Morningstar Magazine - June/July 2018 - 28
Dispatches
costlier. BICE allowed firms to include a
waiver of punitive damages in their contracts,
so class action lawsuits would only be for
restitution, or enough to make investors whole.
SEC enforcement, on the other hand, tends
to include both restitution to harmed investors
and penalties. During the past two years,
the SEC has imposed approximately $2 billion in
penalties through its enforcement actions.
The SEC's Regulation Best Interest, just like the
fiduciary rule, could have wide-ranging
effects throughout the financial sector based on
how it regulates the behaviors of financial advisors
that are major distributors of financial products,
such as mutual funds and securities.
Similar to the fiduciary rule, the SEC proposal has a
"conflict of interests obligation." More specifically,
when a broker/dealer has a material conflict of
interest arising from financial incentives associated
with a recommendation, the advisor must either
eliminate the conflict of interest or disclose
and mitigate the conflict. The broker/dealer must
also have reasonably designed policies and
procedures in place for identifying these conflicts.
If the SEC enforces these proposed rules, it could
arguably have as large of a transformative
effect as the fiduciary rule. Potentially the only
relative winner, if the fiduciary rule is fully vacated,
is the insurance companies. The SEC is the
regulator for securities, and certain insurance
products aren't considered securities and may slip
through regulatory jurisdiction cracks.
Regulations are in flux. The SEC's proposed
best-interest regulation along with a new
disclosure form and clarification of existing
fiduciary duties for advisors are subject to change.
The Department of Labor's regulation of advice on
retirement account assets may be adjusted after
further study. Furthermore, some states have taken
it upon themselves to explore fiduciary rules.
That said, the trend persists. With best-interest
or fiduciary standards being propagated in
multiple jurisdictions in the United States and
across the globe, wealth-management firms
are likely better off putting systems in place where
they can reasonably prove that they're putting
28
Morningstar June/July 2018
their clients' best interests above their own
financial interests, as they'll almost undoubtedly
be subject to a best-interest standard somewhere.
In addition to the best-interest trend, investmentmanagement firms must also adapt to the
long-term trends of the move toward lower-cost
investment products, fee-based services, and
digital advice. In the near term, it is asset prices
and interest rates that will affect profits.
Michael Wong, CFA, CPA, is sector director, equity
research, with Morningstar Research Services.
How to Get From Good
to Gold
How does a fund earn a Morningstar Analyst
Rating of Gold? It isn't easy. The fund
must rate highly on nearly all five pillars: People,
Process, Price, Parent, and Performance.
The road to earning a Gold rating usually lacks
the obvious trigger of funds that we downgrade.
Manager changes rarely lead to upgrades.
But that doesn't mean things aren't going on
under the surface. You want your doctors,
pilots, and dentists to be experienced, yet you
probably can't point to the exact date when that
happens. In our case, it's often a matter
of seeing a manager through more environments.
It's not just about performance; it's also about
if these funds live up to their stated strategies.
Some of this you can judge right away, but other
aspects take some time.
Likewise, we also look at the supporting analysts
for sufficient experience, skill, and stability.
A firm may have a wave of departures of managers
or analysts, and it takes some time to be assured
that things have changed. All this is a way of
saying that subtle but real changes can get us to a
Gold rating. Let's look at several funds that
recently made the grade.
Western Asset Core Bond WATFX was raised
to Gold from Silver in late 2017. Western Asset
is a well-known bond firm that mostly runs money
for institutions. It has historically owned more
spread product than peers and benchmark
alike and generally made quite a lot of money for
investors doing just that. However, Western
Asset had its pedal to the metal in 2008, and the
wipeout wasn't pretty. Since then, it has
posted returns that are robust enough that
performance is excellent even over trailing periods
that include the financial crisis of 2008.
But it wasn't just returns that got us to Gold.
More important was that the firm retooled
its strategy in the hopes of moderating returns
a bit while at the same time staying true
to its emphasis on making money with credit.
We've been pleased as Western Asset executed
the strategy of still producing solid returns
with a closer focus on risk. Morningstar senior
analyst Maciej Kowara describes a team and
strategy that have come together nicely:
"Western Asset is one of the premier fixed-income
shops in the industry and can command
research resources that are commensurate with this
status. Of a grand total of 126 investment
professionals, 28 are devoted to broad market
strategies, another 28 to emerging markets,
17 to high-yield, 21 to investment-grade credit, and
11 to structured products, among others.
These numbers make it one of the better-staffed
asset managers among its competitors."
Besides the gradual improvement at the fund, we
also noted improvement at parent company
Legg Mason LM, leading us to upgrade the Parent
rating to Positive. Together, these developments led
us to raise the fund to Gold in December.
T. Rowe Price QM U.S. Small-Cap Growth Equity
PRDSX had a long, slow climb to Gold.
We started coverage in 2012 with a Bronze rating,
then raised it to Silver in 2015 and to Gold
in April 2018. The fund's consistency over the years
has impressed us, as has the stability of the
slowly growing team of nine quantitative analysts
supporting the fund. It has been led by Sudhir
Nanda since October 2006. He runs a diffuse
portfolio selected by an array of measures that fall
into three buckets: valuation, profitability
and capital allocation, and momentum. The first
two account for most of the weighting in
Nanda's system.
Table of Contents for the Digital Edition of Morningstar Magazine - June/July 2018
Contents
Morningstar Magazine - June/July 2018 - Cover1
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Morningstar Magazine - June/July 2018 - Contents
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