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Investing Insights: Portfolio Spring Cleanup, Solid Dividend

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Josh Aguilar: The stocks of multi-industrial companies are ideal places to park cash for active yield-seekers. In fact, five diversified industrial firms have continuously paid an annually increasing dividend for over 60 years. These include wide-moat 3M, narrow-moat Dover, wide-moat Emerson Electric, narrow-moat Parker Hannifin, and Stanley Black & Decker, which we don't cover. Of the four companies we do cover, at these prices we're most attracted to Emerson Electric, which trades at a 4-star rating. While we recommend a larger, wider margin of safety around the name, we do think it merits a place on an investor's watchlist. 

Emerson currently pays out about a 2.7% yield and offers investors the potential for capital appreciation at today's prices. In our view, Emerson is the undisputed king of process automation on this side of the Atlantic. Process automation deals with materials like oil and chemicals, while discrete automation deals with automobiles or electronics. Emerson sells a number of award-winning products on the automation side, including flow meters, pumps, and valves. It also boasts a massive installed base with long-lived assets spanning over two decades. Secular long-term drivers for Emerson include less available skilled labor in the manufacturing world as well as the need for environmental and safety compliance. 

Take, for example, Emerson's Coriolis flow meter. These flow meters measure mass flows of liquid and are widely used for custody transfer of petroleum liquids. While the capital cost of installing one of these flow meters is higher, the value proposition is that they lower customers' total cost of ownership. One specific use case is titanium dioxide, which is added to fine white paper to make it brighter and whiter. Using too much titanium dioxide means customers incur substantial incremental costs, while using too little will produce off-spec paper. Magnetic flow meters offered by competitors won't work for this specific use case because they're not accurate enough. Using one of these can result in a 15% rejection rate for being off-spec. But customers using a Coriolis flow meter interfaced with their control system can save a facility a meaningful amount of money--up to $250,000. The simplified spooling design doesn't require a complex installation and can support up to four individual flow transmitters and tolerate extreme temperature conditions. This allows for premium pricing relative to competitors.

With Emerson, investors are also getting a portfolio of climate control technologies and cold chain solutions, as well as tools and home products protected by well-known brands. The brands include Copeland compressors, InSinkErator food dispensers, and Ridgid tools, which you can find shopping the aisles of Home Depot. Ridgid, in particular, has a long and deep association with its plumbing tools. 

Finally, we see the potential for a long-term catalyst in the stock with a breakup of the portfolio between Emerson's automation and commercial and residential platforms. In our minds, this would be a 2021-and-beyond event and wouldn't take place before the retirement of current CEO David Farr.


Christine Benz: Hi, I'm Christine Benz for How can retirees maintain equity exposure while also keeping a lid on volatility? Joining me to share three ETF picks for the job is Ben Johnson. He is Morningstar's director of global passive strategies research.

Ben, thank you so much for being here.

Ben Johnson: Thanks for having me, Christine.

Benz: Ben, let's talk very generally, and of course, all retirees are different, but let's just talk about why many/most retirees should maintain ample equity exposure even once they begin drawing down from their portfolios.

Johnson: Well, to take it from the general, and I'll make it hypothetical and specific. So, let's assume the case of Ben Johnson, and I'm thinking about my retirement, which is still many years away. My life expectancy is longer than my parents' life expectancy, is longer than my grandparents' life expectancy. So, if I'm going to live longer, I've got a longer time horizon, which lends itself to increasing my ability to take risk over that longer time horizon. So, in that context, it makes sense to take more equity risk over a longer period of time.

Benz: Let's talk about some specific funds that investors might use where they know they want to maintain X equity exposure in their portfolio into retirement, but they would like to try to reduce the risk of--or the volatility of--their equity portfolio a little bit. You brought some ETFs that you think address this challenge. One is an iShares fund that is specifically focused on the lower-volatility subset of the U.S. equity market. So, let's talk about that. What is the case for low-volatility products like this one, and what do you like about this specific fund?

Johnson: So, the case for low volatility isn't so much a return-driven case. It's a volatility-driven case. So, these portfolios aim to reduce the volatility of your equity exposure versus just owning the market outright. So, the first fund that you mentioned is the iShares Edge MSCI USA Minimum Volatility ETF. The ticker for that is USMV. So, this ETF looks to create the least volatile portfolio--not possible--but a less volatile portfolio, within sort of the universe that is the MSCI USA Index, which is an all-cap U.S. equity benchmark.

So, it doesn't necessarily take the least volatile stocks out of that universe. It looks to combine stocks that have different characteristics that in aggregate have a much less volatile profile than owning the benchmark outright. So, every once in a while, people look at the portfolio and say, wait a minute, Newmont Mining is in USMV, what does this mean? Newmont Mining is a gold-mining firm; it's up, it's down, it's left, it's right, it's sideways. It's in there because it has very specific characteristics, because it has low and often negative correlation with other stocks within that portfolio. It almost acts somewhat counterintuitively as a ballast of sorts in the context of the overall portfolio. So, it's a unique process, and the ultimate outcome is that over its history the volatility profile of USMV has been pretty consistently below and significantly below just owning the total stock market or owning U.S. equity exposure through, say, the S&P 500.

Benz: Another fund you like of this ilk is the ticker SPLV. Let's talk about that one.

Johnson: So, actually, an Invesco fund, so Invesco S&P 500 Low Volatility ETF SPLV. This is a different approach to creating a low-volatility profile. So, it starts with the S&P 500, and it looks for the least volatile 100 stocks from those 500 within its starting universe, and then it weights those stocks by the inverse of their volatility. So, it creates a portfolio of the least volatile stocks within the S&P 500 and gives the greatest weightings to the least volatile of the least volatile. So, this is an interesting approach. It's somewhat more straightforward. It's somewhat more intuitive. The difference here is that it doesn't have the same constraints in place as does USMV, which most notably can lead itself to having very significant sector level concentrations.

So, if you were to look at this fund's portfolio today, those are evident in a significant overweighting in the utilities sector and a significant overweighting in the real estate sector, both of which are very much interest-rate-sensitive and potentially introduce other new, maybe unwanted or unforeseen risks into the portfolio. So, something to keep in mind.

Benz: Perhaps a more tried and true way to think about having an equity portfolio without as much volatility as the broad market would be to just focus on high-quality dividend-paying companies. So, let's talk about a fund that you and the team like in that particular area.

Johnson: So, Schwab US Dividend Equity ETF SCHD, is one of our longtime favorites. It looks for good firms and good firms that have done a good job of returning cash to shareholders, chiefly through dividends, but there's also a lot of share repurchasing that's been going on amongst these organizations. So, it looks for a long track record of sustained and ideally growing dividends over time. It screens out everything that doesn't fit that profile, and it's got a bit of a yield bent to it as well. So, it introduces a bit of a value screen of sorts. The net result is a portfolio of very high-quality companies, companies that inherently have sort of defensible business models. They've got wide economic moats around them. Their cash flows are more stable, they are more predictable, and thus, they are able to continue to pay out dividends to their shareholders and grow those dividends over time. Long been a favorite of ours within the dividend bucket of ETFs.

Benz: A good short list of ETFs that retirees can investigate and see if they are possibly interested in tweaking their equity exposure. Thank you so much for being here.

Johnson: Thanks for having me.

Benz: Thank you for watching. I'm Christine Benz for


Christopher Franz: Hello, I'm Chris Franz with Morningstar. I'm here today with Amy Zhang, portfolio manager of the Alger Small Cap Focus Fund.

Amy, thanks for joining me.

Amy Zhang: Chris, it's great to be here.

Franz: Amy, your fund had a fantastic 2018, returning over 14% in a down market. And one of the key contributors was Abiomed, a medical device company that you've owned since 2016. What do you like about that stock?

Zhang: Well, Abiomed is a medical device company specializing in a very minimum invasive heart pump called Impella. In fact, it's the smallest heart pump in the world. So, what Impella does is to provide temporary circular support for the heart while the surgeon operates on a patient. Usually, it's a heart failure patient that otherwise would be too sick or too old to be operated on. So, Abiomed's mission is recovering hearts and saving lives, which is consistent with what we invest in. And as a result, they also reduce a lot of costs for hospitals.

So, what attracts us to Abiomed is because it really possesses all the qualities that we look for in a company--style-wise, a very strong competitive moat, a very wide moat too in the sense that they are at the cutting edge of innovation. So, they spent over $500 million on R&D on Impella over the last 20 years. That gives them a large lead, way ahead of any rivals in the industry. And also, under the CEO Mike Minogue over the last 15 years, he has a very disciplined execution approach. The company was able to sustain not only revenue growth but also kept expanding margins. So, that was very important for us. So, currently, this is a very high-growth company at 30% of top-line growth, but the GAAP operating margin is also reaching 30%. At the same time, the company has over $450 million in cash, no debt. So, it really exemplifies what we look for in a high-quality but also high-growth company.

Going forward, we think the company is going to continue to expand its addressable market. Currently, it's about $6 billion, that's U.S. alone and current penetration is 12%. While the company will continue to further penetrate within the U.S., we also expect them to expand internationally and also with more usage of Impella in different areas. So, over the next five years we think the company can expand its addressable market more than double to over $12 billion-plus. So, it's still a very long runway for growth.

Franz: Sure. Really interesting. Maybe kind of turning to a more recent addition, Avalara, provides compliance solutions. What do you like about Avalara?

Zhang: Well, yes, Avalara, we invested in since its IPO last June. The company is a cloud-based software company that specializes in sales tax automation. Sales tax itself is very complex and time-consuming, and there's no margin for error. So, it's a very tedious process. In this digital world I think it's inconceivable for that not be automated in the next five, 10 years. And Avalara is really the leader, especially, they are dominant in the middle-market space, which is really the sweet spot for sales tax automation, because for sales tax, especially with the proliferation of e-commerce and the recent ruling--right after they went public the Supreme Court ruled that anybody who sells goods online needs to collect tax to everywhere that they ship. Before it was just a physical presence, only if a company has a store or warehouse. So, that's a huge change which is a big positive for a company like Avalara.

And so, now, sales tax is very complex. Not only you need to have the right rate but also the right moment because the transaction has to be real time and also in the U.S. alone there's over 12,000 tax jurisdictions. So, it's very complex. And Avalara makes that possible for companies which really saves time, money, headaches. So, it's a very strong value proposition. More importantly, the company has a very strong competitive moat over the years. The company is not a startup. It's been--the CEO Scott McFarlane co-founded the company 15 years ago. So, over those years, it spent a lot on R&D. It still spends 18% of its revenue on R&D. And so, it built a very significant proprietary database or tax content and also has the largest network of integration partners. So, the company's revenue is only $300 million now and we think the addressable market is over $8 billion. So, that is a really open-ended growth opportunity that we think the value should compound over time.

Franz: Sure. Well, Amy, thanks for your insight. 

Zhang: Thanks for having me.

Franz: For Morningstar, I'm Chris Franz. Thanks for watching.


Susan Dziubinski: Hi, I'm Susan Dziubinski for It's the time of the year when many of us set our sights on washing windows and cleaning up the yard. But this can also be a great time to spring clean your portfolio. Joining me to discuss some tips for doing just that is Christine Benz, director of personal finance for Morningstar.

Christine, thanks for joining us today.

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

Dziubinski: Now, why is spring a good time to give your portfolio a review and maybe clean out some of the dead wood?

Benz: Well, one of the key reasons is that this is usually the time when we've got all those tax documents out, or tax-related documents. So, you probably have some of the key things top of mind. And sometimes tax season is a reminder that maybe our financial lives are a little more complicated than is ideal. So, it's a good time to do some pruning, maybe make some changes to streamline things a little bit.

Dziubinski: And what are some of the advantages to decluttering your portfolio?

Benz: Well, tax season is easier, but it also means if you are able to streamline your accounts and in turn your holdings a little bit, it gives you fewer moving parts to monitor on an ongoing basis. I think that's a huge plus--we are all busy. And it also reduces the chance that you will have such a sprawling portfolio that you are kind of generating indexlike returns, but you are not necessarily paying indexlike expenses. I see that a lot--where people have assembled so many holdings, they've kind of got an index portfolio there, but they don't have index fund expenses.

Dziubinski: So, where should investors start if they want to undertake this process?

Benz: I think one of the key things to look at is whether you can do some streamlining at the account level. So, the typical person today has 12 jobs in his or her lifetime. People have old retirement accounts that have piled up. So, you might have old rollover IRAs, little silos here and there. Or you might have 401(k) plans left behind with former employers. You can clean all that up. Usually, the best thing to do would be just to roll it all into one mega IRA. But if your company retirement plan is really good, you might even be able to roll the assets into the plan. So, ask your employer if you really like that 401(k) plan.

Dziubinski: And what about brokerage accounts? That's another area that maybe investors should take a look at?

Benz: Anecdotally, when I look at investors' portfolios when we do our portfolio makeovers every year, that's one thing I see--where people kind of have these token equity portfolios, four or five stocks. Sometimes they are duplicating exposure that is already existing in mutual fund holdings that they might have. And then, another thing people might not think about is that those small brokerage accounts might incur some sort of carrying cost. So, there might be administrative expenses associated with those accounts. If you are not really paying that much attention to the account, you might want to think about just rolling it into a fund portfolio. If you are an avid individual stock investor, by all means, keep going. But if it's not really something you are that into, consider streamlining.

Dziubinski: And how can we declutter our cash holdings? What about there?

Benz: Well, this is something to take a look at right now. For a while, it didn't really matter where your cash was. The yields were close to zero. Now, we are really starting to see a big differential open up between higher-yielding instruments like money market mutual funds, like CDs, like online savings accounts and everything else, which is, in many cases, not yielding much. So, take a look at that. See if you can't roll some of those token cash amounts into other accounts that will give you a higher yield.

Dziubinski: And moving away from the individual account level, what about looking at your long-term portfolio allocations this time of the year?

Benz: I think it's a really good time to do that, Susan, because we had a tremendous rally in the equity market in particular, but bonds had a great first quarter. If investors haven't taken a look at their asset allocation--and I'll concede it's been pretty easy to let things ride with the exception of the fourth quarter of 2018--if you haven't been paying attention, I think it's probably a good idea to tune back in, use our X-ray tool to see where your portfolio stands today and see if perhaps you don't need to take some risk off the table.

Dziubinski: And lastly, you think health savings accounts are another area that perhaps investors should be looking at and paying attention to?

Benz: Right. So, these are accounts that are available if you are covered by a high deductible healthcare plan. And one thing that I've noticed in talking to people who use HSAs is that they've been using them for a while, they've been funding them for a while, and they've started to build up way more in their HSAs than they need to pay ongoing healthcare expenses. Or maybe they are not spending from their HSA at all in an effort to preserve those great tax features of the HSA.

So, my advice is, if you want to get that money invested, you should think about doing so. And Morningstar has done some great research where we've looked at the best HSAs for investors as well as people who are spending them as they go. And the best--the favorite--HSA for both savers and investors was called HSA Authority. So, that's one to investigate. Even if you are captive in your company-provided HSA, you can actually do a transfer out into the HSA of your choice. So, that's something to consider.

Dziubinski: Christine, thank you so much. A lot of great spring-cleaning portfolio ideas here today.

Benz: Thank you, Susan.

Dziubinski: Thanks. For, I'm Susan Dziubinski. Thanks for tuning in.


Travis Miller: California utilities are back in the news yet again. Back in January, PG&E declared bankruptcy. That set off a wild ride for most of the California utilities, especially PG&E but also Edison International and Sempra Energy. Most recently, the California governor, Gavin Newsom, came out with a plan to save the utilities and protect their future. This got investors very excited, and PG&E stock was up 21%, and we think now it's at the point where it's well beyond any kind of reasonable evaluation coming out of bankruptcy. We think the stock is worth more like $12.50 as it comes out of bankruptcy, not the $23.00 where it ended after Gov. Newsom's announcement. Edison International, we think, is a good pick. It enjoys all the upside that PG&E will benefit from in new policies in California but still remains slightly below our fair value estimate even after a recent increase in the price. We like its 3.5% yield and 6% earnings growth, giving a total return for investors at a very good 9%-plus.


Madeline Hume: Funds in the multi-asset retirement-income institutional category are trying to crack the essential question of how to fund an individual's retirement, but the industry's tackling this problem in several different ways.

First, there's the question of asset allocation: What is the appropriate level of risk for a retiree to take? Spending in retirement is far from uniform, and so are the risk levels of funds in the category. American Funds Retirement Income Portfolio-Enhanced offers more than 60% of its portfolio allocated to stocks, whereas Fidelity Advisor Simplicity RMD Income allocates less than 20% to stocks.

Then there's the question of how to spend. Retirees can either take the income distributed from the fund annually to make their purchases, or sell a certain amount of their investment every year to take as spending. Vanguard Managed Payout takes the former approach by setting an income target based on the fund's yield in previous years and averaging it out. JPMorgan SmartSpending has gone for the latter approach by constructing a portfolio that's meant to be sold out of incrementally as a retiree ages, down to zero. This is designated by the fund's maturity date of 2050.

There are many ways to spend the retirement nest egg. Retirees should be aware that just as their spending needs are very different from other retirees, multi-asset retirement-income funds are not all alike.