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Investing Insights: Kinnel's Portfolio and Graduate Gifting

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Christine Benz: Hi, I'm Christine Benz from Morningstar's director of manager research, Russ Kinnel, is a long-time observer and researcher of mutual funds. He's here with me today to share some of the holdings in his own portfolio.

Russ, thank you so much for being here.

Russ Kinnel: Glad to be here.

Benz: Russ, I feel a little like I am getting a look at what's in Bobby Flay's cupboard or something like that. It's great that you are willing to share some of your own personal portfolio holdings. Before we get into them I'd like to talk about what qualities generally speaking you look for when selecting mutual funds.

Kinnel: I look for low cost, great management, great strategy, ideally something that can be a core holding for a long time in my portfolio. Really a lot of the things we look for in a Gold-rated fund are what I look for. To be a top holding in my portfolio naturally has to be something you can really depend on, something I really have a high opinion of.

Benz: Where do you come down on the passively managed versus actively managed question when it comes to your own portfolio?

Kinnel: I think they are both great. I have mostly active funds in my portfolio, but I do have some passive as we'll discuss. I think they are both great. We have Gold-rated funds from both categories. I think most people should probably own some of each, I think it just makes a lot of sense--each can do a good job and it also depends, how much effort you want to put into the research obviously. Active requires a little more effort than the passive.

Benz: Good point. Before we get into some of your specific holdings, for each of them I am hoping you can say where you hold them--whether you hold them in 401(k), IRA, taxable account, or so forth. Let's start with American Funds New World. Talk about where you hold it and then I'd like to get into why you like it.

Kinnel: I have got this one in my 401(k), it's in Morningstar's 401(k). I just like the fact that it's a nice conservative emerging-markets fund. We have institutional share class of the fund, so very low cost, very dependable fund.

Benz: For people who aren’t familiar with this particular fund. It's really different from most other pure emerging-markets equity funds. Let's talk about that and how it's construction sets it apart and makes it more conservative.

Kinnel: That’s right. It's got some of your typical emerging-markets equities. But it also has some in developed market equities from businesses that do a lot of business in emerging markets. It's kind of taking a more holistic approach to that, and what that means is that it's less volatile, but it also means you are giving up a little. When emerging markets really rally this fund's going to lag. I think it makes a lot of sense, that there are a lot of different ways to get that exposure. To me, it makes a lot of sense, but it's not going to be the highest potential returner in the EM space.

Benz: Right. So, in a year like 2017 when EM is going strong this fund will perhaps tend to not perform quite as well.

Kinnel: That’s right, but I think its useful for investors because these more cautious EM funds are the kind that people will hold through the downturn, because when emerging markets get hit they get hit really hard. You lose 50% or 60% of your investment. If you can minimize that loss or reduce it a bit that’s going to help people stick through to the good side.

Benz: Really good point. Let's look at another international fund, this is Dodge & Cox International Stock. Let's talk about where you own it first and why you own it.

Kinnel: Sure. I have got this one actually in my 401(k) and in a taxable account. I initially brought in a taxable account before it was available in our 401(k), later added it to our 401(k), so I own it in both places.

Benz: In terms of it's appeal it lands in our foreign large blend category it's a Gold-rated fund. Really time-tested process on display in this fund.

Kinnel: Dodge & Cox is an old school value investing firm. But to me maybe the most important thing is just the stability of people, that their analysts and managers tend to make a career of it there. You've got team-managed approach here, and so one person, retiring doesn't throw off the fund in the least. Really a great group of analysts and managers there. When I talk about a fund you can own and forget about, Dodge & Cox is really almost like an index fund in that you can buy their funds and they are pretty much going to be the same fund in five or 10 years. 

Now this one does obviously have some risks. It got burned in '08, it had too much in financials, but I really believe in the fund, obviously, I owned it before that time and I held through. So, I am a true believer.

Benz: Dodge & Cox funds are really low cost.

Kinnel: Very low cost. Again, we talk about active versus passive, and I think whether you are active or passive, you want low costs. When you have a low-cost active fund like this one, they only have a small hurdle to catch up with a passive fund.

Benz: Now, let's look at another fund that you hold. This is Vanguard Primecap Core. Let's talk about where you hold it and why you like it. By the way, this is one I own, too.

Kinnel: This one is closed to new investors. I hold it in a taxable account. There are Primecap Odyssey funds that are still open, so you can get pretty similar fund. But low cost, the best growth investors out there. I just really believe in them. You have a team approach here where each manager picks stocks separately from the other managers, but they all have the same input of their analysts. They are just very good fundamental growth investors. You put that together with Vanguard, and its really low cost. This one I have in a taxable account. I have Vanguard Capital Opportunity in an IRA, and I have Primecap Odyssey Aggressive Growth in a 401(k). So, I am a big fan.

Benz: It is one of the firms, when we ask our analysts, what's your highest conviction active shop, Primecap usually bubbles close to the top.

Kinnel: They are outstanding.

Benz: Let's talk about the last fund, also a Vanguard fund, this is Tax-Managed Capital Appreciation. Based on its name, I'm assuming you hold it in a taxable account, you better.

Kinnel: Good guess.

Benz: Let's talk about that. I think that these tax-managed funds, you and I both like them, but they are kind of under-recognized among investors, especially as many investors have gravitated toward ETFs for tax efficiency. Tax-managed funds, though, are still worth a look.

Kinnel: Yeah, they are. Jack Bogle once joked about the words "tax managed" being the best way to scare investors away, and it seems to continue to work. You put "tax" in the name and people think it's boring, you are sacrificing returns. It's really just essentially the Russell 1000 with a couple of tilts. One, they tilted slightly away from dividend payers, because dividends sometimes get taxed more than capital appreciation. The other thing is they actively harvest losses in order to offset gains. The upshot is on an aftertax basis you should do really well, and in fact it has done really well. It's actually beaten the Russell 1000, the S&P 500 on a pretax basis. I don't know that I would necessarily that going forward. That may just be a little bit of luck. But the more important thing is on a aftertax basis, this fund should continue to deliver. It really is good at avoiding capital gains distributions.

Benz: It gives you very broad diversification almost indexlike exposure but with a little bit more tightness around the tax efficiency.

Kinnel: That’s right, and it's super cheap and of course when these funds came out there were not many ETFs out there. Now it's maybe less of a standalone draw compared with ETFs because now there is lots of ETFs with good tax advantages. But it still keeps on chugging, it's really low cost, and it does a great job.

Benz: The other thing that I like about it is that it can adjust to the tax regime. If tax laws change, and as you suggested dividends could be at some point taxable as ordinary income again, the fund would be able to adjust its strategy a little bit.

Kinnel: That's right. Because it's not actually an index fund, it's passive more or less, it does have some flexibility to adjust that. It is nice because the tax laws change every few years.

Benz: Russ, thank you so much for giving us a peek into your own portfolio, really helpful.

Kinnel: You are welcome.

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


Heineken is the only truly global premium lager brand, and we see the firm as well-positioned to exploit the long-term trend of consumers demanding higher-quality alcoholic beverages.

At 8% global market share by volume, Heineken is a distant second behind Anheuser-Busch InBev, which controls more than one fourth of the market. But those volume figures don't tell the whole story. Heineken's consumers have higher incomes than drinkers of mainstream beer categories, where AB InBev dominates.

Demand for premium beer is also less subject to cyclical macroeconomic forces, and consumers are somewhat less price-sensitive. As a result, brand loyalty is a more significant source of economic moat for Heineken than it is for the other leading brewers.

Heineken's narrow economic moat is also supported by its cost advantage over smaller competitors. Heineken is the number-one or -two brewer in the majority of its large geographies and is the global leader in cider. This market leadership gives the firm a cost advantage, since brewing is a capital-intensive process that requires large investments in plant and equipment.

We expect Heineken's competitive positioning to strengthen over time and for the company to deliver long-term improvements to returns on capital. We therefore assign the firm a positive moat trend rating.

Our fair value estimate for Heineken's ADRs is $52 and shares are fairly valued today. At a wider margin of safety, though, Heineken is a solid investment opportunity.


Jaime Katz: Narrow moat Tractor Supply continues to trade a compelling discount to our $84 fair value, in 4-star territory. The company released solid first-quarter results despite a spring that has yet to arrive across many of its geographies, capitalizing on an increasingly nimble supply chain to keep cold-weather gear in the network where appropriate. Moreover, this implies that spring sales remain postponed in many areas, potentially leading to a warm-weather season that is compressed into the second quarter and comps that could be around 3%, similar to first-quarter comp store sales of 3.7%. The first quarter was the third sequential quarter of same-store sales growth above 3%, a key level where Tractor Supply can leverage expenses, although we caution investors that the rest of the year is forecast to deliver comps below this quarter's metric.

While some of the categories that Tractor Supply operates in are relatively mature, we view the breadth of its offerings and potential for growth of its current consumer base, as well as increased penetration of new consumers, as positive factors that could drive top-line growth. We project that total sales can grow at 7% over the next five years supported by low-single-digit comparable-store sales and mid-single-digit square footage growth. On the cost side, our assumptions incorporate modest margin expansion of about 20 basis points annually on average after 2018 leading to an operating margin of 9.4% in 2021. Besides lower costs attributable to opening new distribution and third-party logistics facilities ahead, Tractor Supply should be able to tactically allocate its advertising spend, drawing on information from the 7.6 million members in the Neighbor's Club loyalty program the company launched nationally just one year ago.

For investors seeking exposure to the consumer discretionary industry, we think Tractor Supply remains one of the best-positioned brick-and-mortar retailers in operation, thanks to its differentiated product mix, loyal customer base, and defensibility against e-commerce competitors, thanks to the high weight/value proposition of their products. 


Billy Fitzsimmons: We recently re-evaluated our entire cybersecurity coverage list. And in doing so, we took a fresh look at Palo Alto Networks. We still maintained the no-moat rating, but we upgraded the trend to positive from stable. Overall, we think there's two major trends affecting cybersecurity vendors like Palo Alto Networks. First, complexity and second, consolidation.

It used to be that network security vendors were creating firewall services whether physical or virtual. Today, the vectors of attack for enterprises is becoming much more complex. You have firewall, you have SaaS, you have endpoint security, cloud security. They are making the enterprise security efforts much more byzantine. You need multiple solutions to protect yourself from all those vectors.

Second is consolidation. It used to be that a point vendor would sell you the services for endpoint which would be separate from firewall. Now we're seeing consolidation where one vendor like Palo Alto can do all those things together. We think that's increasing the switching costs for a company like Palo Alto Networks. We have solid uptick in new products such as WildFire, sandboxing operation, and we are also seeing growth in nascent products such as VM-Series and Aperture, which are poised to grow.

We think overall instead of just selling the next-generation firewall, which is Palo Alto's bread and butter, customers are going to increasingly buy subscription offerings from them, which is going to keep growing average revenue per user, which has been ticking upward the past five years. We think this is poised to continue and as enterprises purchase more and more solutions from Palo Alto Networks, it engrains Palo Alto's services inside the IT infrastructure of its client base, growing switching costs.

Now, having said that, our $182 fair value estimate places Palo Alto Networks in fairly valued territory. For investors looking to get into this space, we'd recommend a look at Check Point Software Technologies, which we believe is trading at a discount. It's poised to grow at a slower rate than Palo Alto, but we like the firm's 50% operating margins, $4 billion in cash and marketable securities, and strong management team that we think is poised to continue to buying back shares over the ensuing years. 


Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. It's graduation season, and many people might think a check to the new grad is the best gift. Christine Benz, our director of personal finance, thinks that there's some more nuance there and some other choices that you have.

Christine, thanks for joining me.

Christine Benz: Jeremy, great to be here.

Glaser: You think that when thinking about gift giving to new grads, you really do have to consider their life stage and that cash may not always be the best choice?

Benz: That's right. For people exiting high school, oftentimes college is on their radar, so some sort of dedicated college savings vehicle might make sense. If it's someone who is exiting college, maybe they have higher education or further education on their radar, maybe additional savings for that educational expense makes sense. For people who are exiting college and beginning new jobs, you may have some other investment types that you want to help contribute to on their behalf.

Glaser: Looking at high school grads, or someone who has grad school on their future, are 529s really the best vehicle?

Benz: Well, certainly, when it comes to the tax benefits, 529s are hard to beat. As long as the money stays within the confines of the 529 plan, assets can be invested and grow without any tax burden. Then when you pull the money out for college expenses, for qualified college expenses, those withdrawals will also be tax-free. Another key advantage is that if you contribute to your home state's 529 plan or whatever plan you contribute to offers tax deductions or credits, that also burnishes the appeal of 529 plans from a tax standpoint.

Glaser: One downside though can be how it impacts your financial aid?

Benz: That's right. It does depend mainly on your relationship to the student. If you are a parent, the 529 assets tend not to be particularly punitive from the standpoint of that FAFSA form, that financial aid form. But if you are a nonparent, say, you are a grandparent or an uncle who wants to contribute to educational expenses, those assets will tend to affect the child's financial aid eligibility if they are spent prior to the child's final year of college. That's one reason why college funding experts say, if you are a nonparent, advise the parents to hang on to those assets until that last year of school, so it won't affect financial aid eligibility.

Glaser: Writing a check or giving cash also is going to impact financial aid too?

Benz: Well, it could. Large cash gifts to a student will potentially affect their financial aid eligibility; so will saving for the student within the confines of a UGMA/UTMA account, because those assets are technically the property of the child. That tends to look the worst from the standpoint of the financial aid applications. The other thing to know about the UGMA/UTMA accounts is that those assets become the property of the child when he or she reaches the age of majority. The child does not bound to use those assets for college funding. If that's your goal, you may want to get the money inside some sort of college savings wrapper.

Glaser: Let's talk about investing in these 529 plans. Sometimes the time horizon is quite short. For a high school student, it could just be a couple of years. What's the right asset mix that's going to make sense?

Benz: It's a really good question. Certainly, if you have a time horizon of, say, shorter than five years, you should not be in stocks with that component of the 529 plan. You'd want to focus on high-quality bonds, ideally short-term bonds, perhaps even cash investments for very near-term expenditures. Some 529 plans have stable-value funds. Those can be a nice option that offer you a little bit higher yield than cash, perhaps a little bit more risk, but not much more so. That's another vehicle type to investigate.

Glaser: Turning to the grad who doesn't have school in their future again, what are some of the options there that could get them off on the right foot?

Benz: There are a couple of things to think about. One is, if the student has some sort of student loan that he or she is exiting college with, perhaps you can lend a helping hand in terms of paying down that debt. The typical student exits college with about $30,000 in college expenses or in college loans. Many students have much more than that. If you can help burn through some of that debt, I think that that's a really gracious, terrific thing to do.

Another idea is, if you have someone in your life who is just exiting college, maybe getting an apartment, getting that first lob, maybe you can just give a baseline of cash and counsel about the virtue of having that emerging cushion. Say, this is not money that I intend for you to use to take great trips or buy a car. This is money that you are going to use to hold as an emergency fund to help defray any unanticipated costs. You can do a little bit educating along the way.

Finally, for young people who are exiting college and who have landed jobs, one other idea is to consider contributing to a Roth IRA on his or her behalf. The big advantage is that that young person can take advantage of his or her very long runway to grow those assets for retirement. Of course, there are really valuable tax benefits that accompany a Roth IRA. The other thing I like about the Roth IRA as kind of starter savings vehicles is that it can multitask for emergency fund needs and for long-term retirement funding. If you pull your contributions out of a Roth IRA, there will be no taxes or penalties, which makes it a nice, kind of, retirement savings vehicles with training wheels for people who are trying serve multiple goals.

Glaser: The question I know you get a lot is about the gift tax and people being worried about the gift tax. You think a lot of these worries are overblown?

Benz: I do. If you contribute or if you give more than $15,000 to a single individual in a single year, so in 2018, you will have to file a form to accompany your tax return. But unless your total lifetime gifts combined with your estate after your death exceed $11 million, you will not be subject to actual gift tax. You won't have to pay extra taxes for having been generous during your lifetime. I do think that sometimes people hear about that gift tax form and think that it necessarily entails paying extra tax; in most cases, it doesn't.

Glaser: Christine, thanks for your gift giving tips today.

Benz: Thank you, Jeremy.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching. 


Disney shares were modestly lower this morning despite the firm turning in better than expected quarterly results. With the stock trading in the 4-star range, we believe current prices offer an attractive entry point for investors. 

While management did not discuss the potential for a spoiler bid from Comcast for either the Fox assets or Sky, CEO Bob Iger reiterated the importance of the assets and the firm's desire to buy both the Fox media assets and Sky. 

Overall revenue for the quarter increased 9% year over year to $14.5 billion. The studio segment continues to outperform as Black Panther has grossed over $1.3 billion worldwide and "Avengers: Infinity War" has already exceeded $1.2 billion in global box office without opening in China. 


Andrew Lane: Within the Morningstar equity research department, we keep a close eye on the performance of the Wide Moat Focus Index, a collection of the cheapest U.S. wide-moat-rated stocks under our coverage. Typically, the strategy holds 40 to 50 stocks, with the reconstitution and rebalancing process taking place four times per year. The index is important to us as its construction represents the cross section of our differentiated economic moat methodology and our rigorous bottom-up valuation work.

In the first quarter of 2018, the strategy underperformed its Morningstar U.S. market benchmark by 1.6 percentage points. This represents a pause from the strong momentum established over the last two years. In 2017, the Wide Moat Focus Index outperformed its benchmark by 2.3 percentage points and in 2016 the strategy outperformed its benchmark by 10 percentage points.

In the first quarter, index performance benefited from a positive allocation effect, driven primarily by an overweight position in the consumer cyclical sector. However, unfavorable stock selection more than offset sector positioning tailwinds. From a stock selection standpoint, the index saw impressive first-quarter performance from technology holdings but disappointing performance from healthcare and consumer cyclical stocks. Veeva Systems, Amazon, and Salesforce stood out as top contributors to index performance in the quarter.