Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Morningstar's director of manager research, Russ Kinnel, is on Morningstar's 401(k) committee, and he wrote about the plan in the most recent issue of Morningstar FundInvestor. He is here with me to discuss some of his favorite funds in Morningstar's 401(k) lineup.
Russ, thank you so much for being here.
Russ Kinnel: Glad to be here.
Benz: Russ, you are on the 401(k) committee at Morningstar, as am I. Let's talk about some of the key things that you think about when recommending funds for the 401(k) lineup, because you tend to be our main person in terms of recommending alterations and recommending new funds that we should consider?
Kinnel: One way you could say it starts is with low costs. You want to keep costs as low as possible. You don't know, the next 15 years could be a low return environment. So, let's keep costs low. Another thing you want is, of course, tremendous diversification. You want to hit all of the key areas in building a portfolio. But I think you also want stability in management, because as you know, 401(k)s don't change on a dime. If a manager leaves or there's some reason you don't like a fund anymore, you can't just flip that out. It takes a while to make those changes. And of course, you have to remember that there's thousands of employees. They may be working with financial planners and others. And so, there's a lot of ripples to any change. You want to minimize those changes. I love firms where the managers are there for a long time, the analysts are there for a long time. Or of course, index funds do the same thing because they are low cost and they still follow the same index over time. They are really low maintenance. I love those kinds of funds for a 401(k).
Benz: How do you think about balancing the passive options, the index trackers, with actively managed funds?
Kinnel: I think you want to build in some redundancy so people can do some of each. We've got some of each and there's some overlap with what they do, but I think that's fine. I think there are really great options in both camps. I'm one who is generally agnostic, I don't worry too much about that. But obviously, whether it's active or passive, you want low costs. Again, if you've got an active fund charging 50 basis points, that's not such a big difference from a passive fund maybe charging 15 basis points.
Benz: Now, as I mentioned, in the most recent issue of FundInvestor you talked about the whole lineup and you looked at some of the specific funds in the plan. Let's take a look at the funds that you own within the 401(k) plan, the funds that you personally really like. Let's start with Primecap Odyssey Aggressive Growth.
Kinnel: As the name implies, it is one of the most aggressive funds in the portfolio, but I really like Primecap because they are such good growth investors. This is a little more aggressive partly because it's smaller market cap, also has a little faster growth rates. But we've seen this movie before when they invested back in the early days of Vanguard Capital Opportunity, it invested in the space and did tremendously. I have a lot of faith in it. But of course, it is a fund that you have to be very patient and you have to understand that you could take serious lumps for a couple of years along the way.
Benz: Now, I know Primecap tends to score well on the stewardship front as well. In fact, several of its funds are closed to new investors. Is this one open?
Kinnel: This one is also closed. I hate to be a tease, but it is closed to new investors. Primecap didn't want the fund to move up too much in market cap.
Benz: Are there any Primecap funds open at this point?
Kinnel: Primecap Odyssey Stock is the one that's still open. Very good fund. It's more of a large-cap, a little less aggressive fund, but still a very good one.
Benz: That's a domestic equity fund, obviously. Let's take a look at an international fund that you own, that's Dodge & Cox International Stock. Let's talk about why you like it.
Kinnel: I mentioned stable management and this is a perfect example. Dodge & Cox has had managers and analysts make the entire careers of working there. There's tremendous stability. It's a team-managed fund, so one person isn't going to throw things off if they leave. Dodge always has very low costs. They are very consistent with what they do. It's a value strategy that kind of borders on the blend border, but is very consistent. Everyone at Dodge invests in this value style. It's very much embedded in the firm. And they are just a very good steward as well. It hits a lot of key points I like in a good fund.
Benz: As you mentioned, it's a value-leaning fund. Is it the sole core international fund that you have in the plan?
Kinnel: No. I also have Vanguard International Growth, which is more growth-leaning as the name implies. It's divvied up among a couple of subadvisors. It's a little more boring fund, but it's super low-cost and that works, too. Again, 401(k) funds that you don't want excitement necessarily. I think a little dullness isn't necessarily bad. This is a dependable fund with low costs. Vanguard does a pretty job of selecting subadvisors. It's another kind of good 401(k) fund. You just allocate some money and don't worry about it too much.
Benz: How do you set your allocation to foreign stocks, foreign stock funds relative to U.S.?
Kinnel: I typically go for about a 40% to 45% weighting. I'm one who believes that generally people tend to underweight foreign equities. Of course, the last few years, I guess, that's hurt me a little bit because U.S. has outperformed, but it's really kind of an irrational fear we have of foreign equities. Every country in the world people perceive foreign as higher risk which doesn't actually makes sense, and especially given the added diversification you get, I think it makes sense to have a sizable weighting in foreign equities.
Benz: So, when you say 40% to 45%, you mean of your equity allocation?
Kinnel: Of my equity allocation.
Benz: So, 40% to 45% foreign. Obviously, not a recommendation for everyone, but the way that you're approaching it.
Let's talk about another fund that you like within the lineup. American Funds New World. This one might be a little less well-known to some of our viewers. Let's talk about that one.
Kinnel: That's right. This is an unusual kind of fund because it's technically an emerging-markets fund but a chunk of its equities are actually in developed markets, but it only invests in developed market companies with large business in emerging markets. It's kind of taking two routes to emerging markets and that seems reasonable to me. The effect is that it's less volatile. So, when emerging markets are really running, it's going to lag. When emerging markets are really hurting, it's probably going to do better. But again, it's got low costs, and with American Funds, we know they have a very deep team, very good foreign managers, very good foreign analysts. And so you really see a lot of their strengths come to the fore in a fund like this.
Benz: This is a product you mentioned that the strategy makes sense to you. It's a sensible lower risk take on emerging markets. But this is one you would probably keep to a smaller share of your total portfolio?
Kinnel: Definitely. Even though it's tame by emerging-markets standards, it's pretty bold compared to the rest of the world. It's going to be more volatile. When emerging markets go into slumps, they really go into slumps. So, yeah, it's going to be a little smaller part of my portfolio. I think the core is those Dodge & Cox and Vanguard, I think, are really going to do the heavy lifting from my foreign portfolio.
Benz: Let's talk about a bond fund that you like and it's, I assume, not your only bond fund in the 401(k). But let's talk about Loomis Sayles Bond.
Kinnel: This also counts as aggressive. I guess we are highlighting most of the aggressive funds today. But I do have some conservative funds, I promise. But yeah, this is a really good fund that's kind of a wide-ranging, invests in the U.S. and foreign, invests in investment-grade and high-yield, really wide-ranging fund. Dan Fuss leads it, and of course, he is not particularly young these days. He is not too far from retirement, I would guess. But we like the other managers with him and we like the rest of the team, which is why we still have faith in the fund.
Benz: Russ, great discussion. Thank you so much for being here.
Kinnel: You're welcome.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.