529 Ratings and Value and Growth Picks

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Susan Dziubinski: Hi, I'm Susan Dziubinski for Morningstar.com. There may be good reason for some investors to explore value-oriented mutual funds and ETFs today. For instance, if you've been using discrete funds for your growth and value exposures, you may find that your once-balanced style portfolio maybe light on value given growth's extended run. Or you may be among those who think value stocks are finally going to have their day, and you'd like to tilt your portfolio toward that style. Here's a look at three highly rated value funds.

Alec Lucas: American Funds American Mutual is a very reliable, large-cap-oriented fund that focuses on dividend-paying companies with sound balance sheets. Each of the fund's seven managers, who each manage an independent sleeve of the fund, has to meet an above-market pre-expense yield target in managing their sleeve of the portfolio. Otherwise, the managers are free to invest according to their own investment style. Splitting up the portfolio in this way and dividing among those seven managers and their two analyst teams minimizes key-person risk in the fund. The fund has been very reliable since its 1950 inception. This is the kind of fund you can own when you're worried about market valuations and markets plunging, because this has proven the ability to preserve capital better than the S&P 500.

Robby Greengold: Fidelity Low-Priced Stock is an excellent value fund that investors should consider. Since the fund's 1989 inception, manager Joel Tillinghast has steadily built one of the finest track records of any fund in either the small- or mid-cap Morningstar Categories. He's achieved that by reliably protecting shareholder capital during market drawdowns while participating healthily on the upside. That pattern derives from Tillinghast's extraordinarily methodical approach, his ability to spot high-quality companies, and his refusal to chase short-term fads. This portfolio is broadly diversified across hundreds of stocks, and with each of those positions Tillinghast focuses on the long run. He looks for resilient companies with staying power. That means that he's generally trying to avoid companies that lack an enduring competitive advantage, and he steers clear of companies loaded up with too much debt. Almost without fail, this fund has offered investors refuge during rocky market environments. And with Tillinghast's steady hand at the wheel, we continue to have high conviction in this Silver-rated strategy.

Alex Bryan: Vanguard Mid Cap Value ETF is one of the cheapest and most broadly diversified funds in the mid-cap value Morningstar Category, which makes it one of the best. This strategy targets stocks representing the cheaper and slower-growing half of the U.S. mid-cap market and weights them by market capitalization. Now that reflects the market's collective wisdom about the relative value of each stock. These stocks aren't necessarily bargains since they're growing more slowly than their pricier counterparts; however, they could become undervalued if investors extrapolate their lackluster past growth too far into the future. While this portfolio often looks a lot like the mid-cap value Morningstar Category average, its durable cost advantage and lower than average cash balance gives it a durable edge. It beat the category average by just over 2 percentage points annually over the past 10 years, and it should continue to reward investors over the long term. ***

Charles Fishman: Coal and natural gas have been fighting for the top spot in the U.S. generation market for the last 20 years. In 2016, gas generation topped coal for the first time. Gas is the new king, with 35% market share. Now the battlefield is shifting, and in the next decade we expect natural gas and renewable energy, particularly solar and wind, to slug it out.

Renewable energy has been growing at extraordinary rates but still has just 10% market share. By 2030, we forecast renewable energy to produce 22% of U.S. electricity generation, surpassing coal, nuclear, and hydro as the second-largest source of power generation in the U.S. We think gas will also be a winner because of its flexibility to support intermittent wind and solar, extending its market share lead to 41% over the next decade.

The U.S. Energy Information Administration and others believe renewable energy growth will level off as wind and solar tax credits ramp down early next decade. We disagree and think renewables will continue to grow at a similar pace. Our bullish outlook is built on the investment utilities are making to meet state renewable portfolio standards and satisfy corporate demand.

We believe integrated utilities with supportive regulatory frameworks should benefit as they retire coal plants and replace these assets with natural gas, renewables, and transmission infrastructure. The largest U.S. utilities--Dominion Energy D, Duke DUK, NextEra Energy NEE, Southern Company SO, and Xcel Energy XEL--are investing billions in narrow- and wide-moat projects that should result in strong earnings and dividend growth over the next decade. ***

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Bond-fund yields look underwhelming relative to cash yields today, but bonds can still serve a valuable role in investors' portfolios. Joining me to share some favorite bond exchange-traded fund picks is Alex Bryan. He's Morningstar's director of passive strategies research in North America.

Alex, thank you so much for being here.

Alex Bryan: Thank you for having me.

Benz: Let's get right into your first pick, Alex. This is kind of a tried-and-true option, maybe even a one-and-done option for many investors. This is Vanguard Total Bond Market Index ETF. Let's talk about why you like it.

Bryan: So, I like this fund because it offers broad exposure to the U.S. investment-grade bond market. It weights its holdings based on market value, which tends to tilt it toward really high-quality government bonds and agency mortgage-backed securities. About 70% of its portfolio is invested in AAA rated debt. So, those bonds tend to do well in environments when stocks don't do very well. There's not a lot of credit risk here. And to the extent that interest rates go down further, that can provide some capital appreciation here. I think this is a really good portfolio because it's really well diversified across different sectors, and it doesn't have a lot of issuer risk in it. So, I think if you're looking for a way to diversify away from stock risk, this can provide a nice defensive counterweight to that.

Benz: A more conservative option, because it's shorter-term, would be Vanguard Short-Term Bond Index ETF. Let's talk about that one. That's presumably for investors who have even shorter time horizons for their money. Maybe they expect to spend that money within the next two or three years or so. Vanguard Short-Term Bond ETF, why do you like that one?

Bryan: Yeah. So, this fund offers exposure to the short end of the investment-grade market, invest in bonds maturing between one to five years. It owns both government as well as corporate bonds. Like the Vanguard Total Bond Market ETF, it is very conservative. Most of the portfolio is parked in AAA rated securities. But I think this is a particularly attractive option if you are looking at the yield curve and thinking that long-term bonds currently may not be offering very good compensation for their additional interest-rate risk. So, if that's a concern, or if you need money in a couple of years, this is a really good option to consider. It tends to be less sensitive to changes in interest rates than the broader bond market. So, that means that if interest rates were to ever go up, which presumably at some point, they will, these bonds tend to lose less of their value than longer-term bonds. So, this is a safer option than a broad bond market fund, which might make it a really good option if you are a bit more risk averse.

Benz: So, let's talk about a pick for investors who are potentially a little bit more risk-tolerant, that they are willing to tolerate some price fluctuations in exchange for a slightly higher yield. A fund you like in this sort of category is iShares Broad USD Investment Grade Corporate Bond. The ticker is USIG. Why do you like that one, Alex?

Bryan: So, I think this is a really good option if you're looking for a slight yield pickup over what the broad U.S. investment-grade market offers, but you want to keep risk in check. So, this particular fund invests in a broad range of investment-grade U.S. corporate debt, with bonds ranging anywhere from one year to maturity all the way up out the yield curve. This fund effectively diversifies issuer-specific risk, sector-specific risk, and I think this is a really good option to pair with a core bond holding like Vanguard Total Bond Market ETF. So, if you're looking to get a slight yield pickup but you don't want to venture out into high-yield territory, I think this is a really good way that you can get some additional yield without taking on a lot of risk. This is also one of the lowest-cost investment-grade corporate-bond funds out there. It only charges 6 basis points. So, I think that makes it a really attractive way to get exposure to this area of the market.

Benz: Alex, timely discussion. Thank you so much for being here.

Bryan: Thank you for having me.

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

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Karen Wallace: We recently updated our ratings on more than 60 529 plans. That covers nearly every plan available to college savers. I'm here with Madeline Hume. She's an analyst on our Manager Research team covering multi-asset strategies, and she's one of the report's authors.

Madeline, thanks so much for being here.

Madeline Hume: Thanks for having me, Karen.

Wallace: Let's dive in by talking about a high-profile downgrade, the Vanguard 529 plan, and this is run by the State of Nevada. This has been Gold-rated for years. Why isn't this best-in-class any longer?

Hume: The Nevada Vanguard 529 plan has always competed on cost, and its once really robust cost advantage has eroded over the past couple of years. It's no longer the cheapest plan, and it's no longer even in the top five cheapest plans. In fact, it's not even the cheapest plan that features investment management by Vanguard. That honor goes to the New York 529 plan, which is 3 basis points cheaper. Although it's a very thin margin, costs have compressed a lot in the 529 space, and Vanguard has always been pretty competitive on fees.

Wallace: So, let's dive into one of the upgrades now. The California ScholarShare Plan--this went from a Silver to a Gold. What were some of the improvements we saw there?

Hume: Yeah, California is the first state to debut a progressive glide path with investment manager TIAA. They've come to this space before many of the other plans that have featured investment management by TIAA. And this progressive glide path is something that Morningstar considers an industry best practice. In addition, California leverages an open architecture model, which features investments from a wide range of excellent asset managers, including T. Rowe Price, DFA, Pimco, and Metropolitan West, which we think is resulting in a fine option for college savers.

Wallace: Madeline, thanks so much for being here to discuss this.

Hume: Thank you for having me, Karen.

Wallace: You can read the full report on Morningstar.com, which includes all the upgrades and downgrades as well as a description of our ratings methodology.

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

Alec Lucas: The large-growth Morningstar Category has been the best-performing asset class within domestic equity mutual funds over the past decade through September 2019. While investors shouldn't count on a repeat performance over the next decade, there are three large-growth strategies currently open to new investors that carry Morningstar Analyst Ratings of Gold and should provide superior long-term results. The strategies differ in what they're trying to do and understanding those differences should help investors select the right one for them.

T. Rowe Price Blue Chip Growth TRBCX is the only single manager fund in the group. Larry Puglia launched the strategy in 1993 and has led it through multiple market cycles. At more than $100 billion in assets, the strategy’s size presents a challenge, but it is one that Puglia, drawing on T. Rowe’s well-regarded analyst bench, has navigated well. He has consistently invested in 120 to 140 large- and mega-cap stocks throughout his tenure, even as the strategy has grown. That’s kept the portfolio fairly diversified, but concentration in individual names can be significant. In September 2018, for example, the fund’s position in Amazon.com AMZN topped out at 11.45% of assets, nearly double the stock’s weighting in the Russell 1000 Growth Index at the time. Puglia’s highest-conviction picks have tended to work out, though, and outperformance has been consistent. The biggest risk here is in choosing the right person to succeed Puglia, who is in his late 50s. Yet, T. Rowe Price’s track record in handling such transitions breeds confidence.

With American Funds AMCAP AMCPX, key-person risk isn’t really an issue. Using parent Capital Group’s multimanager system, its roughly $66 billion asset base is split between six named managers and two analyst teams. And like T. Rowe, Capital Group has a good track record navigating manager succession. AMCAP differs from T. Rowe Price in its multi-cap mandate and in its more-muted growth profile. In fact, its 130- to 150-stock portfolio has been mostly closely correlated over long periods of the time with the Russell 3000 Index, not the Russell 3000 Growth Index. And while the fund’s weighting in tech stocks often represents its biggest sector exposure, it has not had a tech overweight versus the Russell 3000 Growth Index since at least the mid-1990s. A double-digit cash allocation is typical. That helps the fund moderate its ups and downs and enables managers to buy stocks in falling markets. That’s been a long-term recipe for success against the Russell 3000 Index, and it should continue to be.

Like American Funds AMCAP, Primecap Odyssey Growth POGRX uses a multimanager system. In fact, prior to co-founding Primecap in 1983, Howard Schow was one of the original managers on American Funds AMCAP upon its 1967 inception. While Schow passed away in 2012, he left behind him a strong team at Primecap, which includes Primecap Odyssey Growth’s five named managers. Also like AMCAP, Primecap Odyssey Growth has a multi-cap approach. While sensitive to valuations, it tends to be more aggressive, though, in building exposures to fast-growing market segments within tech and healthcare. And, like T. Rowe Price Blue Chip Growth, exposure to single names within the fund’s roughly 130- to 150-stock portfolio can be significant. Its stake in Nektar Therapeutics NKTR peaked at 6.3% of assets in March 2018, for example. Picks like Nektar have weighed on the fund’s results since mid-2018 and provided a reminder of its risks. But over a long period of time, the fund should reward investors who can stick with it.