2 Investment Themes to Consider in the New Year

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. The turning of the calendar page provides an opportunity to reassess your portfolio. Joining me to discuss a few investment themes that could be worthy of further research is Russ Kinnel. He is director of manager research for Morningstar.

Russ, thank you so much for being here.

Russ Kinnel: Glad to be here.

Benz: Russ, in the most recent issue of Morningstar FundInvestor you looked at some investment ideas, some themes to investigate in 2019. But before we get into that, let's just talk about 2018. It was not a great year for stock or bond investors, right?

Kinnel: That's right. Just about everything was in the red. Bonds were about flat, but equities lost between 5% and 20% depending on what area you were invested in. Definitely, a really volatile year and certainly could have really altered your portfolio mix.

Benz: You do think that as investors are sort of looking at their portfolios, surveying the damage, it's time to take a look at that baseline asset allocation, see where you stand relative to your goals, relative to your spending horizon.

Kinnel: Exactly. I think the main thing you want to think about is making sure you are still on your plan and making whatever changes are needed to get back on that plan. Because obviously when you have some big moves, that can change your portfolio mix.

Benz: One area that you highlighted in the most recent issue of FundInvestor was the small-value space. It's an area where even if investors haven't been actively pulling away from it, their positions there have probably shrunk. Let's talk about what's going on with that category.

Kinnel: Small-value is an area that just keeps underperforming for a number of years, and usually that's a trend that reverses very nicely and you then have a multiyear rally in small-value or at least outperformance. There's certainly a lot of potential positives and you can see some reasons why if you think about large-growth doing well, well some of the FAANGs are eating some of those small-value companies' lunch. It's tough to compete with the Googles and Amazons of the world, but not all of small-value companies are in their target area and some of that sell-off may be overdone.

Benz: You highlighted a few funds that you like in this space, and I'd like to talk about a couple of them. One of them, I think, will probably be familiar to people who have watched you talk about the small-value space, Royce Special Equity. Let's talk about what you like about it. It's Silver-rated, very long-tenured, senior manager on the fund. Let's talk about what's to like about it.

Kinnel: I really like Charlie Dreifus and his approach that really focuses on accounting and quality balance sheets. It's a strategy that leads them into good, relatively safe names, and in downturns it really stands out nicely. If you look at the long-term record of Dreifus, he has got a very strong record, and a lot of that is built in losing less in downturns because of that emphasis on accounting. I think it's a little different from anything you see anywhere else. And again, when I look for a fund, I want a competitive advantage and I think this fund has a genuine competitive advantage.

Benz: It has a comanager now. So, Charlie Dreifus is not flying this fund solo. He has been on the fund for a number of years, but he has a comanager.

Kinnel: That's right. No retirement date has been announced for Charlie, but obviously the successor is there, someone who really buys into Dreifus' way of investing. We feel pretty good about where the fund is going.

Benz: Another small-value fund you like, also Silver-rated, might be a little bit less familiar, LSV Small Cap Value. Let's talk about that one.

Kinnel: Right. Fairly different fund. This is a quantitative fund. LSV is a shop that has an academic grounding, lots of Ph.D.s and quants running their funds. It's a quantitative fund looking for good value names, good companies that are slightly beaten down. If you look at their long-term record, they have done a very good job across the board at their funds, and we just like that academic grounding and the fact that they are always willing to update their models but at the same time they don't drastically overhaul. It doesn't feel like the momentum version of a quant fund. We think that they are really well-designed funds.

Benz: Another theme that you hit on--and this might seem a little perhaps counterintuitive because investors are really moving away from active managers in general and to the extent that they have active managers, they tend to want the very seasoned ones--but you actually say that rising-star managers are people to take a look at or funds to take a look at. Why is that?

Kinnel: Well, I think, if you find a manager who has got some experience but not, say, 30 years, you've got someone who may have a very long runway. They may have a lot of years ahead of them of doing well, and yet, many of these funds are ones that are not that big. You really kind of have potentially a sweet spot of a manager who is really hitting their stride but is not overwhelmed with assets. That's really the ideal, to get to these funds a little ahead of the curve. I think it's worth paying attention to funds. Not that I would avoid the seasoned managers. Obviously, I like Charlie Dreifus, who's got a very long track record. But I think some of these managers are worth investigating, putting on your watchlist.

Benz: You did compile a more detailed watchlist in FundInvestor, but let's talk about a couple of ones that you especially like. One is Vincent Montemaggiore at Fidelity Overseas. Let's talk about that one.

Kinnel: He is a very interesting investor at Fidelity. He has kind of got a Buffett influence and you see that emphasis on high-quality moats, a little willingness to pay up. He fits in the foreign large growth, though there's a lot of large blend names in the portfolio, too. But just a very thoughtful investor who really thinks long term and has built a good record yet hasn't gotten overwhelmed with assets yet. We raised that to Silver not too long ago, and we really have a high opinion of Montemaggiore.

Benz: How are you feeling about managerial stability at Fidelity funds these days? Have they stabilized, would you say? Or what's your view?

Kinnel: Much more so. So, say, versus 10 years ago, where you had musical chairs, but also a lot of people leaving the firm, we really haven't seen that in recent years. It's been much more stability and better handling of manager transitions. We feel a lot better about them. I wouldn't yet put them maybe at the top of the list of stability, but they have improved a lot.

Benz: Another fund you like also, a foreign stock fund, this is T. Rowe Price International Concentrated Equity run by Federico Santilli. Let's talk about that one.

Kinnel: This is a fund that's got about a four-year record on the retail version, about an eight-year record on the institutional. So, we got a little more to go on than you'd see on the retail version. But he has built a really good record with a concentrated strategy. Of course, because it's T. Rowe, it's only kind of concentrated.

Benz: Well, that's what I was going to ask. I don't usually think of them as a concentrated fund shop.

Kinnel: Right. This is not like a Bill Nygren or Sequoia. They have got 60 names, but the top holding isn't even 3%. So, it's not that bold. You are not living or dying on a couple of stocks. But again, a good strategy. Kind of like Montemaggiore's in that they are looking for good companies with competitive advantages trading at a reasonable price, but a little more of value tilt. This fund is in the blend category. It's got a big emphasis on Europe, in particular. You see overweights to German and Swiss companies. A pretty distinctive strategy from T. Rowe Price. But again, I think this is one that's still under people's radar.

Benz: Russ, some interesting themes and some interesting funds. Thank you so much for being here.

Kinnel: You're welcome.

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