(New York)

The media is reacting very strongly to a new move by Morningstar. The legendary fund rating company has just taken the somewhat surprising move of replacing outside funds with some of its own in its “managed portfolio service”, which allows financial advisors to outsource investment decisions to Morningstar. It will now rely on its own funds as the building blocks of those portfolios. Its own funds will be scored by the company itself, but it says an algorithm will do this. The company’s CIO says “We have structures in place to make sure [investment management] is at arm’s length from research. There is structural separation of research and investment management”.

FINSUM: We think this is a ridiculous conflict of interest, made even sillier by the fact that Morningstar acts like an algorithm is any less biased than a human rating system. As if Morningstar did not write the algorithm in the first place…

(New York)

As fees fall, there is an inevitable reality in the US asset management industry—scale is everything. Investors need to deeply understand this concern if they have money in the sector. For instance, analysts and the market are putting so much preference on large managers, that one analyst just upgraded BlackRock to outperform, while downgrading Invesco and WisdomTree, even though BlackRock’s P/E ratio is 18.6, and the latter two’s are an average of just over 10. BlackRock’s stock is down 15% in the last year, while Invesco and WisdomTree have both fallen more than 30%.

FINSUM: The more fees need to be cut because of competition, the more money one needs under management to maintain profitability. Hence the battle for scale.

(New York)

Right now everyone seems to be focusing on the possibility of an inverted yield curve occurring between the 2 and 10-year Treasury. However, that might not be the best recession predictor after all. If you are strictly focusing on yields, then the 1 and 10-year is better, as it gives less false positives. But speaking more broadly, the M1 money supply and housing starts are other great places to look as both tend to peak well before a recession; M1 is usually about a year, and housing starts two years.

FINSUM: The reality is that if you take a broader view, things don’t look too bad. M1 is still growing, as are housing starts, so those indicators look healthy.

(Washington)

Everyday it seems less likely that the current SEC best interest rule, “Regulation best interest”, will make it through to implementation in anything near its current form. Not only has the industry complained about its governing of titles, but many say the rule’s complex grouping-but-delineation between brokers and advisors just doesn’t make sense. Now, the group of advocates that succeeded in bringing down the DOL’s fiduciary rule have officially turned their sights on the SEC rule. The group, called NAIFA, says it supports a best interest standard, but vehemently protests the restriction on the use of titles.

FINSUM: We commiserate with the SEC because we understand the logic they used to make this rule, but we do feel the current iteration is doomed.

(New York)

One of the market’s favorite prognosticators has just called for a big financial crisis. Mark Mobius, 81, veteran investor, thinks that EMs are going to plunge, and that the normalization of interest rates and monetary policy will cause a crisis. “There’s no question we’ll see a financial crisis sooner or later because we must remember we’re coming off from a period of cheap money … There’s going to be a real squeeze for many of these companies that depended upon cheap money to keep on going”, says Mobius.

FINSUM: Emerging markets are currently having a rough time and the rise in rates is going to be turbulent, but calling for a Crisis seems a bit premature.

(New York)

Advisors will see it first hand, but it is still worth discussing the intensification of the current ETF price war. While the industry has been slashing fees for years, things have escalated significantly over the last few months. State Street has introduced a suite of ultra cheap funds, but more recently, BlackRock and Vanguard have made major moves. BlackRock cut fees on several stock and bond ETFs last month, and just last week, Vanguard announced that almost every ETF on its platform would be commission-free. The ETF market is supposed to grow to $10 tn in the next decade, and fees have fallen 30% in the last decade.

FINSUM: This is great news for investors, but it will certainly drive further consolidation in the ETF business as massive scale is needed to support these prices cuts. We ultimately worry about such imbalance in the market.

(New York)

Advisors need to be aware. In less than 8 weeks, everything you know about the market make up of the tech sector is going to change. Both MSCI and S&P are shifting the way they group technology companies. Netflix, Google, and Facebook will be the biggest movers, and the changes are expected to have a material affect on prices. Those three stocks will be moved to the newly formed “Communications Services” sector, and away from the two sectors they are currently split into. That will greatly lower the total weight of the Information Technology sector from 26% to 20% of the S&P 500.

FINSUM: This could really change prices as it will have a significant effect on ETF demand and other funds linked to specific indexes/sectors.

(New York)

Pensions have been on a long and miserable path since the Financial Crisis. They have been chronically underfunded and suffered from poor returns, but after a weak decade, there is finally some good news. That news is that interest rates are up, which means that US corporate pension plans are now 92.8% funded versus 87.6% funded at the beginning of the year. The shift is almost entirely because of changes in yields. Higher yields make it easier for pension funds to meet their future cash needs.

FINSUM: Higher interest rates will be better for all retirees, and it is good that pensions are finally catching a break. One wonders if we are approaching a sweet spot in rates where mortgages remain affordable, but yields are high enough to satisfy pensions and retirees.

(New York)

Are you worried about an inverted yield curve and the arrival of a recession? Morgan Stanley thinks you should be, as the bank has just called for a big bust coming to markets and the economy. MS thinks the Fed will end its contraction of its balance sheet soon, which will be supportive for long-dated Treasuries. Accordingly, with short-term rates still rising, the yield curve will invert soon; by mid-2019 says the bank. Morgan Stanley recommends investors to be overweight US Treasuries and underweight corporate credit.

FINSUM: The spread between two-years and ten-years is only 27 bp right now. We think it will much less than a year before an inversion, especially given the hawkishness of the Fed coupled with the threat of a trade war.

(New York)

Those who only pay causal attention to muni bonds might be scared away from the market by negative stories about big buildups in debt, bankruptcies, and a general erosion in credit quality. However, this year, nothing could be further from the truth. There has been a massive deleveraging of the sector in 2018, with total US muni bond issuance down a whopping 17% to-date, and on pace for 25% by the end of the year. The dearth of issuance has pushed yields down and prices up. “It’s a seller’s market”, says one muni bond analyst.

FINSUM: Part of the lack of new issuance is due to the federal tax changes, but nonetheless, the market is looking increasingly healthy.