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Active Personalization Is the New Active Investing

Active Personalization Is the New Active Investing

Tony Hixon: The most important thing to our clients right now is having that trusted financial advisor to walk alongside them through their retirement journey.

Charlotte Geletka: I would say 50% would probably say inflation, and the other 50% would say market volatility as it relates to geopolitical current events.

Carolyn McClanahan: What they want is somebody who is going to care about them, serve them well, do an excellent job so that they can know that somebody has their back.

Peter Lazaroff: The days in which one model portfolio is deemed to be a one size fits all for everybody is starting to fade. More and more retail investors are realizing that they can have customization so that a portfolio meets their needs.

Seema Ackerman: When we think about portfolio construction on behalf of the families that we work with, the first lens is risk, then alpha, and then, of course, taxes.

Phil Huber: Having that flexibility and seeing direct indexing coming more downstream and at lower minimums I think it opens up the door to quite a few more investors.

Cathy Curtis: Most of the discussions I have with my clients are not about the specifics of their portfolios at all. It's about the issues that concern them the most.

Danika Waddell: The numbers are important, investment performance is important, but they're really looking for something that is profoundly different from the way that, I think, the prior generation of advisors worked with clients. So, they want their investments to align with their values. I hear that from just about every single person who talks to me about ESG investing.

Tara Tussing Unverzagt: It's really nice that there has been more data that's been coming out. I think that the fact that Morningstar is pushing it and the industry is pushing it to make sure that you are truly investing in things that are sustainable.

Waddell: I think our ability to really understand what's important to our clients is, again, how we add value as advisors.

Announcer: Welcome to MIC 2022. Please put your hands together for the chief executive officer of Morningstar, Kunal Kapoor.

Kunal Kapoor: Hello, everybody, and welcome to Chicago. It's great to welcome you back here in person. I came in this morning, and the first thing I did was ask our team, "How many people do we have?" So, it's 2,500 people who are going to be here in person, which is fantastic after doing this on a lighter scale last September. It's really great to have you all here, and welcome to Chicago.

We've got a great conference for you, as always. And for me, this is my 25th conference. And my first conference was in June 1997. And I was trying to think about what I could recall from that conference. And one image that came back to me was that over lunch on the first day, the emerging-markets manager, Mark Mobius, put a picture up of a baby. And he asked the audience, "Does anybody know who this is?" The punchline, of course, was that he then whipped out a letter that had been written to him by the baby's parents. And the long and short of it was that that baby was investing in Mobius' fund, and it was his college fund that the parents had put into that fund. And I remember Mobius saying that this is what it's all about.

And so, I'm thrilled to have you here because after several years of health security issues, financial security issues, all of you have really come through for your clients. And just like that baby, it's all about who we try to relate to and help at the end of the day, who we're trying to empower for their investing success.

To do that effectively, our team has built, I think, a terrific agenda. It's advisor-focused, investing-centric, and most importantly, no pay to play, which means our team has basically invited the best folks possible as always to share their thoughts with you. And I'm excited today in particular to kick things off, because there's so much going on in the macro environment, right? Like, I think you have to turn this way or that way, and you've got news. And just last year, in September, we had Bill Browder here, the hedge fund manager, who had been kicked out of Russia by Putin. And I have to say, we had no idea of what was going to come. But we're following that up this time with a conversation with former U.S. ambassador to Russia, Mike McFaul.

And I think sometimes when there is a macro issue like that going on, one of the challenges we have is, maybe a client comes into your office and says, what does this mean? And let's face it, that's not an easy question to answer at a macro level, particularly with an individual client's account. But I was reflecting on the fact that this morning McDonald's announced that they were going to exit Russia. And suddenly, that's a security that probably is in your clients' accounts either directly or through a fund they own or some other means, and it starts to come home. And I bring this example up because not only do we have a great conference and lineup, but I think, too, what you're going to find, and what I hope you leave here with is that the time is right for personalization and personalized conversations with your clients about their portfolios and how you're positioning them. From the Morningstar perspective, we have the tools ready for you to personalize your practice at scale. And that is a theme you will hear from us over and over again in the next two days.

But this is an investing conference. And so, I have to start, of course, with the slide I've relied on for the last six years, which shows Morningstar's fair value indicator and gives you a sense of how we think the markets, in the U.S. at least, are currently positioned. And this has actually been a very successful predictor of how markets will do in the future if you've looked at when we said the markets are undervalued and bought, and if you've been a little bit more cautious when we found the markets to be undervalued. If you look at the chart right now, you're seeing that our analysts think that the market is about 16% undervalued as of May 12 of this year, so pretty meaningful in that context. I think this is important, too, because while flows have favored passive investing, there are a number of changes that are taking place, specifically as it pertains to the next generation of investors. Now, I know many of you are on and have been on it for many years. But maybe one thing you don't realize is that the type of investor we're seeing on has changed meaningfully.

Interestingly, the 25- to 34-year-old age group cohort now ties for the top spot in share of site visitors, and we're seeing meaningful year-over-year increases in visits among the 18- to 24-year-old age group. This is not the regular type of investor we used to see five or 10 years ago, but it is also the type of investor that is going to power your practice in 10 years, in 15 years. And so, we have to start laying the seeds together for what that means to help those types of investors. And this is where the concept of active personalization comes into play. And you're going to hear me talk about this repeatedly today.

At Morningstar, we believe active personalization is the new active investing. Soak that in for a moment. Active personalization is the new active investing. And what it does is it blends traditional approaches with more modern ones to create a new way to help you serve your clients in a personalized, scalable fashion. Most importantly, we see through three lenses that I think you're mostly familiar with, one may be a little less so. The first is returns. The second is risk. And the third is sustainability. So, let's start with returns and the concept of scale. And this is a story I'm really going to enjoy telling.

First, let me talk about how we're scaling our ratings, so you can help every investor start with winning investment strategies. Because let's face it, without good results, no amount of personalization is going to matter. Second, I'm going to show you how to tie the person to the portfolio that you're building for them. And this is what tangible personalization really requires you the advisor to uncover investors' true goals and then connect that information and the portfolios you're building for them together. And then, finally, we're going to reframe sustainability as investability—sustainability as investability. And for that, I'm going to ask you to set politics aside and really think about sustainability through how your clients think about risk and reward. Because investors increasingly want both sides of ESG—risk mitigation and being rewarded for making a difference in the world. And you can show them how to do these things even though they're not the same, as well as demonstrating the trade-offs that they might need to make. This is at the core an investing discussion; it's one you should be able to embrace easily.

But let's start with how to pick winning strategies. Because let's face it, returns are where a lot of our clients' minds go first. Now, earlier today, you've likely caught my colleague Jeff Ptak highlighting that the 10-year track record of the qualitative Morningstar Analyst Rating shows a pretty good record. I'm also pleased to share that its algorithmic corollary, the Morningstar Quantitative Rating, which now has a five-year track record, is also looking pretty good. These are pretty good investment returns considering the uncertainty you often get in the investing world. Our team has been doing a really good job of sorting funds for excess returns and spotting the bad apples early so you don't have to have them in a client's portfolios. And our ratings in this context are living up to the promise of helping investors pinpoint winners.

Now, why is this even more important than before? Well, right now, the number of products available to you is increasing by about 11% annually. And if that continues, we're projecting that the number of managed products that advisors will have to choose from in the next five years will be over 1 million. Think about that. You'll have a million products potentially that you will be sorting through for your clients in the next five years. That's a lot, and that's a lot of things to put ratings on. And so, we're using the best of our analyst expertise and machine learning to begin to scale our ratings coverage without sacrificing that quality that I showed you earlier.

Today, our analysts are rating more than 4,000 funds, and our quantitative model covers an additional 140,000 funds. As I shared, the data is very positive. But what we're also seeing is that Gold-rated funds are getting much more engagement from investors. On, for instance, Gold-rated funds are seeing 94 times more engagement than those funds with Negative Analyst Ratings. Think about that—94 times more engagement. As we started to put more behind our quant ratings, and as they've built a record, they too are seeing similarly high engagement of more than 7 times between the top-rated and the lowest-rated funds.

And so, what are we doing next? We're starting to bring together the best of these two rating systems a little bit closer together. This month, we're welcoming advisors to start using our new Morningstar Research Portal. This is a personalized research experience that's going to debut in our Morningstar Workstation and Morningstar Direct in the third quarter of this year. Until now, if you think about searching and screening for the two rating systems, we've kept them somewhat separate. In the new portal, we will start to blend them together to surface the best managed products. And there's tons more behind me that you're going to love to experiment with. You can dive into particular reports, download them to share, and the side panel keeps adjusting along the way to show you the news and research for the holdings and investments that you want to dive in the most to. And it's also really easy to find new investment ideas, whether they come from our analysts' picks lists or classic model portfolios, like my favorite, the Tortoise and the Hare. There's many lenses for stocks, ETFs, and funds on our cover pages. I love the research portal myself. I've been playing around with it, and I think you will as well. If you're so inclined, please stop by the Innovation Lab across the hallway and give it a whirl. I think you'll find it's going to make your life friction-free.

Now, let's move to another theme that's often on my mind and likely on your mind today, which is risk. I am one of those people who believes that tough lessons of down markets are sometimes more important to the long-term success of investors than those of rising markets. So, getting this right is different for every person and every portfolio. Last year, we rolled out two of the Morningstar Risk ecosystem's three pillars in Advisor Workstation. I've talked to you about them in our conference. First, we introduced the Morningstar Portfolio Risk Score. It's a really simple metric that looks to find a holding's true risk level. Think of it as a product risk score. And then, we paired it with our Risk Profiler, which measures the level of a risk that a client is psychologically comfortable taking. This is that person's individual risk score.

Now, we're proud to debut the final piece, and we call it our new Risk Comfort Range, which connects the person's risk to the product's risk. Now, it does not come with a mattress unfortunately, but it is designed to help you and your clients sleep much better at night. Let's take a look here, for example. The Portfolio Risk Score for Carmen's portfolio is 109, consistent with a relatively aggressive benchmark. Yet, the Risk Profiler is telling you, the advisor, that Carmen's personalized level of appropriate risk is somewhere between 44 and 64. So, the software is now proposing a portfolio that scores to 56 and in line with a more moderate benchmark that suits Carmen.

It's that easy to demonstrate to your client why our portfolio is aligned or isn't to their specific goals and headspace. Now, you'll notice, of course, that the Portfolio Risk Score is not capped at 100. Because a well-diversified stock portfolio, like the iShares Morningstar US Equity Index, may have a score of 100. But as you'd expect, things that are more risky are likely to be higher. In fact, among the 9 million portfolios in Morningstar systems that we scored, one in five of those portfolios exceeds 100 today, which means that a lot of your clients may be taking on more concentration or idiosyncratic risk than even you realize. That's why the uncapped scale helps you measure this by capturing the differences among high- and ultra-high-risk investments.

For example, let's look at the Portfolio Risk Score for the ARK Innovation Fund. Anyone who has followed that fund is probably not surprised to see that it's 241. So, almost 2.5 times riskier than the broader market, illustrating that these kinds of differences matter to you, your client, and how you build that portfolio. It's not just about investment returns.

Moving forward, what I want to talk about now is that our star rating had brought, of course, this concept of risk-adjusted returns into the public debate as a new way to define fund investability. Now, we're moving forward with the next step as well and introducing the next concept of this notion of the investable world.

If you've walked through our exhibit over across there, you will see that our team has put together a new experience for you to interact and get a sense for how a client's portfolio can be measured against future ESG risk as well. It's a very, very simple concept. And I'm going to show you now just a few of the measures that we will be using to bring this to life.

So, this is where returns begin to interplay with two other different concepts that you may be somewhat familiar with. This is the more recent integration of ESG factors into risk factors as well. And that ends up loading into 13,000 companies and 85,000 funds that can help you and your clients more fully understand how a changing world is affecting the risks in their investment. And most importantly, we are introducing the concept of positive and negative impact into the investability equation. So, let's talk about this for a second.

Morningstar launched impact metrics earlier this year to give you and your clients a consistent look at the company-, fund-, and portfolio-level revenue alignment to the Morningstar Impact Themes. Now, we can show you and show the investors that you work with the extent to which these themes play out, whether it's climate action, healthy ecosystems, or even human development. Similar to risk tolerance, sustainable impact is never ever absolute. It varies in magnitude or relevance based on the investor's choice. It's another face of personalization, candidly.

Let's take the emerging area of climate tech. I think we can all agree that this emerging industry provides a very valuable investing theme that at least is worth investigating. Our data in PitchBook suggests that carbon-negative technologies, especially one around direct air capture, is part of a megatrend today that's driving significant investments from venture capitalists. So, why should this be an area that you ignore for your clients, especially when many of them are beginning to tell you that they care about the positive impacts associated with making investments in spaces like this.

This is where our impact metrics let you invest in where the world and the money is going, even if you are not a VC, while meeting an important consideration for many of your clients in a tangible, measurable manner. Now, I understand that gauging your client's true motivations and conviction for impact isn't simple, and it's not easy, especially when people might feel judged about their answers. And this is where our new ESG commitment survey is going to help you. It guides the client through hypothetical trade-offs to reveal their level of commitment to six sustainability themes from avoiding negative outcomes to advancing positive change. This means that when a client comes in and says they're not going to own a coal company at any cost, or they want to own Tesla regardless of the valuation, you have a tool that will help you explain to them what the potential trade-offs are, and more importantly, when you sit down with them three years later, measure the impact of the choice that that client asked you to make. Think about how powerful that is in showing them the value that you can bring to the table.

Investors' different level of ESG commitments are going to be fed into our new portfolio construction tool, Advisor Workstation. And with a click of a button, this new optimizer is going to build a portfolio that matches their risk profile and their sustainability aspirations. Let's say, for example, that the questionnaire reveals that your client has a high degree of conviction around advancing climate action. Behind me, you can see what the impact metrics look like for the climate action theme if you're invested in the Morningstar Global Target Market Exposure Index. It's about 2 times revenue involvement. But when you choose the Karner Blue Biodiversity Impact Fund, the average revenue involvement jumps all the way to 9.5%, showing you that more holdings in that fund are acting on climate by focusing on products and practices like renewable energies.

So, even so if the same fund only carries 2 globes, it might not be right for a client who is focused on limiting ESG risk. So, there are different pieces of this puzzle that you can start to put together. In fact, some research we just completed shows that advisors that are provided with ESG resources are now 5 times more likely to have a conversation with their clients about sustainable investing, and they're even more likely to do it with new clients who are walking in to work with them.

And you need to have these clients. As I talked about this earlier, these are the clients who are likely to grow with you and become cornerstones of your practice over the next 10 years. So, when the exhibit hall opens today, check out the Investable World Data Display that we've created to help investors explore sustainability themes that range from food and water, to energy, health, and community. I was messing around myself with the display a little bit earlier, and it's really neat and impactful. Please do take a look. What I love about these topics too is they're simple, and they're plain-spoken. Morningstar has made it a habit of arming you to have conversations with your client that they can relate to. And that is what we are trying to do when it comes to sustainability as well.

Now, all of this leads into direct indexing, which we think is the best opportunity to combine all these ideas—returns, risk, and impact—to create a bespoke portfolio that meets the modern definition of investability.

We have a new direct-indexing capability here at Morningstar. I talked to you about it last September, and I'm really pleased now to say that we are bringing it to life, and it takes our investment research, ESG data, indexes, and technology to offer you and your clients the best of Morningstar. On the screen behind me what you're seeing now is a workflow that lets a financial advisor customize a portfolio based on a Morningstar index. It then guides you through the tax trade-offs between capital gains and tracking risk as you transition a client's existing portfolio to a direct-indexing strategy.

Our pilot program is going to kick off in June of this year, and we'll share the broader rollout by the end of the year. But if you're excited or interested in getting a look, you can head to our website, or we've made it easy for you with the most giant QR code that I've likely seen in my life before. And of course, should you be so inclined, I'd also recommend the session tomorrow morning, Direct Indexing in Practice, which takes place at 9:10 in the morning, and four of my colleagues who are the brains behind what we're putting together will be there to talk to you about it.

It's time, these are the tools that you can use to build the future of your firm and increase the investors in the families that you're serving. Because active personalization is indeed the new active investing. It starts with the strength of our ratings system to deliver you a winning hand of investment strategies. Stocks, funds, bonds, or whatever may come, we're going to help you sort through it for your clients.

Next, let's show them how their goals and motivations become part of a personalized portfolio. The simple workflow and reporting options in our risk ecosystem, the ESG optimizer, and direct-indexing tools break open a side-by-side conversation that's never been easier to have.

Finally, all you need to do is create a new definition of risk and reward by showing them new aspects of investability—positive impact and negative impact. In the opening video, if you recall, you heard your peers talk about what's changing—customization possibilities and investors' desire for personalized impact—and what's not—the need for trust-based relationship with your clients to weather the volatility and to ensure that accounts stay with you across generational transitions. Investing is a long-term game after all, just like your business is, and serving the next generation of investors means taking what we do today and turning it up all the way to 11. It means showing your clients the value of collaboration. We believe this is a chance for you to be a navigator for a growing pool of investors and to grow your practices with them. We're going to help you with the tools to do that. And together, we're going to help investors win because when they win, we all win.

Thank you for being here, and I look forward to the rest of the agenda.

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