Morningstar is ready to move beyond the style box

Powerful research firm asks advisers' help to better customize asset allocation

Apr 27, 2015 @ 2:30 pm

By Trevor Hunnicutt

After years of promoting the style box as a tool to help investors build more diversified portfolios, Morningstar Inc. is emphasizing a “total wealth approach” that could result in dramatically altered investment recommendations for clients.

“The style box is a two-dimensional risk map — it's a really nice simplification,” said Scott Burns, the company's head of asset management client solutions. But, he added, “The world has evolved beyond this two-dimensional framework.”

The company is asking advisers for help to “tear down that house” and advisers are more than willing to do so.

“I'm glad they finally saw the light and realized the world is not made up of style boxes,” said Paul Schatz, president of Heritage Capital.

“Morningstar lectured and preached to the industry that style boxes were the only way to go for all these years,” he added.

Mr. Burns, however, said that style boxes have been evolving almost since they were first introduced in 1992 and the current discussion around them “is about renewal and rebirth in the way advisers deliver financial advice to clients.”

The research firm helped to define the way generations of financial advisers and fund companies think about investing, and the style box is the symbol of that influence. The grid organizes a universe of investment styles simply: for stock portfolios it ranges from value to growth and from large companies to small.

The new approach, which is built on the firm's research on retirement planning, suggests that wealth managers are not focused enough on factors such as clients' real estate, place of residence and occupation when they build portfolios.


If they were, advisers wouldn't put real estate investment trusts in a portfolio for a real estate agent, for example, Mr. Burns said last week at the annual conference of the Investment Management Consultants Association Inc. in Las Vegas. That asset is highly correlated to the lifetime earning power of the client, according to the firm's research.

Theodore Feight, owner of Creative Financial Design, suggested that Morningstar consider factoring in tactical asset allocation “and rate some of the areas in the style box as to their current value over the next 30 days, six months and 12 months,” which could help give advisers a sense of direction.

Todd Rosenbluth, director of mutual fund and ETF research at S&P Capital IQ, which also rates funds, agreed that firms like Morningstar — and his own — need to move away from strict definitions for investments and how they might fit in individual portfolios.

“I don't know exactly where they're going, but we, they and everybody else are trying to provide wealth managers with enough tools to help advisers offer good financial advice to their clients,” he said, explaining that five years ago, S&P Capital IQ started ranking equity mutual funds based on a combination of performance, risk and cost factors, including holdings-based analysis and expense ratios.

Advisers fully agree that the time is ripe for Morningstar to revamp its style boxes.

“Growth versus value and big versus small is not sufficient to define what investors are seeking,” said Marcio Silveira, founder of Pavlov Financial Planning.

He said two areas in which the style boxes fall short are socially responsible investing and developed versus emerging markets.

“Vice versus virtue is emerging as a real investment approach,” he said. “I think developed versus emerging is more relevant than domestic versus international strategies.”

Mr. Silveira said Morningstar's style boxes are not part of his core approach to building client portfolios but he does use them in specific situations.

“If somebody wants to be extra aggressive, maybe they want small-cap value, I would use it for that,” he said.


Mr. Schatz added that some equity investments, such as REITs and liquid alternatives funds, simply don't fit into the style boxes.

“I've always seen value in it,” he said. “I just didn't think it was the be-all and end-all.”

Until earlier this year, Mr. Burns, a former analyst, ran Morningstar's influential manager-research division. He said the company wants help from advisers in figuring out how to define its approach to total wealth.

Morningstar currently makes use of some wealth-forecasting functions in its services for retirement accounts, and it also recently acquired consumer financial wellness tool HelloWallet and data aggregator ByAllAccounts.

But Mr. Burns said the industry has a long way to go before it properly uses data to serve investors' needs. The current generation of robo-advisers, in his view, doesn't measure up.

“These guys are getting it wrong,” Mr. Burns said. “None of this is total wealth. They've just taken the style box and put it on the Internet.”

Jeff Benjamin contributed to this story.


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