Investing Insights: Stock Funds for Retirees, Bank Earnings

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Susan Dziubinski: Hi, I'm Susan Dziubinski for Morningstar.com. Today's retirees need their portfolios to last for two decades or more. Stocks can provide some much-needed growth during the drawdown phase. Morningstar's director of personal finance, Christine Benz, includes three stock funds in her model portfolios for retirees. She is here today to discuss them with us.

Christine, thank you for joining us today.

Christine Benz: Susan, it's great to be here.

Dziubinski: Now, your retirement portfolios include stock funds in that very last bucket, Bucket 3.

Benz: Right.

Dziubinski: And the stock fund that takes up the largest percentage of assets in that bucket is Vanguard Dividend Appreciation. Why this fund in particular?

Benz: This fund is available as either an exchange-traded fund or as a traditional mutual fund. The reason I like it, Susan, is that it is focused on companies that have had a history of growing or increasing their dividends. That tends to anchor it in financially healthy firms. A big share of this portfolio is classified as wide-moat stocks. So, these are generally higher-quality companies than the broad market. I like it because that tends to reduce the volatility relative to other stock funds. It's also very, very cheap. It charges just 8 basis points.

Dziubinski: Oh, it's great. Now, speaking of the broader market, you do include another Vanguard index fund in your portfolio, Vanguard Total Stock Market. How does that one fit in?

Benz: Well, this one could be one-and-done. If you just wanted a single U.S. equity fund, this would be the one that I would use. The reason I use it as a complement to the Dividend Appreciation fund is that it provides some exposure to sectors that are somewhat lacking in the Dividend Appreciation fund. So, it's broadly diversified. It has exposure to technology stocks, for example, which tend not to pay very large dividends certainly. So, it's a good complement or it's a good sole stand-alone holding. It's also very, very cheap. In fact, cheaper than Dividend Appreciation.

Dziubinski: And then you round things out with a little bit of an international flavor with American Funds International Growth and Income. Tell us a little bit about that fund.

Benz: Yeah. This is a fund that is run by American Funds' Capital Research Group. It has multiple managers, but they are all applying what we think is a very sensible strategy. They look for dividend-paying firms by and large. And one thing that people might not know about American Funds' products is that they are available through Schwab in the F share class without any sales charge and without any transaction fee. So, a lot of people might say, American Funds, that's for load investors. Not so. You can access the funds through Schwab.

Dziubinski: That's great. A lot of good ideas for retirees today. Thank you, Christine.

Benz: Thank you, Susan.

Dziubinski: Thank you for tuning in. I'm Susan Dziubinski for Morningstar.com.

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Damien Conover: As we approach the first-quarter earnings for the large-cap pharmaceutical stocks, there's a lot of important themes that we think investors should be aware of. One of the key themes will likely be commentary about drug rebating. Over the last couple months we've had congressional hearings about the potential to eliminate drug rebates. And this is really an effort to try to make drug pricing more transparent. And we expect commentary from a lot of the firms to explain what this potentially means for the outlook of sales growth. When we unpackage this outlook, we think it's going to be really beneficial, especially for firms that don't do a lot of drug rebating. Firms like Roche, Celgene, Bristol--we think these firms are well positioned in a rebate-free environment, but there are other firms that really lean into rebating. These are firms like AstraZeneca, Eli Lilly--it could be more of a challenge for them, but in the whole scope of things, we think more transparency should largely be good for the large-cap drug firms.

Another key theme we're looking at in the first-quarter results is how the next-generation drugs are doing and, really, the ability for these next-generation drugs to offset drugs facing generic and biosimilar competition. Johnson & Johnson is, I think, a good example of what we're looking for. They have a key molecule called Remicade that is facing biosimilar competition, and we're anticipating this drug to lose about 20% of sales annually over the next several years. However, Johnson & Johnson also has a lot of great new molecules that are gaining increased traction. So, when we look at J&J overall, we think the firm is well positioned for steady growth; however, on a valuation perspective, this is a firm that we think is largely fairly valued, nevertheless has a strong, wide economic moat that we think will protect its profits over a long term.

Shifting gears to a few other firms that we think are undervalued and we anticipate this quarter's earnings results to help guide us to more granularity on some of the valuations--Bayer is a name that we think is undervalued. We anticipate this quarter's results to really show fundamental growth within its core business and to talk a little bit more about the litigation around the glyphosate concerns, which we think has caused an undue amount of pressure on this specific stock. The last name I'd mention here is AbbVie. This is a firm also facing biosimilar competition against Humira--one of its key molecules. However, it's got a lot of great next-generation molecules in oncology, immunology, that we think will support long-term growth.

In aggregate, when we're looking at the quarter, we think large pharmaceutical stocks will report solid earnings that really should help give us more granularity around the drug rebates that potentially could be eliminated, as well as more granularity around some of the new drug launches offsetting products losing exclusivity to generics and biosimilar competition.

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Karen Wallace: Hi, I'm Karen Wallace for Morningstar. How much does likability matter when initially choosing an advisor, and what role does it play in maintaining an ongoing relationship with that advisor? Here to discuss this is financial-planning expert Michael Kitces.

Michael, thank you for being here.

Michael Kitces: Thanks, Karen. Good to be here today.

Wallace: So, you've recently had a discussion with Carl Richards on your blog where you tackled this question of likability. And it sort of goes beyond just politeness. It sort of goes into communication styles and authenticity. Can you discuss what role these play as an advisor?

Kitces: So, this is kind of an interesting challenge to me. I think from both the advisor end, what we try to do to be successful with our clients, and from the investor end, how do you find and pick your advisor. Because there's been this long-standing challenge out there. You look at some of the consumer surveys--nobody trusts their financial-services institution, but everybody likes their individual advisor: "I don't know about the firm, but my guy or my gal is a good person and I like them." I think, well, all right, that's great; I don't want to denigrate anyone. But how do you actually know they are any good and doing the right thing? "Well, like, well, they are really nice; I like them a lot." But how do you actually know if they are any good and they are doing the right thing?

There's this challenge I think in the world of trying to find an advisor where it's an intangible service. I don't know if the advice is good until five, 10, 20, 30 years from now when I look back and hopefully say, well, my advisor gave me good advice, that went really well, I'm so glad I did those things. It's really hard to evaluate. It's even really hard to evaluate shortly after the fact. You often don't know until way later whether this advice was actually good and helpful and fruitful.

And the challenge I think it creates is--and I have a lot of sympathy for this from the investor end--it gets really hard to pick an advisor. Just literally, what are you going to go on, how are you going to choose? And what is it often now coming back to: "Well, I feel like I get along with them. I like them; I like my advisor." And not that I'm negative on having a relationship with an advisor that you like, but I'm not sure it should necessarily be the best driver of this person can give me advice based on my accumulated life savings that I've worked 30 years for because he or she is a nice person.

And so, to me, from the advisor end, I think this is still sort of a cross that we have to bear to some extent. I can't give someone a good advice if they don't like me, don't want to communicate with me. This is not going to work as a relationship. And so there is at least some burden on us as advisors to try to be at least reasonably likable and polite and have reasonable rapport in company even if--and sometimes especially when--we have to give hard advice and deliver hard medicine.

But I think from the investor end as you are thinking about this and working with advisors, I would caution people about framing it too much as, well, "I just want to make sure I like my advisor." Because frankly, if they are going to give you hard advice, I actually hope you don't like them sometimes because sometimes that's part of giving people hard advice they need to hear. And what I encourage instead is--just think about it from a communication style. You do need to be able to communicate with them well, you don't necessarily need to enjoy breaking bread with them and playing golf with them and doing social stuff with them. But you do need to communicate well with them. And people communicate in different ways. Some are very visual and do a great job drawing pictures and telling stories. If that's what works for you, that's great. Other people love to delve into the numbers. So, find yourself and advisor that loves delving into the numbers as much as you do. You have a right to demand and insist that. If you can't find an advisor that can communicate what you need to see and hear, find a different one who does.

But I just would caution: Sheer likability alone ... unfortunately Bernie Madoff was a likable guy. In fact, part of the reason why con men are successful in what they do is because they are very likable people who then don't always tell all the truths. And certainly not to imply that all likable people are cons or all likable advisors are cons, but you have to go a step deeper into--are they actually competent? They have some credentials, they know what they are talking about, and communication matters, but saying "Can I communicate with this person?" is different than trying to just find someone you like.

Wallace: So, ideally, you want somebody who can explain things that you don't understand to you clearly and someone you can trust to tell you when you are on the wrong track?

Kitces: Yeah. As I kind of view it, it sort of boils down to three pieces that are very related. One, is the communication there? Can they explain things to me the way I need to hear them and have them explained to me? And we all take in information differently. So, one advisor could be fantastic for one person, is a terrible fit for another, because the styles are just different.

I think the second driver is essentially what I would call competency. Do they actually have the expertise? Do they actually have the knowledge? I find sometimes we sort of forget, "Oh, they also have to actually know what they are talking about," not just communicate well but communicate things that are factual and knowledgeable and accurate. The unfortunate reality in the advisor industry is our minimum standards are very low. Doctors have to go to med school, and lawyers have to go to law school. Financial advisors don't have to go to financial advisor school. Our minimum regulatory requirements are fairly simple, a minimum exam just to make sure we know the laws that apply to us. So, looking for things like CFP certification, other advanced designations, and the experience just to be competent matters.

So, communication is the first, competency is the second. And then, the third I think it does still come down to trust. Not necessarily likability per se. Although it's hard to trust people I completely dislike, but do you trust them? Meaning, if they are going to give you advice, do you trust the advice? Because if you are going to spend all of your time second-guessing and error-checking and back-checking your advisor, you are not getting very much leverage and time savings and efficiency out of this relationship; find someone that you can trust enough that when they do give you the advice, you are comfortable and willing to take it. And if you just fundamentally don't trust them, that should be the biggest warning flag of all that you need an other advisor. Not that they have to be a bad person, but if you can't place that trust in them, find someone that you can.

Wallace: That's really a great advice. Thanks so much for being here to discuss it.

Kitces: My pleasure. Thank you, Karen.

Wallace: For Morningstar, I'm Karen Wallace. Thanks for watching.

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Sarah Bush: Despite a recent downgrade of its Morningstar Analyst Rating from Gold to Silver, there's still a lot to like about Loomis Sayles Bond. A team of veteran managers, including bond-fund legend Dan Fuss, skipper the fund. They're backed by one of the deepest credit analyst teams in the business as well as dedicated sovereign and macro researchers. That depth is important because the team's approach is wide-ranging. The fund has the flexibility to invest across corporate bonds, convertibles, and non-U.S. dollar debt and will venture into emerging markets. Even the occasional stock pops up in the portfolio.

This mix typically makes this fund one of the most aggressive in the multisector bond category, and it's vulnerable to steep losses in weak equity and credit markets. Meanwhile, modest concerns about concentration risk in the portfolio led to the fund's recent downgrade to Silver. That said, the team's combination of a research-driven and often-contrarian approach gives this fund plenty of appeal. The managers take advantage of downdrafts in the credit markets to identify bargains, as they did starting in mid-2014 when junk-bond prices fell sharply. At that point, they found good opportunities in larger and well-known issuers as well as commodity-driven names that were hurt by plunging oil prices. The fund turned in big losses in 2015 when these names and its currency exposure suffered but rebounded sharply in 2016 and 2017. Over the long haul, investors who have been patient have been well-served here.

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Eric Compton: All of the big four U.S. banks have reported earnings, giving us greater insight into the overall health of the U.S. banking industry. While many have been worried about an imminent recession and a flattening yield curve, underlying bank operating performances remained strong. We have been paying close attention to management commentary on the economy, loan growth, and credit metrics to gauge how healthy the economy actually is. So far, commentary has been largely positive, core loan growth is still decent for most of the banks, with several even highlighting middle-market strength, and the credit environment remains benign. Yield curve aside, many of the fundamentals still look OK.

For Citigroup, results were mixed. The bank contained costs well and is already getting close to hitting their full-year return-on-tangible-equity target; however, the bank is lagging from a growth perspective. While growth isn't perfect, even moderate growth combined with continued expense control should reasonably have Citi meeting or getting very close to its profitability goals, which is a welcome development for a franchise that has historically struggled here, and shares look relatively cheap to us.

JPMorgan has firmly established itself as the most profitable bank among the big four. Despite a difficult trading and issuance environment, the bank hit new highs for returns on tangible equity. We do not expect much improvement for the bank from here but do think the bank can sustain these returns without a turn in the credit environment.

For Wells Fargo, results were once again disappointing. Management guided down on their net-interest-income outlook, and while they stuck to their expense guidance, they admitted that they were spending more on compliance issues than they previously expected. The return on tangible equity did stay at 15%, but without a long-term CEO and more work to be done on the regulatory side, Wells still has a long way to go.

Bank of America, similar to many peers, also saw slowing revenue growth, but expense control and share repurchases drove EPS growth. The bank stuck to full-year expense guidance and is growing core deposit relationships, wealth assets, and commercial loans. We like where B of A is positioned competitively and think there could be room for improving profitability in the future.

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Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Investors with truly diversified portfolios might consider holding a few specialized funds around the margins of their portfolios. Joining me to share a few of his favorites is Russ Kinnel. He is director of manager research for Morningstar.

Russ, thank you so much for being here.

Russ Kinnel: Glad to be here.

Benz: Russ, let's talk about specialized funds. When we talk about specialized or niche funds, what kinds of funds are we talking about?

Kinnel: There are often areas that focus on small parts of the market. In other words, the total market cap isn't that big. So, it could be a certain region or an investment type that's not that big. And generally, when we look to these, we are looking for some mix of diversification, because it doesn't act like the broad market and/or value-add. So, good little niche alpha generators. So, useful players used in moderation.

Benz: So, that was my next question. If I want to use some of these funds that we are going to be talking about, what should be on my to-do list first? I assume that I should have a well-thought-out asset-allocation plan and some of the core type funds first.

Kinnel: That's right. Build out your core. And I think niche funds are fine, but you don't want to build a portfolio that's all these niche funds. Niche funds can be kind of exciting; you hear about something in the headlines, you buy a fund. You don't want to have 10 of these funds taking up a third of your portfolio. So, be disciplined. Have a couple. Don't go crazy with them.

Benz: So, let's talk about some of the ones that you really like. One is a foreign smaller-cap fund. So, this would be maybe a complement if I have my core international-stock holding, I might hold a little bit of this one as well. This is an Artisan fund. Let's talk about it.

Kinnel: Artisan International Small and Mid-Cap is run by Rezo Kanovich, who came over from Oppenheimer in October of 2018, and he really changed the fund into an aggressive growth fund. We saw him at Oppenheimer, he had tremendous success with that strategy. But, to me, because it's a very aggressive strategy, I don't think it's really a core holding. I think it's one I might make, say, 5% of my portfolio. Again, very aggressive investor. And I like the fact that right now it's a fairly small fund, under $1 billion. Artisan has a good record of closing funds before they get too big. Oppenheimer is a little more shaky at closing funds. So, I like it when a manager goes from that kind of shop to one like Artisan. I see a lot of positives there. But again, I would be cautious because it is an aggressive fund.

Benz: When you and I were talking about which funds to talk about here, you sent me three Matthews funds. We settled on one. First, let's talk about what you and the team like so much about Matthews and what their specialty is.

Kinnel: So, their specialty is investing in Asia, and they do it really well with a big team of managers and analysts all dedicated to Asia. They typically favor kind of a growth-at-a-reasonable-price strategy, tend to be a little lower in market cap. So, they are not just owning Samsung or the household names--they go beneath that. And so, we've really come to like them as a firm that just has a lot of expertise, a lot of people who make a career investing in Asia.

Benz: So, Matthews Emerging Asia is the fund that you are highlighting here.

Kinnel: Right. So, this is very much a niche fund. If the Artisan fund was a 5%, this fund maybe should only be at 2% because it's a niche within a niche. It's focusing on emerging Asian. So, what that means is, forget about Korea, Hong Kong, and China, the giants of Asia--

Benz: --Or Japan.

Kinnel: Or Japan. This is a fund that's investing in Pakistan and Bangladesh and Sri Lanka--some of the smaller markets. So, again, I think it's got a sensible approach. They have very experienced managers despite it being a relatively small fund and a small niche. So, I like all of those things. But again, it's a niche fund. You have much lower correlation with the U.S. market. It's about a 30 correlation with the EAFE as well. And so, it's a better diversifier because these markets move differently. But again, they truly are emerging markets with higher risk. It actually has a lower standard deviation than the S&P 500. But don't trust that--it's a high-risk strategy.

Benz: And these two funds, the Artisan fund and the Matthews fund, they are also not cheap relative to my big core foreign-stock fund, most likely.

Kinnel: That's right. That's another reason to keep these funds at a small amount. They are cheap relative to their peers in those categories. Particularly, the Matthews funds are generally pretty cheap. But right, they are pricier. So, that's another reason you want to keep that smaller. Most of your portfolio should be in low-cost core funds.

Benz: Another fund that you like, a U.S.-focused fund, is Fidelity Select Health Care. This is one space where you'd want to do a good survey of what you've already got in your portfolio before adding on dedicated healthcare exposure, right?

Kinnel: That's right. Your typical growth fund is going to have meaningful healthcare exposure. So, it's a good thing to run your portfolio through Morningstar X-Ray or some other tool that says "How much exposure do I have to this area" before you add to it. But I think what's appealing here is that Fidelity has built a really good team of analysts under Eddie Yoon. They have 15 dedicated healthcare analysts with a wide range of medical specialties. And so they really know the space. So, to me, this is a space where you can really get some good value-add. But again, you are right, in this case you are going to have some overlap. It's not going to be as much a diversifier as an alpha-generator for you.

Benz: The last fund on your list is, I think, truly an interesting diversifier idea. So, if I've got my core equity, my core fixed income, Gateway Fund is another fund to consider. Let's talk about that one.

Kinnel: This is a very different fund from the other ones we've talked about. It's going to be less volatile and less risky than the market, whereas the other ones potentially are much riskier. The idea here is they own essentially the broad market, but then they do a collar strategy with options. And what that does is it significantly lowers the upside and the downside. So, in a strong bull market, it might only get a third of the upside. In a strong bear market, it might only lose half as much. So, it's a really nice diversifier in that way. But I think, to me, the risk here is a little sneaky. It's kind of opportunity cost, right, that you are giving up. You could have put that money in a straight equity fund and had greater upside even with the downside. So, again, to me, that says it's still a niche fund, but it's a nice diversifier, it's a nice way to tone down some of that equity risk.

Benz: OK, Russ. Interesting ideas. Thank you so much for being here to discuss them with us.

Kinnel: Glad to be here.

Benz: Thanks for watching. I'm Christine Benz from Morningstar.com.