Morningstar Magazine - June/July 2017 - 48

Spotlight: The Future of Investing

largely falling victim to the flight to passive in
recent years. Even so, the returns generated by the
company's funds are competitive on a riskadjusted basis, primarily because its approach to
managing assets in sleeves, across multiple
independent managers, has been effective at this
research-intensive shop. There's no succession
risk with these funds. American Funds does
have some vulnerabilities on the fixed-income side
as it works to increase the level of sophistication
of its bond offerings. But we think that its funds
are strong long-term investments. The firm
also has an edge when it comes to low fees. All
told, 23 American Funds, representing 92%
of the firm's fund assets, earn Morningstar Analyst
Ratings of Gold, Silver, or Bronze.
Dodge & Cox
This traditional active shop uses a low-turnover
value strategy that can run hot-as it has
recently-or cold-as it did during the financial
crisis. But the team-based investment process
is tested, consistent, and well-supported by a large
and long-tenured research staff. That bodes
well for the firm's six funds. Low fees give the firm
another competitive advantage. We have
Gold ratings on five of Dodge & Cox's funds, which
account for nearly 100% of firmwide assets.
Primecap Odyssey
Another firm with a strong, team-based approach
to active equity investing. Primecap Odyssey
subadvises Vanguard Primecap funds and offers
just three active equity strategies on its
own, all of which are rated Gold by our manager
research analysts. Performance across the
lineup has been strong, which has been a rarity in
active equity, and expense ratios on these
funds are low relative to the competition. The firm
actively avoids the spotlight, and it is unlikely
to pivot if its investment approach falls out
of favor. Those potential drawbacks seem relatively
minor; we think this firm will be a good partner
for investors and the advisors that serve them
going forward.
Parnassus
Parnassus is another firm that has been growing
quickly on the backs of strong-performing,
actively managed funds, but the company is also
riding another growth wave: environmental,

48

Morningstar June/July 2017

social, and governance, or ESG, investing. The
firm uses ESG criteria in its stock-picking process,
and an increasing number of investors
have been including ESG funds in their portfolios.
We expect ESG investing to grow in popularity
over the next decade, particularly since
wealth is growing among women and millennials-
two demographics that rate ESG criteria highly
when investing. Parnassus has a sound investment
process, with three of its six funds being
Morningstar medalists. The potential downside
for the firm, which is the case for any
active manager, is that its funds hit a performance snag together and the company is beset
with outflows.
DFA
Over the previous decade, Dimensional Fund
Advisors has demonstrated the asset-gathering
prowess of strategic-beta strategies. The
firm's strategies are grounded in an unwavering
belief in market efficiency and transaction
cost management. DFA's cost advantages come
from its quantitative, repeatable strategic-beta
strategies, and its 10% annualized organic growth
has made it a top 10 industry player on both
a scale and growth perspective. We think DFA has
staying power, with all 21 of the firm's funds
we rate earning medals, which is a strong
endorsement of the investment process at
this firm. To be sure, the strategic beta landscape
gets more competitive each day, but DFA's
business model and investing approach give it
a sustainable edge, in our view.

Charles Schwab
We are highlighting Charles Schwab SCHW
for its more recent arrival to the passive scene. Its
launch of plain-vanilla ETFs at very competitive
prices is a strong example of a firm adapting
its approach to the changing competitive
landscape. ETF inflows have boosted Schwab's
market share and have attracted and kept
investors on the firm's broker/dealer platform. That
low-cost approach and access to distribution
through Schwab's retail and advisory platform will
fuel further growth in the coming decade. Our
manager research analysts have assigned
medalist ratings to 18 of Schwab's funds, with 10
other funds having Neutral ratings. On the
equity side, our stock analysts assign a wide moat

rating to Schwab, primarily due to its massive
scale and industry-leading cost efficiency.
Follow the Four Traits

Asset manager fees and performance are under
great scrutiny. The DOL's fiduciary rule has
put fees and performance under a spotlight. As
retail-advised distribution platforms become
more institutionalized, we expect broker/dealer
and advisory networks to more regularly cull
their platforms of high-cost and poor-performing
products.
Low-cost funds are receiving more inflows than
high-cost funds. Assets have steadily migrated to
low-cost share classes. Meanwhile, passive
strategies will continue to take share. By 2022, we
think passive strategies will account for nearly
half of our estimated $24.9 trillion in industry
assets. And industry consolidation will continue to
occur, as active managers look to increase scale
in the face of fee and margin pressure.
Who will survive and thrive in the long term?
Successful fund managers will have four traits:
a level of differentiation in their operations,
a stable of low-cost funds, repeatable investment
processes that generate consistent returns,
and adaptable business models. Firms with these
characteristics have survived the disruption
seen in the industry over the past several years,
and they will be best positioned to thrive over
the coming decades. K
Laura Pavlenko Lutton is director of manager research
practice with Morningstar Research Services. She is a
member of the editorial board of Morningstar magazine.
Greggory Warren, CFA, is a senior stock analyst with
Morningstar Research Services.



Table of Contents for the Digital Edition of Morningstar Magazine - June/July 2017

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