Amazon's Future, Long-Term Care, and Unqiue ETFs

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Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. When assigning Morningstar Analyst Ratings, we focus on managers with disciplined approaches that we think will outperform during a full market cycle. But that doesn't mean there won't be some dry spells along the way. Here are three Gold-rated funds that are struggling in this year.

Alec Lucas: Gold-rated Primecap Odyssey Growth is having a tough year thus far in 2019. It's up more than 12% through June 27, but that lags the more than 20% gain of the Russell 3000 Growth Index, and it places the fund near the bottom of its large-growth Morningstar Category. Healthcare holdings have hurt the fund thus far in 2019. For example, it had a top 25 position in Biogen in March when that company's share price plunged 29% in a single day because of the failure of a late-stage Alzheimer's drug. Other holdings that have hurt the fund include Abiomed and the biotech firm Alkermes. The fund, though, maintains one of the best records in the Morningstar large-growth category since its inception, thanks to those kinds of picks. Its managers tend to be patient with their stock picks, and they have a tremendous tolerance for pain. Investors have to as well, and this year is a reminder that, to succeed with this fund, you have to have the kind of patience that its managers do.

Dan Culloton: I think a little perspective is needed when looking at the performance of Oakmark International this year. Yes, it's been a volatile year for it, and it is trailing its peers and benchmark for the year through about midyear. But it's also up nearly 11%. But this isn't out of character with longtime manager David Herro's approach. He typically gravitates to areas where there is controversial headlines and looks for companies that--even though they maybe going through some temporary trouble--are still increasing their intrinsic values. So, when we look at the portfolio and we look at the companies that have been holding the fund back so far this year, what we see are the type of firms and stocks that David Herro and his team have long invested in and have actually turned in good results over 27 years for investors of this fund over the long term. So, although the fund is trailing its peers and benchmark so far this year, it has come back from a very difficult 2018, and it's not doing anything different than it has done over the last nearly 30 years. So, while it's difficult, we think this is a fund that investors should hang on to.

Kevin McDevitt: Yacktman Funds' poor relative results so far in 2019 are easily explained and not cause for worry for those who are on board with its approach. The fund's 10.5% year-to-date return through June 26 trails the S&P 500 index's 17.4% and the Russell 1000 Value's 14.7% by wide margins. The fund's subpar 2019 return owes largely, though, to the fact that the fund had more than 29% of its assets in cash heading into the year and through the first quarter. This created a huge drag on performance. Otherwise, the fund's holdings had performed quite well. The fund's big cash stake shows how risk- and valuation-conscious managers Stephen Yacktman and Jason Subotky are. It's nothing new either for this fund to hold a lot of cash. Over the past decade, cash has usually been greater than 10% of assets outside of a brief stretch during the 2011 correction. As a result, the fund captured just 66% of the S&P 500's losses during down markets over that 10-year time frame. Therefore, this fund is best suited to investors who are similarly risk-averse and are willing to sacrifice gains during a bull market to protect in the downside. So, for investors who are comfortable with its conservative approach, this fund remains an attractive option.

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Christine Benz: Hi, I'm Christine Benz for Morningstar.com. 2019 is a pivotal year for Social Security claiming. Joining me to discuss that topic is InvestmentNews contributing editor, Mary Beth Franklin.

Mary Beth, thank you so much for being here.

Mary Beth Franklin: Thanks for inviting me, Christine. I love talking to Morningstar readers, listeners, and members.

Benz: We love to have you here. You say that 2019 is really a pivotal year. Let's talk about why that is, especially for people who are reaching what Social Security refers to as full retirement age in 2019.

Franklin: Correct. There is a valuable claiming strategy available to married couples, and in some cases eligible divorced spouses, that can maximize a couple's lifetime benefits. Normally, when you file for your Social Security benefits, you are simply paid the biggest benefit to which you are entitled at that age, whether it's on your own earnings record or as a spouse. Because if I'm married to a husband who has a Social Security benefit and I never work outside the home, I may not have a benefit on my own record, but the fact that I'm married to him means I'm entitled to a spousal benefit that's worth up to half of his amount.

So, why is 2019 a big deal? It's the last year for people who turn 66 this year that if they wait until their full retirement age of 66 to claim benefits and their spouse has already filed for benefits, they could say to Social Security, don't pay me my retirement benefit. Let it keep growing by 8% a year up until age 70. But in the meantime, pay me only as a spouse. Pay me half of my husband's benefit, pay me half of my wife's benefit while my own retirement benefit continues to grow.

Benz: And that won't affect my eventual benefit on my own work record at all, right?

Franklin: Correct. And the value of delaying my own retirement benefit if I wait till 70--the difference between collecting at 70 versus my full retirement age is an extra 32% in Social Security benefits.

Benz: That's huge.

Franklin: Huge. And that's guaranteed cost-of-living-adjusted income for the rest of my life.

Benz: The name of the game, though, is that you have to be reaching full retirement age in 2019. In 2020, this maneuver is going away.

Franklin: Right. I am one of those people who will turn 66 in 2020, I can't do this. And I always joke that my face is on a dartboard at the Social Security administration ...

Benz: As you tell so many people about it.

Franklin: Right. And they know my birthday. So, it's my fault and I do apologize to anyone born in 1954 or later; we will never be able to exercise this creative claiming strategy. Now, that doesn't mean Social Security is not going to be important to me and everybody else in my birth cohort. It just means that whenever we claim Social Security benefits, we will get the highest benefit that we're entitled to at that age. We don't get to choose. We don't get to be fancy with it.

Benz: Let's discuss--we talked about married couples, why they might consider it. Let's talk about people who are divorced. How would this work?

Franklin: This is so important. Because many people don't realize that if they had been married at least 10 years, divorced, and currently single--now, you may have married somebody in between and that marriage dent, Social Security considers you currently single. So, if you are married at least 10 years, divorced, and currently single, and you turn 66 this year, you too can say, don't pay me my Social Security retirement benefit. Let it keep growing by 8% a year. Pay me only as a spouse on my ex's earnings record. And that makes people nervous. Do I have to talk to him, do I have to tell him?

Benz: Right. And you don't?

Franklin: No, you don't. You do it strictly through the Social Security Administration. They are going to check your birth year, that you are born in 1953 or earlier, that you are married for at least 10 years. That means from the date of your wedding until the date of your final divorce decree. So, my word to people out there is, if your marriage is a little rocky ...

Benz: Hold on.

Franklin: ... string out the paperwork--it's really important!

Benz: And this would also apply even if your spouse had married other people in between the time that you and he were married, still be eligible for this?

Franklin: Well, whenever these marriage restrictions apply to the person who is claiming benefits, OK? So, say, my husband was married, divorced, now he has married me again. So, all bets are off with that first spouse. It's just the two of us. He has claimed his benefit. I turn 66 this year, I can say, give me your benefits. If he and I were married at least 10 years and we are divorced now, even if he remarries, doesn't marry, I'm currently single, I can say, give me half of his benefits.

Benz: Got it. How about surviving spouses? So, widows and widowers, how does this restricted claiming option work for them?

Franklin: This is the most important message I'd like to get out to the whole Morningstar audience. All of these claiming changes were a result of something called the Bipartisan Budget Act of 2015. That's what put these rules into effect. That legislation did not change the fact that if I have my own retirement benefit and I am a widow or widower, I am entitled to two benefits perhaps--on my own retirement record and as a survivor benefit. And depending on my age when that event happens, I maybe able to claim my own retirement benefit first and switch to survivor benefits later, or vice versa, whichever is going to be most beneficial to me. Those rules have not changed. Unfortunately, not everyone at Social Security knows that. And I've been hearing from all sorts of readers and financial advisors who are saying, I'm a widow, I went to Social Security, they tell me I can't do this. And I say, you're wrong ...

Benz: Keep pushing.

Franklin: Keep pushing! Go to the Social Security website, ssa.gov, and in the search box put "widow" or "widower," and you will get information that will come up that will tell you what your rights are.

Benz: Mary Beth, super helpful information. Thank you so much for taking the time to be here.

Franklin: Thank you.

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

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Debbie Wang: We've been taking another look at LabCorp because this company is slightly undervalued and it has been under a lot of reimbursement pressure from Medicare, thanks to a new market-based reimbursement system that was heavily skewed towards the lowest-cost producers including LabCorp and Quest. Now we're seeing the diagnostic lab industry fighting back, and they have convinced Medicare to include more of the high-cost, hospital-based labs as we go into the next reset of these reimbursement rates. Most recently, we have seen bipartisan legislation come out of the House that would allow for more time for these hospital-based labs to comply with the onerous reporting requirements. In the end, we think that this will lead to higher reimbursement rates for Medicare going into 2021.

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Christine Benz: Hi, I'm Christine Benz. I'm here at the Morningstar Investment Conference. I'm thrilled to be joined today by Carolyn McClanahan. She is cofounder of Whealthcare Planning, and she is also an M.D. So, she is uniquely situated to discuss how people can think about the role of long-term care in their financial plans.

Carolyn, thank you so much for being here.

Carolyn McClanahan: It's a pleasure to be here. Thank you for having me.

Benz: Carolyn, let's talk about long-term care expenses starting with the costs. They can be ruinous, obviously, but let's talk about the swing factors that affect long-term-care costs and also the likelihood that someone may have to pay out of pocket for long-term care.

McClanahan: Long-term care costs have two components actually, the direct component of, say, a nursing home, assisted living, the living situation. But there is a bigger indirect component and that's the unpaid caregiving, the people who come in and have to give up their jobs to help you, your family members or those little niceties that long-term care insurance doesn't cover. And that cost is enormous. We spend over $500 billion a year in unpaid caregiving in this country. It's huge.

Benz: And a lot of that care is provided by family members. In fact, I think much of the long-term care in this country is provided by these unpaid caregivers that you're talking about.

McClanahan: Yeah, exactly. And most people, they didn't intend on becoming caregivers. More than 50% of caregivers would prefer not to be the caregiver for their family. It's huge numbers.

Benz: But it's the only option in many cases.

McClanahan: Only option, yeah.

Benz: So, let's talk about how people should approach this issue. Say, they want to get ahead of this long-term care issue. Let's take it one by one. The sort of purest protection against paid long-term care is to purchase some sort of an insurance policy. Let's talk about, kind of, what's been going on in that marketplace. It's not been great for consumers.

McClanahan: The long-term care insurance market has--it's gone crazy, because the costs have gone so high and so many people need care. And so, now the traditional long-term care policies are hugely expensive, and people don't want to buy them. They don't want--it's like you are going to pay into this 20, 30 years. Is the company still going to be around? Are the costs going to continue to go up, which they have astronomically. There are hybrid policies that people can buy that are a combination of either long-term care life insurance or long-term care and an annuity.

Benz: Do you like those products?

McClanahan: I still--they are still not much better than buying bonds really. It depends on when you use them whether they end up being a good deal. And so, the better thing for people to actually do is to plan for the actual cost of long-term care. This is where for years I've realized that most of long-term care needs are reactive. So, all of a sudden, mom falls, breaks her hip, and it starts this decline and this issue around caregiving. And so, what we actually do is help people plan for the logistics of aging of: When are you going to move to a safer situation? When are you going to quit driving, which is actually a long-term care issue. And who is going to help with those healthcare decisions? Too many people don't talk about when they want to actually die and what situations are going to occur. So, families incur a lot of expenses doing unnecessary care and providing things that don't add to the quality of life and just make the cost become even more exorbitant. So, thinking through these and putting a plan in place long before there's trouble can greatly reduce the costs of long-term care.

Benz: And that's something that your firm focuses on, is thinking about and troubleshooting some of these long-term-care costs.

McClanahan: Yes.

Benz: So, one question I often get is, How much do I need to have in assets if my plan is to cover these costs out of pocket? I don't have a long-term-care insurance policy. How much do I need to set aside? To me, that seems like the wrong question, but I want to get your perspective on that issue.

McClanahan: It's multifactorial. And so, you have to look at: What is your health? If you have poor health, your chance of needing long-term care for a long time is not real high.

Benz: It's counterintuitive in a way.

McClanahan: Yeah, exactly. And if you are very healthy, you could have long-term-care costs for a very long time. And then, where do you plan on aging? So, I call this the "blue toenail syndrome." The people who say I want to live in my home until I die no matter what. Well, if you get dementia and they say, "You have to drag me out by my cold blue toenails," right. And so if you have that and you get dementia, the cost can be astronomical. Twenty-four-hour care in some areas can be $300,000 a year. So planning out those logistics of where is it are you going to age, and if people agree they are willing to move to assisted living and skilled care at a much sooner (place), it actually could be less expensive. So planning through the logistics of where you are going to live, what is your health, and who is around to help you. People who have nobody to help them, the costs are going to be a lot higher than people who have extended family where everybody is willing to pitch in.

Benz: So we've ticked off the major ways of paying for long-term care in terms of the peer insurance policies, the hybrid policies, self-funding. Let's talk about the last one--the major funder of long-term-care expenses in the U.S.--that's Medicaid. So some people might say, "Well I'll just exhaust my resources and fall back on Medicaid." What should people think through before they think of that as their plan?

McClanahan: Well first off, How much is the government willing to give up to long-term-care funding? There are policies that the current presidential candidates are promoting to help pay for long-term care. Will that happen? We don't really know. And so what is the funding that's going to be available? And nursing homes--they don't want to take Medicaid. So if you come in straight off the bat and need Medicaid, it's going to be hard to get the place you want. What we advise people is to save at least enough money for couple of years of care because if you can pay your way in, they are willing to take you and is less likely they'll kick you out at the back end. Most people really only need two to three years of long-term care, and so if you happen to exhaust that, that's when you can go to Medicaid.

Benz: Carolyn, such an important topic. I am so appreciative of you being here today.

McClanahan: Thank you for having me.

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

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Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Some investors may wish to use total market index funds to populate their portfolios and call it a day, but other investors may wish to venture off the beaten path a little bit. Joining me to discuss three smaller exchange-traded funds is Alex Bryan. He is Morningstar's director of passive strategies research for North America.

Alex, thank you so much for being here.

Alex Bryan: Thank you for having me.

Benz: Alex, in the most recent issue of ETFInvestor, you looked at some off-the-radar exchange-traded funds, and we are going to talk about some of the ones that you think are worthy of a further review on the part of investors. Let's start with iShares Edge Investment Grade Enhanced Bond ETF. The ticker is IGEB. So, this is one that someone might use to fill sort of that core intermediate-term bond slot in their portfolios?

Bryan: So, this is actually a corporate-bond-focused ETF. So I think this is a good component of a bond allocation, but it probably shouldn't be the entire bond allocation in your portfolio. This is effectively a quality and value strategy. It essentially starts with a broad universe of investment-grade-rated corporate debt, and then it screens out bonds that have higher probabilities of default, which might be overpriced by investors reaching for yield. And then, of the bonds that are remaining, it tilts toward those that are offering attractive yields relative to their default risk. So, that's the value component of the strategy.

So, this is a good way of basically removing the riskiest investment-grade corporate bonds without sacrificing much return. I would expect something like this to actually offer better returns than the broad investment-grade corporate market over the long term, and it's very competitively priced at 18 basis points.

Benz: Your next off-the-beaten-track ETF is IQ S&P High Yield Low Volatility Bond. The ticker is HYLV. Alex, first, let's quickly talk about why your team has historically been a little bit reticent to recommend high-yield bond ETFs and also how you think this fund maybe approaches that space in a more sane, risk-conscious way.

Bryan: Well, as you alluded to, high-yield bonds are a risky corner of the market, and this is an area where active management of both credit and liquidity risk can make a lot of sense. A lot of funds out there--they are just following the composition of the market and oftentimes that means owning a lot of the most heavily indebted companies out there. What I really like about this fund is that it's investing in high-yield bonds in a risk-controlled way. It's effectively looking for bonds that have low yields and that are less sensitive to changes in credit spreads than some of their peers. So, this is going to tilt toward higher-quality junk bonds. Most of the portfolio is parked in BB bonds. And I think that's important if you are looking for a more defensive way of getting exposure to this area of the market.

Benz: Your last idea for an off-the-beaten-path ETF is Vanguard US Multifactor. The ticker is VFMT. This is, obviously, an equity--or maybe not obviously--it's an equity exchange-traded fund that employs a multifactor strategy. First, let's talk about what multifactor means and then get into this specific fund.

Bryan: So, multifactor strategies are effectively looking for stocks that have an attractive combination of different characteristics like low valuations, strong recent price performance or momentum, strong quality, things like that. Each of those characteristics has historically been associated with market-beating performance. But each of these characteristics, or factors as they are called in the academic world, goes through long stretches of outperformance and underperformance. So, if you are going to just be a value investor, there's going to be periods where that works, there's going to be periods where that doesn't work.

The basic premise behind owning a multifactor fund is that by combining these different style tilts into a single portfolio, you can better diversify your risk, which can reduce the risk of underperforming for an extended period of time. Now, it doesn't completely eliminate it. You are still taking active bets here. And these will not always outperform. But it's effectively better diversifying your individual style bets.

Benz: And it's a Vanguard fund, so it's pretty inexpensive, I'm guessing, right?

Bryan: So, there's lots of multifactor funds in the market, but I think what makes this one unique--there's a couple of things. One, this particular strategy is investing across the entire market-cap spectrum. So, it's investing in large-cap, mid-cap, and small-cap stocks. And then, secondly, it is active in its implementation, meaning it doesn't track a benchmark. So, that gives the managers some flexibility about when they want to rebalance the portfolio. So, they may not make a trade if the costs of doing so exceed the potential benefits or the expected benefits of doing so. So, there's some implementation advantages from the strategy. And true to Vanguard's nature, it is a very low-cost strategy. It charges 18 basis points. And I think this is a really good core holding even though it sits in the Morningstar mid-cap blend category; because it's offering full market-cap coverage, I think this could be a good replacement for even a large-cap index fund.

Benz: But obviously, not tilting as much toward the large and giant caps as the total market index would?

Bryan: That's right. Yes. So, it's sitting within the Morningstar mid-blend category. While it does own large-cap stocks, it certainly has much less of a tilt toward those names than something like the S&P 500 would. But I think the fact that this owns stocks across the entire market-cap spectrum is beneficial for two reasons. One, it improves diversification. And then, secondly, I think, it's really important to note that factor investing has historically worked better among smaller-cap stocks, and the fact that this invests in small-cap and mid-cap stocks I think will actually improve the efficacy of the strategy and potentially help its performance a little bit over the long term.

Benz: So, these ETFs are all not huge, and there can be some liquidity considerations, especially for smaller ETFs that don't trade a lot. Let's talk about what investors should know before they venture into these or any of the off-the-beaten-path ETFs.

Bryan: So, smaller ETFs do tend to be a little bit more thinly traded. So, it's really important to use limit orders to make sure that you get the price that you think you're going to get. Because if you use a market order, there's a risk that the price that you see could be different than the price that you actually get. Limit orders are always a best practice, but it's particularly important for more thinly traded funds like these newer ETFs.

Benz: OK, Alex. Thank you for being here to provide the short list of ETFs worthy of further research. Thanks for being here.

Bryan: Thank you for having me.

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

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R.J. Hottovy: With Amazon's annual Prime Day right around the corner, we thought we'd take a look at what this event reveals about the company's longer-term strategic priorities and how it supports the assumptions behind our $2,300 fair value estimate.

As a starting point, we believe Amazon has been undergoing a strategic shift the past several years on two fronts. The first is a shift away from a first-party marketplace where Amazon directly sells products to consumers to more of a third-party platform where vendors sell products and Amazon takes a commission from the sale. This is important not only because this is a higher-margin transaction from Amazon but also it unlocks additional services that Amazon can offer its vendors. The most obvious of these is Fulfillment by Amazon, where vendors can store their products alongside Amazon's own products and use the company's logistics services for one- and two-day delivery. However, this also includes Amazon's own advertising services, which was one of the fastest-growing segments across Amazon's portfolio in 2018. As it pertains to Prime Day, Amazon is planning new collaborations with several new key apparel vendors and has noted that small- and medium-size vendors sold more than $1.5 billion worth of products on Prime Day last year, a figure that we expect the company to easily surpass in 2019.

The second notable strategic shift is the move away from Prime member acquisition and toward Prime member engagement. With close to 90 million estimated Prime memberships in the U.S. across almost 75 million households, we believe Amazon is bumping up against the natural limit for the number of basic Prime memberships it can offer in the U.S. This means that Amazon must now get a greater engagement out of existing members, and not just having members buy more frequently across more categories, but instead adopting Amazon's expanding portfolio of subscription and other services. Several of the earliest announced deals for Prime Day revolved around subscription services like Amazon Music, Twitch Prime, and Audible, which we think will have a positive impact on longer-term profitability. Another way to think about this is that over the next few years, many Amazon Prime members will be paying much more than the $120 base price, but perhaps as much as $200-$300 a year for their membership. We believe that this also explains Amazon's recent push into grocery, beauty, and healthcare, each of which offer potential subscription services.

Taken together, the ongoing shift to a third-party marketplace and the move to more subscription services supports our five-year targets, which include mid-to-high-teen annual top-line growth and operating margins pushing 10% from 5.3% last year.