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Morningstar’s own data bases show that, using ETFs in our portfolios instead of no-load mutual funds, on average, would have saved 53 basis points and added 95 basis points of alpha to the returns of our separate accounts. The total average of 148 basis points of improvement more than made up the for our average management fee of 110 basis points.
As Morningstar publishes their Separate Accounts data base on a pre-fee basis (rendering it of less value to us as I cannot show gross returns to a client) while showing SEC-required after-fee returns on Mutual funds, Morningstar makes it difficult to do comparisons between the two investments to show to prospects. Again, Morningstar discourages competition for clients and innovative portfolios in general.
Morningstar’s job is to collect all data on all categories of portfolios (traditional mutual funds, insurance sub-accounts, separate accounts, hedge funds, fund of funds, etc) appropriate for objective comparison and not to tell us which type of portfolios to use or force a choice of strategies on their clients.
When they acquired S&P, Altvest, and Ibbotson, Morningstar cornered the market on rear view mirrors and became the advocate for outdated passive asset allocation investment strategies. Such strategies are no longer relevant in a volatile market with opportunity determined more by currency movements, the growth of Asia, and the chronic problems of the credit markets. At the least, providing alternative strategies is the domain of investment advisors, not Morningstar, which is at risk of being out of date, irrelevant and perpetuating misleading conclusions by restricting the data to only that which can do great harm to investor portfolios. Sticking solely to passive buy-and-hold portfolios may have cost investors as much as $6 trillion from 2000 to 2002.
The future, in my opinion, is in proactively managed fund-of-funds-like portfolios of ETFs, not solely in deer-in-the-headlights traditional mutual funds that take no effective defensive action in down markets. The baby boomer generation, the most highly-educated and ironically mislead generation in human history cannot afford to take no action to protect their assets from depletion in the prolonged bear market ahead of us. They have already suffered through three years of such a market. Morningstar could at least entertain the possibility of an alternative vision of retirees’ future and objectively present relevant data for advisors to make their own decisions about that prospect.
In 1980, one standard for mutual fund data bases was Donoghue’s Mutual Fund Almanac, of which we sold millions of copies. Morningstar started three years later. At the time Morningstar started, due in part to the beginning bull market and in part due to my NY Times best-sellers Complete Money Market Guide and No-Load Mutual Fund Guide which introduced a new generation to mutual funds after a chaotic 1966-1982 stock market, Morningstar added the style-box classification approach, which had not previously been in vogue. In the ensuing years, as interest rates fell from record highs, nearly any investment strategy worked and asset allocation was very saleable as were mutual fund ratings.
Morningstar succeeded beyond my wildest expectations and I congratulate them. However, today I question the value they have added since 2000 by sticking to passive investing strategies and conveniently ignoring the terrible 2000-2002 bear market, most recently in their new hedge fund ratings which ignore that period. Frankly, I think investors want to know what hedge funds will do in a bear market; but, if they buy based on Morningstar’s hedge fund ratings, that knowledge may come too late.
Morningstar thrives on looking back, but proactive investment managers empowered by the freedom of a wide range of ETFs are attempting to build the future.
If Morningstar intends to promote their ratings of high cost hedge funds, they should also promote their objective and comparable coverage of the alternative, separate accounts in Principia’s separate account data base as well; it is only fair. Let the public and investment advisors decide objectively and don’t let Morningstar provide objective data on the problem (inflexible, illiquid passive buy-and-hold investments) and not the lower-cost solution (liquid, proactive investments in separate accounts.)
It is revealing to note that Morningstar does not even include ratings on funds-of-funds hedge funds or include a tactical reallocation strategy as a potential hedge fund strategy class. Morningstar needs to refocus on serving their clients, not competing with them.
William E. Donoghue
Chairman
W. E. Donoghue & Co, Inc.
Norwood Massachusetts
www.donoghue.com
W. E. Donoghue & Co, Inc. is a Registered Investment Advisor and has offered separately managed accounts that utilize ETFs and sector funds for over a decade.
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