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Asset allocation: Morningstar game is slow burn rather than slam dunk

After a small-cap bull run, Morningstar’s Managed Portfolios adopt an increasingly concentrated large-cap exposure for a more tactical play

Stretched valuations mean there are no ‘slam dunk’ areas of investment success at the moment, says Morningstar OBSR Managed Portfolios.

The fund rating and research agency has run its UK-managed portfolios service for just over a year. 

The portfolios heavily base investment decisions on the firm’s quant-driven strategic asset allocation model, which is reviewed by its investment team and tweaked for tactical positioning.

Morningstar investment consulting and portfolio management co-head Dan Kemp says the portfolio weighting is completely benchmark unaware, with positioning referenced to the deviation from the computer models.

“We don’t start with a benchmark perspective but from the strategic asset allocation perspective [of the models], then we add another layer of value by selecting great funds,” he says.

He says funds and allocations are analysed and chosen to complement each other, thereby creating a weave of risks and returns that offer reliable and reasonable returns, rather than shooting the lights out. 

Managers picked for the fund have to be Morningstar rated, Kemp says. “We are only allocating to funds where we see the possibility of really strong alpha generation.”

The largest holding of the balanced portfolio is a FTSE 100 tracker as many UK equity managers have invested in small and mid-caps in order to capture more outperformance.

After the bull run during the past few years of small and med-ium FTSE companies, Morningstar is looking for a more concentrated large-cap exposure to better “blend” the risks and make a tactical play.

“For that reason we have bond trackers as well because, in some parts of the bond markets, it doesn’t make sense to pay an active fund.

“There are no slam dunk asset allocation calls at the moment, nothing looks really attractive.”


Kemp says discussions about how to increase allocations to large-cap equities are under way. “I would expect these portfolios to become more large-cap focused over the course of the year, unless things change radically,” he says.

Allocations are likely to become more barbell, with a reduction in mid-caps making way for larger holdings in the heavier FTSE stocks. “Mid-caps are the part of the UK market we are most worried about at the moment,” he says.

Many funds held by Morningstar have both mid and small-cap exposure but the firm is now looking increasingly to move into small cap- only funds.

The “key tactical overweight” for the portfolios is UK property, with the range recently adding the Threadneedle Property trust in a bid to take advantage of recovery in the secondary property market.

The Threadneedle fund makes up 2.47 per cent of the balanced portfolio, compared with 5.45 per cent allocated to the more blue chip M&G Feeder of Property Portfolio Paif fund that the portfolio have held for some time.

Kemp says chasing the best presently performing fund is not the process of Morningstar, with managers instead chosen for their proven skill.

Julie Dean’s £2.4bn Schroder UK Opportunities fund, which has returned about half that of its peers in the past year, remains a feature of the portfolio. “It hasn’t had a great year but Julie is an excellent manager with a great track record and 

a strong position within that team,” Kemp says.

“It’s not about stacking the portfolios with top performers; it’s about finding the right blend to make sure you’re not losing money. 

“In each of their areas the funds bring something that’s a good ingredient for the overall cake.”


Kemp says Morningstar’s focus is on avoiding absolute loss rather than mitigating volatility. 

He says: “Because we are focused on absolute loss rather than volatility, at the very late stages of a bull market we would expect these portfolios to lag a bit.

“That’s how they’ve been des-igned but then the converse is true: throughout most of the rest of the cycle we would expect them to outperform.”

Morningstar OBSR commercial director Phil Lindsay says the managed service was “an obvious proposition” to add to the fund rating and research business. 

The firm has a long history overseas but only began setting up the UK division two and a half years ago. Global assets under advisement and management hit $164bn (£96.6bn) at 31 March.

Lindsay says the UK portfolio service’s growth in money under management has been “quite sharp” during the past six months, particularly from existing advisers.

Morningstar is focusing on organic growth rather than acquisitions and says it does not see value in smaller discretionary fund management  firms.

Kemp estimates about 230 DFMs are currently operating in the UK but believes this number will fall because many are not making money. 

Many do not have the resources, skills and scale to offer a well priced option, he says.

“It’s an outsourcing of their inv-estment solution; it’s that scale and solidity of a global player that’s been doing it for a long time.”

Morningstar OBSR launched its managed portfolio service to advisers in May last year, offering both active fund portfolios as well as cheaper tracker portfolios.

In the pipeline is a range of specially-constructed income portfolios, which are expected to be unveiled this year. 


Morningstar investment consulting and portfolio management co-head Dan Kemp joined to help run the service in early June. Senior consultant Robin Johnson is the other co-head.

It charges 30 basis points for active portfolio management, and 20bps for portfolios of passive funds.



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