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Financial Advice

New Imperatives to Meet the Moment for Today’s Evolving Investor

Morningstar CEO Kunal Kapoor delivers his keynote address at the 2023 Morningstar Investment Conference.

New Imperatives to Meet the Moment for Today’s Evolving Investor

Kunal Kapoor: Hello everybody and welcome back to Chicago. It’s great to have you here. I tried to organize the weather but didn’t work out, as usual. But welcome to our event. I’m excited to have you here. And the theme of evolving investors is particularly one that is resonant for me. I remember, when I first started at Morningstar, I was very keen to make my first investment, and I wanted to do it immediately. And so, what did I do? I wrote a check, and I walked down LaSalle Street to the offices of Harris Associates, and I opened an account of the Oakmark Select fund, monthly investing, and that was the way I got started. And along the way life happened. Had a family. We had kids. Started to do a 529 plan. Started to get more serious about what we’re going to do in retirement. This year, our oldest will go to college, and we’re starting to think about withdrawing from the 529 plan and funding what he is doing, and we’re going to do it all over our phones or our computers. I’m not going to be walking down any streets to make that interaction happen. I’m starting to think about other issues such as how I want to help the City of Chicago, what happens on that front, and how I seek advice from some of you and the things I want to do and how I interact with you and technology. It’s all changing. And so, just as the investor is evolving—and I look at my own journey as an investor—it’s all very resonant to me as well. So, I hope when you’re here, you’ll take some time to see the gallery that we’ve put together for you about the evolving investor. They really inspire what we’re doing at Morningstar today, and we think they’re going to be resonant for how your practices evolve going forward as well.

As I was sharing, I think every investor evolves, needs change, what you want to achieve in life changes. Sometimes it’s stability, sometimes it’s accumulation or even it’s maybe the art of the drawdown. And it’s also true, of course, that every generation of investors changes. So many folks said that older investors would not embrace technology. Well, that’s not the case. They want both. They want to sit down with their advisors, and they want the technology right next to them. But underlying all these changes is the reality that all investors are influenced by the timing at which they enter and experience the markets, the way they think about risk and how technology impacts their investing experience.

Just look at the last two years. I think it’s very fair to say that if you entered the markets in 2021, you thought you were a genius for about 12 months. I think it’s also fair to say that if you entered the markets in 2022, you’re probably wondering “What have I gotten myself into?” Just last year, if you look at the Morningstar Moderate Allocation Index, it had its worst year on record. That’s a 60/40 portfolio. What we like to say, set it and forget it. That should be a steady portfolio and it was down 15% last year—very, very significant. But amid environments like this, there’s also room for opportunity. And I know many of you in this room think of it that way.

For those of you who have been coming to this conference, you know I almost always start by showing you our fair market value graph. Now this accumulates all the stocks that our analysts cover, adds up their fair values, and compares it to the actual prices. And what you see is that our analysts today think that in aggregate the U.S. market is about 11% undervalued. But what’s remarkable is that at one point last year, the undervaluation was as significant as it had been since 2011 but for one month during the start of the pandemic. Clearly, equity markets have come off their lows, but our analysts still think that if investors are starting to experience the market, this is maybe not a bad time. Over half the stocks that they cover are rated 4 or 5 stars today. So, whether you’re looking at the banking crisis and saying, “I wonder if there’s a bank stock I should be looking at?” We have Truist Financial TFC. Or maybe you’re walking down the street and saying, “I wonder if Krispy Kremes are still a good deal.” Well, they’re 5 stars. And for those who are coming to you and saying, “It’s still tech all the way,” names like PayPal PYPL are rated pretty highly by our analysts these days. So, plenty of opportunity. It’s a good time from that perspective to be thinking about it.

So, we wanted to get a sense of how investors’ behaviors and attitudes have changed, and we turned to investors themselves to do what we call the “Voice of the Investor” study. We polled more than 2,000 people across the United States to get a pulse on their moods and what they’re thinking about. If you want to point your phone’s camera at this screen, you can download and receive your copy of the report. But I don’t expect you to read it while I’m talking up here. So, let me get to some of the key highlights.

First—and this is probably not a surprise to many of you—investors are telling us that they are just overwhelmed with data. It’s probably true of everybody in this room. There’s data everywhere, right? In fact, Oracle just published a study last week saying that nine out of 10 business leaders say that the volume of data that they’re getting is so huge that even they don’t know what to do with it. So, it’s no surprise that investors feel the same way. Second, investors, and particularly those who have not worked with an advisor, tell us that they’re having trouble seeing the value of advice. Surprising to me, people rated advisors as providing similar value to investment or trading platforms and only slightly above financial media.

So, I did a little bit more digging into the data, and what we found is that where we see the value of advice shining through is in boosting clients’ understanding of risk management. A higher proportion of investors who work with advisors, 42% of investors in our study work with advisors, and 90% of those investors said that they find advisors to be extremely valuable because advisors are personalizing the risk experience for them in a very tangible manner.

How can I illustrate that for you? Well, let’s look at our risk profiler tool, which many of you have been using for many years. We’ve had it for 25 years, and we’ve tinkered with it over and over again, but the bottom line is that there have been about 2 million tests that demonstrate that a person’s comfort with risk-taking is a psychological trait that doesn’t meaningfully change with market swings. Now all of you know this makes sense because as your spouse or my spouse will tell you, people don’t fundamentally change no matter how much you wish it.

So, we recently went a step further in Advisor Workstation, giving each of your clients an opportunity for a personalized risk comfort range, so you can tune that long-term portfolio to their true, and most importantly, durable risk tolerance. We call this the person’s risk score. And then, there’s the product risk score that we’ve introduced. The Morningstar Portfolio Risk Score then uses a full holdings-based analysis to quantify the risk of a client’s accounts on a scale of 0, think cash to 100, think very concentrated sector funds. And it uses Morningstar’s Target Allocation indexes as benchmarks to define what it means to be conservative, moderate, or aggressive. The name of the game really is to match the person’s risk score with the product’s risk score for a long-term and happy marriage. And our risk ecosystem is only one example of how we’re trying to meet these needs of technology, risk, and investing in one overall environment. Because the reality is that digital innovation is all around us, it’s disrupting everything. You don’t need me to tell you that.

All of you probably know by now that it took three years for Netflix NFLX to hit 1 million users. For Spotify SPOT, it took five months. And probably because all of you have been using it, for ChatGPT, it took five days. That’s pretty amazing. Now, some of you will tell me, it comes with risks and privacy concerns, misinformation, manipulation, exploitation. I get that, and I think those are real risks. But if we apply AI as an industry, I believe it puts you as an advisor in a position to provide a much better investing experience and do that at scale.

So, let’s have some fun and let me introduce you to my new friend. Some of you may have met him already at our Innovation Lab. But let’s meet Morningstar Mo. Our team has been having some fun loading up the OpenAI service with Morningstar’s signature research and data. Then what we did is we hooked it up to a digital avatar from a company called Soul Machines in New Zealand, and then we added voice recognition, and voilà, over the course of a weekend, Mo was born. Now, many of you have your own experience with ChatGPT, but our goal with Mo was to make him trustworthy and focused in what he was saying when it came to financial information. So, he is loaded up only with the financial information from Morningstar that we all know we can trust.

So, what we’ve done here is we’ve continued since we created Mo to improve him over the past two weeks, and he is learning every day with every interaction. He is imperfect. I will tell you a lot of our PR and legal folks were nervous that Mo was going to make an appearance with me. So, with all due apologies to everybody, here he is. I’m going to ask him some questions, but you too can test him out at the Innovation Lab and coffee bar that we have. But let’s start by introducing you to Mo with what I think is a very basic question.

Hey, Mo, what makes a good financial advisor?

Morningstar Mo: A good financial advisor should offer comprehensive financial and portfolio planning and have a broad range of expertise, including tax specialists, investors, and estate planners. They should also have a certified financial planner credential and be able to add value to clients through their skills and advice. However, the level of fees and the investor’s own skill level should also be considered. Ultimately, a good financial advisor will prioritize understanding of clients’ goals and intentions and offer personalized advice and solutions.

Kapoor: OK. I can tell probably that some of you are saying, “Yeah, that’s good, but it kind of feels like a little bit of a canned answer.” But let me tell you, there’s a lot going on for Mo to give you that answer. First, voice is logged and converted to text. That text is then transmitted to an OpenAI model which analyzes more than 100,000 Morningstar data points to generate an answer. The text is then converted back to speech, and that’s when Mo became animated and began to deliver that answer. And we’re trying to do that within 10 seconds with an answer that the user is likely to trust. Believe it or not, the alternative is to sit there, type it in, and look at a bunch of webpages. I mean, that seems so two months ago, right? This is a game changer. But for the skeptics here, let me bring Mo back up, and let’s try to ask him a slightly different question related to information overload, because we believe AI holds a lot of promise in that regard.

So, Mo, what should a financial advisor tell a prospective client about finding the right strategy among hundreds of thousands of investment options?

Morningstar Mo: A financial advisor should inform a prospective client that finding the right investment strategy involves considering several factors, including their financial position, investment objectives, and risk profile. The advisor should also explain how they use Morningstar’s forward-looking medal and star ratings to evaluate investment options and how they tailor their recommendations to the client-specific needs. Finally, the advisor should discuss the importance of ongoing monitoring and adjusting of the portfolio to ensure it aligns with the client’s evolving goals and risk tolerance.

Kapoor: Nice. So, you’re starting to get the feeling of what he is capable of doing, and I’m going to bring him back up. But importantly, Mo is right. If you’ve been to this conference in the past, you’ve heard me predict that the number of investment choices are going to decrease, and that view was incorrect. In fact, today, there are more than 750,000 investment vehicles for you to choose from. So, I know how daunting it is when a client lands in your office with a list of things they want you to look at.

Now, we think our ratings are the most powerful way for you to cut through the clutter with information that you can trust and that your clients can trust. Many of you are users of our forward-looking Analyst Ratings, and I want to highlight here what a fine job they’ve done in separating the wheat from the chaff. Since we started assigning them, you can see the gap in performance for medal-rated funds compared to Negative-rated funds which are shown with those red bars. So, let’s see how Mo begins to interact with our recommendations. He is back up here.

OK. Before I ask him a question, remember Mo has read and can recall every single piece of Morningstar research. So, if you want to know what Don Phillips said two decades ago or Christine Benz said about a financial planning issue two weeks ago, Mo already knows about it, and you don’t have to go searching for it. That’s something nobody in this room can do, and that’s what’s amazing. So, here’s a very quick example using a popular ETF.

Mo, how does Morningstar rate the ARK Innovation ETF, ARKK?

Morningstar Mo: Morningstar rates the ARK Innovation ETF with a Negative Analyst Rating. While the fund has seen tremendous success in the past, it has shown few signs of improving its risk management or ability to navigate challenging territory. Its recent wretched 44% loss over the trailing 12 months through March 2022 significantly lagged the technology Morningstar Category’s average 5.1% decline and the Russell Midcap Growth Index’s 0.9% loss.

Kapoor: Wretched. Mo comes with a vocabulary as well. But I picked this example because it makes a really important point about humans and machines. At the time when this ETF was flying high, just about any quantitative model, including some within Morningstar, would have suggested that it was a good fund. But our analysts told investors to stay away. They were looking at the costs; they were looking at the risk; they were looking at the long-term record of the managers; and they were proven right, even though flows have, surprisingly for me anyway, remained positive. The takeaway is that we think humans and machines can work well together and help solve some of the problems of ever-expanding investment choices.

In fact, one of the things I’m most excited about is that next week we will deliver on the promise we made here last year, and the Morningstar Analyst Rating and the Morningstar Quantitative Rating will combine into one single rating, the Morningstar Medalist Rating. Thousands of additional securities, including separate accounts and model portfolios, will now carry ratings. Just think of the power of being able to sort through that for your clients or use a screener to get to an answer very quickly. Not only will popular funds like Vanguard Dividend Growth VDIGX have the answers but lesser-known quant-rated strategies like Fuller & Thaler Behavioral Small-Cap Equity FTHNX will now carry a rating and be equally discoverable as some larger strategies.

We’re making investing easier, personalizing risk. So, what is left at this stage to scale? Well, it’s April, and while we’re past tax day, let’s spend a minute talking about taxes because I know that that is often on your minds. Here we think direct indexing in particular is a game changer. And so, let’s bring Mo back up and we’re going to talk to him about direct indexing.

Hey, Mo, which investors are good candidates for the tax benefits of direct indexing?

Morningstar Mo: Investors who are in a high federal tax bracket and a high state tax bracket have a large amount of money in the directly indexed pool, frequently replenish the directly indexed pool, have short-term capital gains of the type that appear on an investor’s Schedule D report, operate in a volatile market environment and have preliquidated retained assets, particularly to donate it or passed along to heirs are good candidates for realizing tax benefits from direct indexing, according to Morningstar’s John Rekenthaler.

Kapoor: I think we still got to work on a little bit of the jargon with Mo, but you get the point in terms of where he is headed. I also like that he is using his hands. I’m often accused of using my hands too much when I’m on stage. So, I’m in good company apparently. But now imagine if the future Mo knew everything about Morningstar’s software as it pertains to your clients and their portfolios. Rather than you sitting there and determining client by client who might make sense for a particular strategy, direct indexing or otherwise, Mo could very quickly tell you by looking in a second at each profile as to which clients you should be calling.

We think direct indexing holds a lot of promise and married with technology like this could really be a game changer. So, check out the possibilities for direct indexing on our Wealth platform, which also brings you tech-enabled tax optimization and trading capabilities. You’ll find it at the Morningstar booth up in the exhibit hall. We’re excited about this because we’re headed, in our minds, for the greatest generational wealth transfer in history as boomer parents and grandparents begin to pass down trillions over the next two decades, tax issues are going to move to the center, and strategies like direct indexing and using them are going to be very, very important.

Now, before I wrap up, let’s turn back the page for a second to the idea of making risk management personal. Imagine that you have a client, and let’s call the client Sam Morales, who has got an average risk tolerance and a balanced portfolio that you recommended for Sam a few years ago. Now, the question is, after all that’s happened in the markets, does it still make sense to manage that portfolio in that way? So, I’m going to ask my final question to Mo here, and you can try Mo out yourself later on.

Mo, is a 60/40 portfolio still the right level of risk for my client Sam Morales today?

Morningstar Mo: Sam’s risk tolerance is average, and his risk comfort Range is 31 to 44. A well-diversified 60/40 portfolio typically has a portfolio risk score between 25 and 49, which is still considered reasonable for a moderate risk portfolio. Additionally, Sam’s 60/40 portfolio risk score has consistently been around 35 to 43 over the past 60 months.

Kapoor: So, what did we do there? Well, what we did is we fed Mo with risk scores for well-diversified portfolios of various flavors, and we built fictional data about a hypothetical portfolio’s monthly risk scores and the client’s risk comfort range. Because when you’re able to tailor a portfolio quickly and easily to each of your clients and simply frame up the trade-offs and choices they can make, your plan will become their plan. It doesn’t take AI, it doesn’t take Mo to know that that kind of engagement leads to a long-term relationship for you and that client.

So, when you leave this theater, I’m going to ask you to do three things. First, take my new friend Mo for a spin at the Innovation Lab and coffee bar. We’ve been asking Mo all kinds of ridiculous questions, and I imagine some of you will do the same. I think somebody asked him earlier this morning about inventing an insect that would help them take over the world. But he is largely focused on investment issues. Take him for a spin and think about how that would work. Second, check out how we’re bringing exciting new research and risk capabilities to our products and merging it with new innovations such as direct indexing, a third-party app in Workstation, and as of earlier today, the launch of third-party models on our Wealth platform. And then, finally, as I said at the start, walk around the Evolving Investor gallery to explore the many ways better technology and analytics are helping us meet the moment for evolving investors.

And of course, we’ve got a fabulous lineup for you. I love coming to the conference because there’s so many great topics. Tomorrow, former Secretary of the Treasury Larry Summers, who was ahead of the pack in warning about inflation, will give us his read on the macro environment. He does not hold back. And our Daniel Needham, who will be interviewing him, does not hold back, either. So, it will be fantastic. Pimco’s Dan Ivascyn is around lunchtime tomorrow. Dan has got a very thoughtful and important voice on the health of the credit markets. And we’ve got other notable speakers, such as Steve Romick, to take a deep dive on valuation. And right after me, Aswath Damodaran from NYU, who is one of the premier voices on valuation. On our final day, which will be a retirement-focused set of topics, the new CEO of the Capital Group, Mike Gitlin, will share what he has planned for one of the largest asset managers around, one in which many of you have assets. And I think you’ll hear what Mike has ahead for them.

And finally, you don’t need to know what the term finfluencers means or have TikTok on your phones to see the value of folks like Humphrey Yang and Tori Dunlap’s 5.5 million followers or their power in reaching younger, newer investors. What I take away when I listen to folks like that is just imagine if you had someone like that in your firm driving that kind of prospective client reach and engagement, what it would do for your pipelines and how meaningful that would be.

So, I hope you’re going to enjoy the show. I’m certainly excited now to sit back, enjoy it, and I would like to welcome my colleague, Katie Reichart, the director of equity strategies for our U.S. manager research team, over to the stage. Thank you, everybody.

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.

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