Morningstar, Inc. (MORN) is one of the best run companies in the financial industry. It is well known for its mutual fund rating system. It provides high quality fund rating and data to individual and institutional investors.
We have seen that many successful financial companies don't apply their savvy to plans and offer their employees a mediocre at best retirement alternative.
We have reviewed Bank of America and American Express 401K plan which were OK, but you should see that the Morningstar plan is better.
Morningstar's retirement 401k plan is a great example of building a plan. In fact, the plan is so good individual investors should consider 'cloning' this plan with ETFs on their own. The plan's investment choices are rated 'Great' by MyPlanIQ's plan rating system (details of the rating methodology). In this article, we will delve into the plan and explain what makes it a model to follow.
The plan consists of 26 funds. These funds enable participants to gain exposure to 6 major assets: US Equities, Commodities, Foreign Equities, REITs, Emerging Market Equities and Fixed Income. These six major asset classes provide nearly complete diversification coverage for portfolio building. It should be noted that a commodity fund is provided for the asset class exposure. Among retirement (401k) plans, few plans provide commodity funds.
If we drill down to the funds in the plan, we see the following fund distribution:
| Asset Class | Number of funds |
|---|---|
| Balanced Fund | 1 |
| REITs | 1 |
| Fixed Income | 6 |
| Commodity | 1 |
| Sector Fund | 1 |
| Foreign Equity | 2 |
| Emerging Market Equity | 2 |
| US Equity | 11 |
| Other | 1 |
| Total | 26 |
It is not surprising to see that it provides most (11) funds for US equity. These eleven funds covers most of nine styles: large (mid-cap or small-cap) blend, large cap, large value. It provides ample opportunities for a participant to take advantage of style diversification or rotation. Well known mutual funds such as Oakmark (OAKMX), Selected American (SLASX), Brandywine (BRWIX) are provided.
On the fixed income side, PIMCO Total Return and Loomis Sayles Bond provide international bond exposure, as well as various credit levels. A high yield bond fund is also provided, allowing a conservative (bond) tilted participant to vary the risk level to achieve better returns (with the current fixed income environment, high yield bond exposure enables investors to harness the equity bull market yet maintain lower risk than directly investing in stocks).
The following are the detailed plan ratings:
Diversification -- Rated as great (96%)
Fund Quality -- Rated as above average (76%)
Portfolio Building -- Rated as great (95%)
Overall Rating: great (90%)
In summary, what makes this a good model is:
- Six asset classes -- helps maximize risk adjusted returns -- with styles that reach other sub-classes
- The right number of funds -- not too many to be bewildering to the participant -- not too few to limit exposure to asset classes and styles
- Well chosen funds that allow participants of different risk tolerances to take maximum benefit of market strengths and protect from market weaknesses
To construct an ETF equivalent plan that mimics the Morningstar's 401K plan, one can use the following ETFs in the asset classes covered by the plan:
Commodities Broad Basket: GSG, DBC
Diversified Emerging Mkts: EEM, GMM, PXH, DEM, SCHE
Financial: IYF, VFH, IPF, PFI, DRF, RYF
Foreign Large Blend: EFA, VEU, GWL, PFA
Foreign Large Value: EFV, PID, DWM
High Yield Bond: HYG, JNK, PHB
Inflation-protected Bond: TIP
Intermediate-term Bond: AGG, CIU, BIV, BND
Large Blend: IVV, IYY, IWV, VTI, VV, SPY, DLN, RSP, SCHX
Large Growth: IVW, IWZ, JKE, VUG, ELG, QQQQ, RPG, SCHG
Large Value: IVE, IWW, JKF, VTV, ELV, PWV, RPV, SCHV
Mid-cap Growth: IJK, IWP, VOT, EMG, PWJ, RFG, UKW
Mid-cap Value: IJJ, IWS, JKI, VOE, EMV, PWP, RFV, UVU
Moderate Allocation: AOM
Multisector Bond: AGG, GBF, BND, LAG
Real Estate: IYR, ICF, VNQ
Short Government: SHY, SHV, VGSH, PLK, USY
Short-term Bond: CSJ, BSV, VCSH
Small Blend: IJR, IWM, JKJ, VB, DSC, PJM, DES, SAA, UWM, SCHA
Small Value: IJS, IWN, JKL, VBR, DSV, PWY, RZV, UVT
Performance Discussion
The chart and table below show the historical performance of moderate model portfolios employing strategic and tactical asset allocation strategies. For comparison purpose, we also include the moderate model portfolios of a typical 6 asset SIB (Simpler Is Better) plan . This SIB plan has the following candidate index funds and their ETF equivalents:
- US Equity: SPY or VTI
- Commodity: DBC
- Foreign Equity: EFA or VEU
- REITs: IYR or VNQ or ICF
- Emerging Market Equity: EEM or VWO
- Fixed Income: AGG or BND
Performance Chart (as of Jan. 14, 2011) - click to enlarge
Performance Table (as of Jan. 14, 2011)
| Portfolio Name | 1Yr AR | 1Yr Sharpe | 3Yr AR | 3Yr Sharpe | 5Yr AR | 5Yr Sharpe |
|---|---|---|---|---|---|---|
| Morningstar Inc 401K Plan Tactical Asset Allocation Moderate | 16% | 120% | 12% | 114% | 14% | 125% |
| Morningstar Inc 401K Plan Strategic Asset Allocation Moderate | 10% | 108% | 3% | 17% | 5% | 33% |
| Six Core Asset ETFs Tactical Asset Allocation Moderate | 9% | 64% | 9% | 73% | 15% | 100% |
| Six Core Asset ETFs Strategic Asset Allocation Moderate | 12% | 89% | 4% | 17% | 8% | 35% |
- This is a great plan that has been well thought out and delivers solid returns. This plan is worth studying to see how they have created great diversification with a limited number of funds.
- Like Morningstar Inc 401K Plan participants, investors seeking to clone this plan for themselves can achieve the best investment returns by adopting asset allocation strategies that are tailored to their risk profiles, which is highly achievable given the excellent investment choices at their disposal.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
