benz: Let's start with Dodge & Cox Stock, a kind of the classic large-cap value fund. Let's talk about why you and the team think it's so good.
Kinnel: Dodge & Cox is just a great steward. They really hire outstanding people. You have a committee-run approach here. They are just dedicated, straightforward, fundamental value investors. It's in a low-cost package. The long-term results at this firm have been great, and I don't see any reason why it can't continue for another 10 years.
Benz: Primecap Odyssey Growth is another fund on the list. It's still open to new investors, which makes it a little unusual in the Primecap lineup. Whereas Dodge & Cox is a more or less pure value fund, this fund has a definite growth bias. Let's take about its features.
Kinnel: That's right. This is a great fundamental growth fund and probably the riskiest of those I have brought for you today, but I think a very good tech and healthcare investor. The PRIMECAP team, like Dodge & Cox, is a very deep team-run fund and they just hire outstanding people. They really have a very high bar for hiring and you really see the results, just really great smart people running this fund.
Benz: There's nothing specific about this fund that makes it the only Primecap fund that we recommend. In fact, we recommend really the whole slate of Primecap funds, but this one is just open to new investors, correct?
Kinnel: That's right. They have six funds, only two of them are still open. That's the main feature, but they're fairly similar. Still a very good fund.
Benz: For investors' small-cap slot, you and the team like T. Rowe Price QM U.S. Small-Cap Growth Equity. This one was recently upgraded to Gold. Let's talk about what's going on there and why you and the team like it so much.
Kinnel: The QM stands for quantitatively managed. This is a quant fund. And quant funds, like this one, typically have a lot of names. You have about 300 names. What that means is, you a diverse portfolio. The quantitative models are looking at things like cash flow, earnings growth, earnings quality, a lot of kind of basic fundamental factors. And under Sudhir Nanda, who took over in 2006, the fund has done very well. It's gotten a little bigger, but quantitative funds are designed to have a lot of capacity. I think that's a positive, and we just see this as a really nice dependable fund.
Benz: You brought a couple of international or foreign funds. Some retired investors might think, well, I don't want to monkey around with currency exposure in my portfolio in retirement. But I think the general thought is that if you have an appropriately long time horizon of like 10 years or so, the currency fluctuation shouldn't be such a big deal, right?
Kinnel: That's right. These funds are for the long-term and I think for the most part people don't a lot of foreign currency exposures. A little really shouldn't upset the cart.
Benz: Vanguard International Growth is one that you and the team like quite a bit. Let's talk about some of the features there. This is a multimanager fund, correct?
Kinnel: That's right. This is a fund that's got two subadvisors. Baillie Gifford runs about 60% and Schroders runs about 40%. They are both growth investors, have done a really good job. It's got some unusual characteristics though. It's got almost 10% in the U.S. It's got a big emerging-markets stake. It's a little unusual, but they've really had good results and that's maybe the only caution I would put is that the last five years have been so strong I wouldn't say you should expect that in the next five or 10 years. It's really done well. But it's a very low-cost fund, 32 basis point expense ratio. It's got a lot going for it.
Benz: Another fund that you and the team like is American Funds International Growth and Income. This is one that I recently added to our Model Bucket Portfolios. Let's talk about what you think are the fund's key attractions.
Kinnel: It really is in the Capital Group wheelhouse because it focuses on income, it wants a yield equal to its benchmark and also it focuses on foreign equities which Capital Group is very good at. They have a very big analyst staff and manager staff. You a really good group of people working on the fund. One thing I would point out too is that it's about nine years and 11 months year old, and because its five-year record looks lousy, but once it hits that 10-year mark, you are going to see, it's actually outperformed benchmark and peers over its entire life.
Benz: Investors hear American Funds and they might think, oh, well, naturally, I will have to pay a load to buy this fund, but that's not the case today, right? No-load investors can access the funds without a front-end sales charge or any type of sales charge?
Kinnel: That's right. The barriers between no-load and load have really come down. Most no transaction fee supermarkets like Schwab or Fidelity have funds like American Funds from no-load. Don't get thrown by a load. You can buy these without the load. They are really low-cost and great funds. It's a great opportunity for people who traditionally invest in the no-load side.
Benz: One of the best ways to radically simplify a portfolio in advance of retirement is to use index funds and ETFs. These products often are extremely tax-efficient, too, so they can be great choices for investors' taxable accounts. I asked Alex Bryan to share some of his favorites.
Alex, thanks for being here.
Bryan: Thanks for having me.
Benz: For the portion of retiree portfolios where they have a longer time horizon, they can put up with some volatility in an effort to earn higher growth over time, I typically think of stocks as forming the bulk of this component of retiree portfolios. In terms of good passive options, one way to start and maybe finish is to just stick with a total U.S. equity market tracker. Let's talk about one of your picks in this space.
Bryan: Vanguard Total Stock Market ETF. I think it's probably the best holding to start out with and it can be the only holding that you have for U.S. equity exposure. This fund basically owns the market. It owns pretty much every single U.S. stock of notable size, and it weights them based on market capitalization, so based on what the market thinks their relative value is. Now, this has been an incredibly difficult fund to beat. Most active funds, if you could go back 10 years ago and you look at all U.S. active funds in the large-blend category, only 8% that were around at the beginning of September of 2008 went on to survive and beat this fund. It's been a very, very difficult fund to beat.
I think there's a few reasons for that. One, this fund basically incorporates the collective wisdom of all investors in the market, and the market tends to do a pretty good job of valuing stocks for the most part most of the time. Number two, this fund is very, very, very cheap. It's one of the cheapest funds out there. It charges of 4 basis points a year, so that's $4 on every $10,000 that you have invested. That gives it a huge leg up over the most actively managed alternatives. It's been very tax-efficient because it's low turnover, it's structured as an ETF. So, there's some tax advantages there as well. I think, if you are just looking for a single place to start and stop, this is the place to be, the Vanguard Total Stock Market ETF.
Benz: We should also point out, there are some other viable options that do track the U.S. market as well. In fact, Fidelity's new zero-cost funds. Investors who perhaps have cheaper options with their providers might look at those.
Bryan: That's right. Schwab, Fidelity, pretty much every major asset manager has their own version of the total stock market index, and they should perform very, very similarly to one another. If it is cheaper for you, you have no commissions for trading one fund family or another, go with that. There isn't a big difference between the different providers' index funds.
Benz: You also brought a pick that is more focused on the dividend-paying slice of the market. Let's talk about that one for investors who are income-focused.
Bryan: One of our favorite dividend income ETFs is Vanguard High Dividend Yield ETF, ticker VYM. This fund keeps it simple. It basically starts out with all U.S. dividend payers and it targets the higher-yielding half of the U.S. dividend paying market. That includes stocks of all sizes. Then it weights those stocks based on market capitalization. Anytime you chase yield, that has the potential to increase your risk because typically the highest-yielding stocks in the market are offering high yields for a very good reason because they have maybe not-so-great growth or maybe they are experiencing some operating difficulties. But this particular fund keeps risk in check through its broad diversification. Like I mentioned, it covers half of all U.S. dividend payers. And also through its weighting approach. It weights its holdings based on market capitalization, which means that it tilts toward the biggest, most established players in the market and these firms tend to have durable competitive advantages. Those two things, the winning approach and the broad diversification, keep risk in check. And this fund still delivers a higher yield than the market.
Benz: For foreign stocks, I guess, one way for investors to go at that market segment would be to simply own some sort of a global ex-U.S. product or a total international index. But you think retirees, especially who want to hold foreign stocks in their portfolio might also consider using a strategy that focuses specifically on limiting volatility. Let's talk about A, the advantages of a lower-volatility strategy in the foreign stock space; and B, what your pick is there.
Bryan: Anytime you invest in international stocks, you tend to get more volatility in the portfolio because not only do you have the stock risk in the portfolio, but you also have currency risk. If I buy HSBC, which is a British bank, I'm getting exposure to what happens with that specific company, but I'm also getting exposure to the British pound and how that currency does relative to the U.S. dollar. That's an additional source of volatility in the portfolio.
One way to address that is, I could elect to buy a currency-hedged fund. But the problem with that is those funds tend to be a bit less tax-efficient and their expense ratios tend to be a little bit higher. I like funds that specifically have a low volatility focus that target more defensive stocks in the international space.
So, one fund that I are really like here is the iShares Edge MSCI Minimum Volatility EAFE ETF. That's a mouthful, but the ticker is EFAV. What this fund does is it basically looks at individual stock volatility as well as how stocks interact with each other. It uses a bit of math and it tries to construct the least volatile portfolio possible under a set of constraints designed to preserve diversification. This fund has done a pretty good job of in offering lower volatility than the market, offering better downside protection than the international market and still give you that international diversification that foreign stocks can offer to you as investors. Overall, this is a great pick for keeping risk in check and still diversifying beyond just the U.S.
Benz: Individual stocks can also work well in a retirement account, especially for investors who don't mind doing a little bit of research. I asked Dan Rohr, who is director of equity research for Morningstar in North America, to share some of his favorite stocks for retiree portfolios.
Dan, thank you for being here.
Daniel Rohr: Thanks for having me.
Benz: We are recommending equity picks for retiree portfolios. We've recommended some individual mutual funds as well as exchange-traded funds. You are here to talk about some stock picks that you think might be retiree-appropriate. Let's talk about the qualities that you think retirees should prize when they are assembling a portfolio of individual stocks.
Rohr: We have three criteria in mind when we are putting together this short list of stocks to consider for a retiree portfolio. The first one being can this be a long-term portfolio holding. We don't want this to be something you're going to monitor week-in week-out. It's more of a set-it-and-forget-it-type thing. And for that, we think, it would be appropriate for investors to consider companies that have structural competitive advantages, that that should allow them to keep competitors at bay for an extended period of time and allow them to outearn their cost of capital decades into the future. Here we screened for wide-moat companies, using Morningstar parlance.
The second criteria what we are looking at, does it deliver income. Here, we are looking for a dividend yield at least greater than what the market as a whole is offering. I think the S&P 500 currently a shade over 2% in terms of dividend yield.
And then third and finally, is it cheap. Here, we are looking for stocks that trade at a sufficient discount to our estimate of intrinsic value.
Benz: Let's get into some of the specific picks. Gilead Sciences is one of the names that met all three hurdles. Let's talk about why the company has a moat in the team's view, a wide moat, and some of its other attributes that you think make it worth further research.
Rohr: For folks who aren't familiar with Gilead, it's a biopharmaceutical company that plays in the HIV space, hepatitis C, hepatitis B, and increasingly in a few other areas. Its moat, like many peers in the pharmaceutical space, is predicated on patents. In the case of HIV drugs, which is really where Gilead got its start, I believe their patent portfolio extends out into the late 2020s. This is a form of structural competitive advantage that investors can be pretty confident about, its durability.
Benz: Another company that looks good from the standpoint of the three criteria that you laid out is Dominion Energy. It's a utility and utilities have been buffeted around a little bit by changing interest rates. Let's talk about why that happens with utilities and why you and the team think that maybe some of the selling has been a little bit overdone.
Rohr: In very low interest rate environment, such as what we've had over the past several years, a certain class of investor will treat utilities as a bond proxy. When interest rates rise, yields on bonds rise, the relative attractiveness of utility falls, folks that had been bidding up those shares in search for yield now exit the shares, putting downward pressure on them.
We've seen over the past, I'd say, since November shares in Dominion underperform the S&P 500 by close to 25 percentage points, which is significant. Over that interval we haven't seen too much change in terms of the company's long-term fundamentals, and that's the reason we think that Dominion offers a compelling opportunity at present.
Benz: Intel is another stock that made the cut in terms of having the dividend yield that you are looking for wide moat and 4 Stars currently as of Sept. 12, 2018. Let's talk about Intel. You say that this one is actually currently as of Sept. 12 trading at the steepest discount to our analysts' estimate of fair value.
Rohr: That's right. Intel has been buffeted considerably over the past several months as investors fret about an increasingly competitive offering from AMD in the server space. We think those concerns are a bit overblown. While we do expect AMD to gain market share, say, something on the order of 5% to 10%, we don't think AMD is going to have a whole lot of success in the areas, the high-value areas where Intel is strongest and that's namely in the cloud computing and the AI space.
Benz: The last name on the list today is Procter & Gamble. This is probably a familiar name to a lot of our viewers. Let's talk about A, why you think that company has a wide moat and also, what do you think Morningstar understands about this company that maybe the market is underestimating.
Rohr: The wide moat that we assigned to Procter & Gamble is predicated on the brand strength, and that's augmented by the cost advantage that comes from being one of the biggest players in consumer goods globally. As far as what the market is missing that we think we understand really comes down to that whole time horizon arbitrage. The market will tend to extrapolate whatever recent trends have been long into the future. In P&G's most recent quarter, they saw a revenue growth of 1%, so it's in the second quarter. And if you assume that's the sign of things to come, well, yeah, P&G is probably worth more or less where it's trading at today.
We, however, think that P&G is likely to see some acceleration in revenue growth towards 3%, maybe 4% as the strategic overhaul the company has undertaken over the past several years starts to bear fruit. They've pared their roster of brands by, I think, something close to 100; 100 brands have been eliminated, allowing them to focus their resources on the best brands. We think that's going to lead to more optimal capital allocation decisions, better strategic focus, all in turn driving a modest acceleration in revenue and a bit of margin expansion as well. That's why we like P&G at the moment.
Benz: Finally, to the extent that investors hold lower-quality bond types in their portfolios, I think they make sense in Bucket 3. Their volatility is going to be a lot higher than high-quality bonds. So, maintaining a long-term mindset makes sense.
I'd like to talk about bond funds that would be appropriate where a retired investor has a longer time horizon. They might take some more risk with this portion of the portfolio in exchange for higher income. One fund that you and the team like is called PGIM High Yield, it invests in high-yield or junk bonds. Let's talk about why you and the team like it.
Bush: This is PGIM, recently renamed; it used to be Prudential High Yield Bond. We do have a Gold Morningstar Analyst Rating on this. One of the things that really stands out about the PGIM team is just a real depth of credit resources, very large credit team, and then very, very thoughtful about how they put a portfolio together, how they are doing their credit research, very attractive long-term record, nice expense ratios on this fund. This is a shop which we also like in the core space, but really think that they are doing a very, very nice job in credit. Their high yield bond is a nice expression of that.
Benz: Fidelity High Income is another high-yield or junk bond fund that you and the team like. This and the other fund, you'd want to have a nice long time horizon, right, for this portion of your portfolio? Let's talk about that one.
Bush: You are absolutely right on the time horizon. And in part, because these are funds that can do badly when equities do badly, and you get a sell-off and they can get hurt. It's definitely important to be aware of. I mentioned Fidelity earlier having a good high-yield team again. They have got a really deep, lots of analysts. Some of the managers who they have in these groups, and Fred Hoff who manages this fund, have just been doing their jobs for a long time and been through a lot of credit cycles and know this market really well.
This is one that's interesting because it's not always going to load up on the lowest-quality high-yield, kind of more of a single B. It's kind of in the middle of the range for junk bonds, not going to hold a lot of equities, but has done a really nice job of navigating a variety of environments and doing some good bond-picking.
Benz: Another fund that you and the team have long liked that tends to be aggressive also is Loomis Sayles Bond. It's better-diversified. It's not a pure high-yield bond fund. But let's talk about what's going on there and why you and the team like it so much.
Bush: This is the fund that's run by Dan Fuss who has run it for a very long time. Loomis Sayles has also done a really nice job of building a supporting team and actually now equal comanagers on the fund. We are kind of comfortable with the future of that fund going forward.
Loomis Sayles Bond has the flexibility to invest kind of old-style multi-sector. They can invest in non-dollar currencies, emerging markets debt, high-yield, very contrarian approach which has always been the case there, even occasionally a smattering of equities.
The other thing I like about Loomis Sayles Bond, and you've actually seen this more recently which you get with a multisector fund is, they are very valuation-conscious. This is a fund that can really get hurt during credit sell-offs, but they will also de-risk when they don't think they are getting paid for a risk, and that's actually something that we are seeing happen right now. As opposed to a pure high-yield fund, which is always going to be in junk bonds, these guys will lighten up when they are concerned about the market or when they are concerned that they may not be getting the kind of value that they want to see, and that's definitely something we are seeing with Loomis Sayles Bond today.
Benz: The Bucket approach is an intuitive way to back into an appropriate asset allocation based on your expected spending needs from your portfolio. We provided a number of investment picks to populate your buckets in this webcast, and I've also created a number of different Bucket portfolios on Morningstar.com for taxable and tax-deferred portfolios. Thanks so much for watching. I'm Christine Benz for Morningstar.com.
Christine Benz does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.