Advisers yet to shine on Morningstar

Morningstar Inc.’s venture into the asset management business has gotten off to a slow start.

But the executive in charge of the program isn’t discouraged, citing the tough market.

“I think a lot of retail clients are just sitting on their hands right now, and I think that’s pretty consistent across the industry,” says Art Lutschaunig, president and chief investment officer of Morningstar Investment Services Inc., the Chicago fund tracker’s registered investment adviser unit.

“We got a lot of interest, a lot of tire kicking, going on. But I don’t think we are seeing the retail client ready to inflate the tires yet.”

After its first year of operation, Morningstar Managed Portfolios has just over $100 million in assets, coming from about 700 individual investors. That represents business from close to 275 financial advisers out of the 6,600 who have access to the program, according to Morningstar Investment Services, which runs the mutual fund wrap program.

“If you had asked me at the beginning of last year, I would have expected them to raise more money, but I think the market got so bad, it just created this inertia effect,” says Wayne Bloom, principal at Commonwealth Financial Network in Waltham, Mass., an independent broker-dealer with 1,000 representatives who have access to the program.

Penetration of Mr. Bloom’s adviser network hasn’t been as much as he had expected, either, with a few dozen reps using the program.

Rough year

However, at least double that number has worked up proposals for clients. “We’re really excited about [the program], even more excited looking forward. Now they have got a year’s track record under their belt,” says Mr. Lutschaunig.

The amount of assets in Morningstar’s mutual fund portfolios would be three times higher if the backlog of investment proposals came through, he says.

Overall, Mr. Lutschaunig, who took over as president after the departure of Tom Florence at yearend, says the startup numbers met his personal expectations “right on the nose.”

“What I didn’t expect was the buzz saw of the market which had held us back,” he says. “I think that no matter what piece of the business you are in … last year was just a terrible year.”

Morningstar launched its Managed Portfolios program at the start of 2002, targeting independent advisers and registered representatives who wanted to outsource management of mutual fund portfolios.

The program consists of 10 portfolios – five taxable and five tax-deferred – ranging from aggressive growth to conservative.

The fund portfolios, over which Morningstar has discretion, are not offered directly to consumers.

Last year was rough in general for third-party mutual fund programs.

Cerulli Associates Inc. in Boston estimates that in the first three quarters of 2002, mutual fund advisory programs received about $5 billion in positive cash flow, about half of what they saw in the same period in 2001.

“The fact that [Morningstar was] able to gather assets at all in that environment is a note on the positive side,” says Jack Rabun, a Cerulli analyst.

Advisers who are using the program say they and their clients are satisfied with the service and portfolio performance.

“If I were to grade them, I would give them a B for the first year, which is probably pretty good because most of these programs ended up being a nightmare for the first year,” says G. David Biddle, president of Biddle Capital Management in Newark, Del., which doesn’t disclose its assets under management.

He says he has about 12% of his firm’s assets in the Morningstar program, representing 40 to 50 clients.

“Even though the market is down, I still think they are doing OK from a performance standpoint. So I can’t fault them for that,” says Mr. Biddle.

According to Morningstar, six of its 10 portfolios have beaten their blended benchmarks since their inception, and five out of 10 beat the benchmarks last year.

Ed Kohlhepp, president of Kohlhepp Investment Advisors Ltd. in Doylestown, Pa., says one would think Morningstar would be able to pick the best funds – even in a down market.

“In general, I would expect that to be the case, except for the fact that we are dealing with 2002. All the rules were violated in 2002, so I think, in 2003, if they don’t do better than six out of 10, I will be disappointed,” says Mr. Kohlhepp, who has about $1 million in the program out of a total $65 million under management.

Mr. Lutschaunig says the portfolios benefited from the performance of a number of their fund picks, including Oakmark, MFS Value, Liberty Acorn, Janus Advisor Income and Growth, Julius Baer International equity, Harbor international, Dodge & Cox Stock, Marsico Growth Fund, PBHG Clipper Focus Fund and the Jensen Fund.

But a number of other funds dragged performance down, including Harbor Capital Appreciation, Brown Capital Management Small Company, ABN Amro/Montag & Caldwell Growth and Janus Mercury. Among the funds dropped from the portfolios were MFS Mid-Cap Growth and Morgan Stanley’s Mid-Cap-Growth.

“I’m pretty happy with where we are. We had a couple of black eyes, but again, it’s a 60-minute or three-year game, not a two-minute game,” says Mr. Lutschaunig.

This year, the program is adding portfolios.

In the first quarter, Morningstar Investment Services will add six specialty portfolios: a concentrated-alpha portfolio, an all-growth portfolio, a total-return-value portfolio, a small- to mid-cap product, a foreign portfolio and an income product.

In addition, Morningstar is pilot testing a product combining exchange-traded funds with actively managed mutual funds for tax- sensitive clients.

Last week, the company launched an enhanced cash product which uses money market and two ultra-short-term-bond funds, where advisers can park client money in order to dollar-cost-average into the portfolios on a monthly or quarterly basis.