Morningstar Advisor - April/May 2009 - 26

Gray Matters money. Similarly, many say that there was no way to make money once the bear market began. If an investor looks at the market through a style lens, however, suddenly a much more interesting and useful picture emerges. 1999 Large Mid +0.6 –6.8 –5.2 +17.8 +42.6 +1.9 +52.5 2003 Large Mid Small +26.3 +24.7 +30.7 +35.9 +38.7 +40.0 +48.9 +42.6 +52.7 Value Blend Growth 2004 Large Mid +14.1 +14.0 +0.2 +24.3 +19.1 +15.5 +24.0 +23.6 +13.5 Value Blend Growth commodity prices and infrastructure spending in emerging markets rewarded these types of companies. Meanwhile, the service super sector was already showing deterioration as financial-services companies were beginning to feel the effects of the credit crisis. A Third View: Morningstar Moat 2001 Large Mid –3.4 –14.4 –29.1 +5.1 +6.1 –21.6 +16.7 +46.0 +18.6 +14.6 –12.9 Value Blend Growth Value Blend Growth Some markets only come into focus when both the style and capitalization lenses are used together. In 2004, capitalization alone didn’t tell the story, nor did style. But when viewed together, a diagonal trend appears—from small value to large growth—that shows the year’s head winds and tail winds. A Sector Alternative Small By any standard, 2008 was a harsh year and one where investors had few places to hide. Sharp declines occurred across styles, capitalization ranges, and sectors. 2008 Ser Large Mid Small It wasn’t a great year for all stocks in 1999, just for the glamour growth stocks of the era. While growth-fund managers enjoyed a tail wind, their value counterparts faced a significant head wind in the same market. No wonder so many value managers were tempted to wander over into the growth territory during that period. (And there’s nothing wrong with that, as long as it is within the agreed-upon parameters set between the manager and the investor. Tools like Morningstar’s style box aren’t designed to tell managers where to invest, but simply to illuminate the implications of their choices.) Conversely in 2001, small-value funds had the tail wind, and growth struggled. The pronounced impact the collapse of big growth stocks had on cap-weighted indexes led commentators to label 2001 a bear-market year. However, the year had pockets of real strength—a fact that only becomes visible if seen through the style lens. There are years when capitalization, not style, tells the story. In 2003, there was no clear style trend, but a pronounced capitalization trend. Managers who skewed their portfolios toward large caps likely struggled on a relative basis, while those who bet on small- or micro-cap names enjoyed remarkable success. urin –36.0 –38.7 –46.3 –31.7 –36.2 –39.9 Value Blend Growth g Sectors are another valid way to view markets. Morningstar divides the stock universe into three “super sectors”: manufacturing, service, and information. Each Morningstar Super Sector is then further divided into four smaller groups, and a Morningstar Sector Index tracks each group. The Morningstar Sector Barometer shows broad-based sector strength and weakness in any given market period. It plots the return of the broad market in the inner triangle and the return of each of the three super sectors around the edges. Like the style-box barometer, the sector barometer displays shades of green and red to show investors where the market is strong and weak. 1999 Ser vic nuf act Ma g urin act nuf +5.5 +66.2 Information nuf act +20.8 urin g Ma Ma 26 Morningstar Advisor April/May 2009 Small vic –36.1 –31.5 –41.9 –37.5 –37.0 e 2007 Ser vic +1.8 –4.4 +5.9 But a new lens, based on Morningstar’s moat rating for stocks, yields a valuable insight into how the market’s flight to quality played out in 2008. Taking a cue from Warren Buffett, Morningstar stock analysts assess whether companies have economic moats around their businesses that will give them enduring competitive advantages. The analysts grade companies as having either a wide moat, a narrow moat, or no moat. The Morningstar Indexes team collects these evaluations and has created indexes to track the relative performance of companies with various moat ratings. The Morningstar Moat Barometer depicts the performance of no-moat firms in the inner circle, narrow-moat firms in the middle band, and wide-moat firms in the outer ring. 2008 –28.2 –40.6 Wide Moat Narrow Moat No Moat Small –36.7 –41.1 Information Looking again at 1999, but this time through a sector lens, an investor sees that the broad market’s gain was disproportionately driven by the tech boom and the information economy. For manufacturing and service stocks, it was a fairly weak year. The 2007 market was driven by the manufacturing economy. Surging e +22.8 Information e +10.5 –49.4 While all three moat groups were down for the year, the sharp differences between the three

Morningstar Advisor - April/May 2009

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