Principles-Based Investing, Industry Trends, and Getting to Know Morningstar Wealth CIO, Philip Straehl

Nicholas VanDerSchie: Welcome back to Simple But Not Easy. We hope you had an enjoyable summer and are ready to finish the year on a high note. In today's episode, we're excited to dive deep into the world of investing, market strategies, and the future of wealth management. We'll start by getting to know Philip Straehl, Morningstar's new Chief Investment Officer of the Americas, as he shares insights from his career journey and a wealth of knowledge on the evolving market landscape. From there, we'll explore Morningstar's mission and investment philosophy, and importantly, what sets it apart in an ever-evolving financial world. Wealth management industry trends are also on the agenda, and we'll close with some investing themes that everyone should be thinking about.

We're packing a lot into this episode, but before we get into the conversation, if you'd like to know more about how we support advisors, we welcome you to email us at simple@morningstar.com or me directly at Nicholas.VanDerSchie@morningstar.com.

Now, let's get started. Philip, welcome to Simple But Not Easy.

Philip Straehl: Great to be back, Nick.

VanDerSchie: So, Philip, you are recently appointed the CIO of Americas. Congratulations.

Straehl: Thank you.

VanDerSchie: How's the new role and what have you been focused on?

Straehl: It's been great. Look, it's been a busy few months here since I stepped into the role. It's a great opportunity. I've been part of this team for 16 years, and it's a real privilege to be able to lead this capability. And so, in my role, I oversee a diverse set of investors, a team that's focused on multi-asset strategies. There's another team that focuses on institutional and retirement solutions. Manager selection is another capability we have, and we also have a systematic strategies team, so it's been great to be leading that team and really engaging with our clients and our investors.

VanDerSchie: And as you point out, this is a new role for you, but you're obviously not new to Morningstar. You started here, would you say, 16 years ago, and you were part of the Morningstar Development Program at that time. Can you tell us a little bit more about your journey at Morningstar and the different roles you've held along the way?

Straehl: Absolutely, yes. It's actually been 17 years in total. I spent the first year in the Swiss office for one year, partly because I couldn't get a H-1B visa in 2006, it was – 2007 it was. So, yeah, I spent one year in the Swiss office, which was a great experience. It was just me and another person in the Zurich office at the time, and really one of the former values that Morningstar had, one of the values we have is being entrepreneurial. And so being in that small office was really formative to just really learn what Morningstar was all about. And then, as I pointed out, I've been part of this team for 16 years, kind of came through the ranks as an analyst and PM, was fortunate then to become head of asset allocation and really dug into our capital market frameworks, how we think about multi-asset investing, and then more recently, had a couple of leadership roles, leading research globally, and also overseeing quantitative strategies as CIO. And so now I'm focused on the Americas from an investment standpoint. So, it's been a great journey.

VanDerSchie: So, digging into that quantitative strategies group maybe just a little more, it's certainly interesting given the so-called quant revolution in markets and all the algorithm-based trading activity. Just curious, is there anything you care to share on the differences in market structure from the time you started your career compared to today?

Straehl: Yeah, and just to – when we say quantitative strategies, this is not sort of short-term algo trading as some people might do in the industry. So, it's really about – one capability there is about leveraging things like quality and value signals systematically in managing diversified equity portfolios. And that's one capability. And the other side was our direct indexing capability, which is building separately managed accounts that have the ability to be personalized and that offer ongoing tax-loss harvesting.

And so, it's not algo trading, but your question about kind of how the market has changed, I would say that's certainly one of the dimensions in terms of what has changed in markets. I think if you look at who is the marginal buyer, you occasionally see market reactions that are probably not consistent with fundamentals. If you look at what happened in August, for example, where you had a jobs report that signaled that labor markets are rebalancing and there's concerns about the growth outlook. And then you had a pretty significant response in capital markets. You had Japan drop 13% in one single day. And so that kind of speaks to maybe some lack of fundamental participation in markets at the time.

But taking a step back as well, I'd say the move from active to passive is probably one of the key structural changes over my career, just the fee pressure and just money leaving long-only active managers in going into passive vehicles, ETFs. And so, I think that, I would say, is one of the key secular trends we've seen over the past 16 years.

VanDerSchie: Okay. So, everything you've shared so far with us has been very much work-related. We should probably give folks an opportunity to look a bit under the hood. So, Philip, what do you like to do outside of work?

Straehl: Great question. So, I've got a young family. I've got two kids, five and seven. And so, spending time with them is what kind of feels a lot of my time. Outside of work I enjoy running and exercising, also like to read some books along the way. I live in Chicago. And so, one of the things that I like to do occasionally, not as frequently as I used to be able to do is check out new restaurants. And so, my wife and I occasionally venture out and check out a new place. Finally, my wife had a bigger birthday earlier in the year. We checked out Alinea, which was quite a treat. So that's some of the stuff I do outside of work.

VanDerSchie: So, are you making an Alinea recommendation for the Chicago-based advisors?

Straehl: I am making – not only for Chicago-based advisors, actually, it's probably worth even a trip. Yeah, it's actually quite an experience. I'd almost compare it to – it's almost like a combination between going to a museum and a restaurant and a concert. It's a really, kind of, multifaceted experience. So, I'd highly recommend it.

VanDerSchie: Sounds good. And please reach out to Philip if you're struggling to procure those Alinea reservations. Philip, You mentioned you enjoy reading. What are you reading right now? Or potentially, what are you watching right now?

Straehl: Yeah, I've been so busy with work, it's been hard for me to read. I'm kidding. But one of the last books I read was called How the Scots Invented the Modern World by Arthur Herman, which is just a historical deep dive on how the role of Scotland played in the, let's say, probably 16th century onward in terms of influencing the enlightenment movement, people like Adam Smith, some architectural innovations, technological innovations, et cetera. So, it's a fascinating read in a part of the history I haven't really had a huge amount of exposure to.

VanDerSchie: Sounds interesting for sure. Check that out. So, I want to shift and talk about Morningstar's mission and investment philosophy. And I think most of our listeners are familiar with Morningstar's mission of empowering investor success. I guess the question I have for you is, specific to Morningstar wealth, how does that ultimately come to manifest?

Straehl: Yeah, I think it's a great question. I think a lot of companies put slogans like that out there and having been part of Morningstar for 17-plus years, I can say that that's really part of the DNA of Morningstar. And I think it really starts with the types of – I'd say our investment philosophy and also the types of products that we tend to offer. We're not buying into fads. We want to make sure that the products we put out there really help investors achieve their goal. It manifests in – if we work with, let's say, sub-advisors or managers, we want to make sure that they have incentives that are aligned with the end investor. We think about outcomes after fees. And so, we want to make sure that ultimately, investors benefit and can save for retirement or save for the goals that they have in their life. And so, I think it's very much part of the DNA of our company and all the decisions we make, whether it's the investment team or also from a product standpoint, really have to stand that test before we make a decision.

VanDerSchie: Sure, and as someone who's been here for over two decades myself, it's clear to see that our investment philosophy doesn't blow in the wind. It's firmly held down, and it's certainly principles-based as you alluded to. So, I guess the question I'd have is, when you're meeting with new clients, how do you go about explaining the Morningstar investment approach?

Straehl: Yeah, look, in simple terms, I think it starts with the point of putting investors first initially, I think that's the first thing I would say. The second thing I would say is, being focused on the long-term and being focused on fundamentals. And so, we don't just make decisions based off of purely quantitative and statistical concepts. We really want to understand the investments we're making well and understand the fundamental corporate and economic drivers. And then once you understand the fundamentals of an investment, it gives you an opportunity to contrast the fundamental value, the intrinsic value of the investment against what it's worth today.

And so, in short, what we're trying to do with our process is buy things that trade at a discount to their intrinsic value. And doing that requires discipline. It sometimes doesn't work out. Sometimes you have parts of the market that are expensive that continue to rally. But in a nutshell, I think those are the two points – being focused on the long-term fundamentals of an investment and making sure we're buying things ideally that trade at a discount to their fair value.

VanDerSchie: Sure. You mentioned value and value investing has sort of become this nebulous term, meaning different things to different people. Some might say an oil company is a value-based stock because it has a P/E ratio of 10. While others might say Netflix is a value stock for reasons tied to its ability to grow consistently over long periods of time. How do you think about value investing?

Straehl: Yeah. I'd say, look, I think what you're mentioning there are simplified frameworks and almost heuristics that in some cases line up with what I would say like a true valuation-driven framework, which – I think a 10 times P/E stock can be expensive and also a 30 time P/E stock, you mentioned Netflix, could be attractive as well. I think the key thing is that the value of an asset is the present value of the future value of its cash flows. And so, keeping that in mind, I think gives you more flexibility. And so, you have, of course, value indexes now, you have style boxes and things like that that sort of simplify value concepts. But ultimately, I think it's just a framework that gives you an ability to buy companies whether they're high-growth companies or lower-growth companies, but just gives you a discipline to understand, to look at the cash flows and discount that back and understand what it's worth intrinsically.

VanDerSchie: Sure. I think we would be doing our audience an injustice if we didn't talk about performance trends and value investing has faced many questions in recent years tied to prolonged periods of underperformance. And dare I say, it's been under attack. So, with maybe that as a backdrop, what are some of the more common concerns or maybe questions you hear from investors who are living through this or who have lived through this and what guidance do you give advisors on how to respond to those questions?

Straehl: Yeah, it's a great question. I would say, not every investment process works in every market environment. And so, I think it's important to stay the course. We think there's decades of evidence that valuation-driven investing works and is paying off in the long run. What I would say is there's some unique features of – we mentioned the market structure earlier. We've gone through a period where markets have become more concentrated. And part of the struggles that many investment processes have had is if you got two or three bets wrong over the past 5 to 10 years, the big tech companies in particular, that really affected your performance.

Now, if you have a valuation-driven process, we were able to buy some tech stocks in 2022, for example, and we're able to benefit from a sell-off there. And then more recently in August, as we've seen a bit of a pullback in tech stocks as well, we were able to close our – (on their way to bit) (14:25) there in that area. So investing is not sort of a constant concept. It's dynamic. And as value investors, we have to, in some cases, evolve and make sure that we have the – we adjust our assumptions. And so, not every value investor underperformed, but perhaps the ones that are just kind of naively focused on some of those P/E concepts might have been more impacted.

VanDerSchie: That makes sense. And I'm going to come back to the concentration of tech stocks later in our conversation, but right now I want to pivot the conversation to industry trends. And I want to start with a trend we're observing in how advisors are managing client assets. Specifically, we see the demand for investment management outsourcing at the advisory practice level. And the data we're seeing continues to show a higher percentage of intermediary advised assets no longer being managed by the advisor, and instead being outsourced to a third-party manager, nearly 40% of all assets, according to Cerulli and Associates. And this isn't just a U.S. trend. We're observing this in other regions, especially those with large populations of independent advisors. So, I guess the question for you, Philip, is what do you think is the driver behind this increased adoption of third-party managers like Morningstar? And do you see this as more of a cyclical or secular trend?

Straehl: Yeah, look, I think, in my opinion, it's really a function of the fact that 20, 30 years ago, being a financial advisor perhaps was more focused on investment products, so recommending stocks or individual products. Over time, there's been more of a focus on financial planning and advice away from just offering products. And so, I think that's, in my opinion, a secular sort of a structural shift that happened with the focus of financial advisors and also just wanting to provide better service to their client. And so, delegating the investment piece to a company like Morningstar and then focusing on the relationship, focusing on financial planning and trying to understand somebody's financial needs holistically, I think, is behind that. We've gone through a transition with more financial advisors retiring and so being able to serve more clients through technology and not having to manage model portfolios and things of that nature really I think has driven that change and in our opinion is likely to continue.

VanDerSchie: Yeah. I saw a statistic recently that over a third of financial advisors are expected to retire within the next decade, so that certainly puts constraints as it relates to the supply of advice, if you will, and how advisors need to think about efficiency and scalability in terms of how they run their own practice.

Another trend that everyone seems to be talking about is the great wealth transfer. And this one Cerulli predicts that over $70 trillion will be changing hands between now and 2045 with the majority of that wealth going to Gen Y and Gen Z. Now, we're also observing different investing preferences for younger demographics, specifically an increased desire for potentially less traditional investments, call it alternatives, call it crypto, along with sustainable investments that allow the investor to express preferences within their investment portfolio. And so, given how challenging it can be to retain the children of clients when a wealth transfer occurs, how do you think advisors should be thinking about catering to the investment preferences of the younger generation?

Straehl: Yeah, I think it's a great question. And I think it's important that that shift and the shift in preferences is taken seriously and as investment managers and financial advisors we think about how to cater to those needs. Obviously, there's some elements where you have to say, okay, what should the role of crypto be in somebody's client portfolio? Our view generally is – so we don't use crypto at Morningstar at this juncture. But I think it's important for us as investment managers or financial advisors that we have an understanding, we can explain why maybe that shouldn't be a core holding in somebody's long-term financial plan. Perhaps there's options for folks to have some small pockets of play money where they can invest in those areas.

But I think on the sustainability side, I think that is a trend where more younger investors are interested in the impact that their investments have on the environment and other dimensions. And we have capabilities and products that sort of cater to that side, whether it's our ESG lineup of multi-asset models or whether it's the ability for somebody within the context of our direct indexing offering, for example, to make exclusions around product involvement. And so, I think there's innovative ways to bring some of those preferences into the package that a financial advisor offers to their clients. But I think it's important to be conversant in these topics. And if it's not part of their capability set, and there's reasons, maybe like in the case of crypto, to give a good answer as to why that's not offered by that financial advisor. So, I think it's a big opportunity if you can have that conversation right and be able to retain those assets that are then passed down to younger generations.

VanDerSchie: Yeah, it's a great opportunity for sure. Philip, the last trend I really want to touch on is this idea of investors having an increased level or perception of fee awareness, or potentially you could think of them as being a little more price savvy. And I think the way to think about that is our observation is that more investors are attuned to the fees they pay to financial advisors and for the cost of their underlying investment vehicles. I think there's just this heightened sense of price paid versus value received, especially relative to say 10 or 15 years ago. And so, in this environment, as consumers are becoming more fee aware and price sensitive, how should advisors think about their overall value proposition?

Straehl: Yeah, I think it's a great question. And my first response when I hear this question, I sat down with Michael Kitces back in June, and we had a long conversation around the topic of future trends in the advice market and really the need for advisors to differentiate themselves. I think it's important to think about the service that a financial advisor provides as a service offering and to be differentiated, there's a number of things you can do. There's ways for you to target certain types of industries, for example. And so, we have a client, for example, who exclusively focuses on air traffic controllers and so really develop the niche around that and has a set of service offering and understands that industry very well and has a client base that's really focused on that side of things. And so, just having a service and financial planning solutions that go beyond just offering products and really thinking about the broad spectrum of advice that you can provide to those clients.

Another idea that I took from that conversation with Michael Kitces was if your solution basically is to – if you're competing with somebody being able to go to a brokerage account and buying ETFs online cheaply, and for you to justify your advisory fees, I think you have to go beyond just offering the product building blocks and really think about the service offering as a whole. And think about helping clients getting financially organized. And there's so much complexity in terms of the – people have statements from former employers and multiple different brokerage accounts and what is the service offering that you're bringing to the table. And so, having that service mindset I think can lead to a great value proposition. And also, that element of specialization that I mentioned, just focusing on the particular type of client, particular job type for example depending on where you're living can lead to really a differentiated solution vis-à-vis somebody going online and just buying a bunch of ETFs online. And I think there's a potential better outcome that comes from having a plan and working with a financial advisor and having the confidence that over the next 10, 15, 20 years you'll be able to work towards a goal that gives you the retirement that you're looking for.

VanDerSchie: So, you heard it here first – differentiation and delivering unique value as a way to differentiate your value prop as an advisor. Thanks Phillip. So, I want to transition into talking about some of the key investing themes that everyone should be thinking about. And maybe we'll come back to the tech stocks which you mentioned earlier in our conversation and the Magnificent Seven, Apple, Microsoft, Alphabet, Amazon, NVIDIA, Meta and Tesla. We've talked about them arguably ad nauseam on this podcast over the last 12 to 18 months. And it's not a secret what's happening in the markets. And so, these are the stocks that are dominating the indexes. And in fact, you wrote about this in your August From the Desk of the CIO letter. Now there's a bit of a contrarian streak that runs through Morningstar and you mentioned in that note that investors should be positioned for broadening out of market leadership. Can you explain exactly what you mean by that?

Straehl: Yeah. So, look, we've gone through a period – and the tech rally at this point is like 10 years old and there's been different cycles to the tech outperformance. But the most recent one was really driven by the AI story. And so, folks – the innovation around large language models, ChatGPT and some of those capabilities really set off a rally in a small set of stocks in 2023 and also through mid-2024. And so, our view was when we looked at where markets were at a broad level with equity markets and also credit markets looking quite expensive mid-year that we were positioned for a broadening of market performance beyond those stocks in particular. We recognize that these are high-quality businesses, the chip demand for NVIDIA, et cetera, is likely going to stay around. But we felt that markets have gotten sort of – they were more than fully valued in some cases, and we felt that there was going to be likely a change in market leadership.

And so, the things we've been buying in Q2 – we started investing more in small caps partly because of the concentration issue we saw on the large cap side. We had added some defensive elements to our portfolios. Consumer staples, for example, was an area we've been interested in – consumer staples, for example, is an area. These are companies that have been more significantly impacted by the goods inflation, if you will. And so, they were not able, in all cases, to pass on that additional cost – an input cost, if you will, to their customers, so their margins were impacted. And now with inflation coming down, our view was that margins of these companies were going to normalize. And so, we had built up some defensive positioning and also positions in REITs. And before that, we had a more diversified profile to our positioning. And so, with the narrative around inflation changing, which really started in July with an inflation report in early July, we saw a bit of a rotation in July and then a continuation of a broadening of the market. And so, we're still positioned broadly for the market to continue to broaden out beyond the tech story. And so that was kind of the context of what we were thinking about at the time.

VanDerSchie: By the way, for the audience, if you are interested in learning more and reading the Desk of the CIO letter that I referenced, which came out in August, those are available on our website, Morningstar Wealth website, at mp.morningstar.com. So go check those out.

Philip, related to the Mag Seven, we've been living through this really unique time of mega-cap stock dominance. And it feels like NVIDIA earnings release receives nearly as much attention as a Fed announcement. What are the most common concerns or questions you get from advisors on this topic?

Straehl: Yeah, look, I think it's interesting that it's such a news event now. There's a few different dimensions. On one hand, it's just the size of some of these stocks in the broad benchmark. And so, 5, 10 years ago – and this goes back to when I started in the industry – no single stock or no group of stocks made up the fraction that these big tech stocks make up today. And so, I think it was mid-year where the Mag Seven stocks made up 33% of the index. And so, the markets have gotten more idiosyncratic, more stock specific. And so, following the earnings announcements of individual companies has become more important in that sense. And the second thing is that it's a new trend and people, investors are really curious as to what the order book of chip manufacturing looks like, and they glean a lot of information from that. And it's also worth saying that a lot of the value of these AI stocks is in the future. And so, getting the growth rate right over the next few years has a huge impact on what these companies are worth. And so, that's – I think, the combination of these two factors really has driven the attention that's being paid to these earnings releases.

VanDerSchie: Fair enough. Just returning to the broadening theme for just a minute, I think it's widely understood by our audience that starting valuations likely play the heaviest hand in that call, as you mentioned. But are there any other potential catalysts here?

Straehl: Yeah, I think it's a great question, because oftentimes, I think you invest because of what the valuation models tell you, but then there's other things that sometimes can be the catalyst. And so, for example, the fact that inflation – the inflation news that we had in June and July and August really changed the market's focus and they started paying attention to things that have been overlooked in the past. And so, the comeback of staples and REITs and some of those more defensive areas, that macro catalyst ultimately led to more of a convergence there

And so, from our perspective, we tend to think about markets in a probabilistic sense. We don't know exactly what the future will hold, but we have positions in our portfolio like small caps, for example, that are poised to do well if we do see a continuation of this economic cycle. And then, conversely, as I mentioned, we've been building up some more defensive holdings, which should hold up better should we see more of a significant economic slowdown. And so, that's kind of how we're positioned.

And so, catalysts, they're funny. Oftentimes, catalysts are only known after the fact. It's hard to predict what the catalysts are. Overnight we saw – China tech stocks, in our mind, have been attractively valued. And overnight, we had a response by the Chinese regulators, and they put in place some more stimulus measures, which led to a bounce back of some of those stocks. And so, you don't know exactly what the catalysts will be when you're a long-term valuation investor, but macro events and factors like that can be the reason why the price moves more closely in line with its fair value.

VanDerSchie: Well, great. Philip, thanks for spending some time with us today. Before I let you go back up to the 9th floor, as we do on Simple But Not Easy, we want to just get your 10-second takeaway. If you wanted to leave our listeners with one theme, one concept, if they had fallen asleep over the last half hour, what would that be?

Straehl: Great question. Look, I think a sound investment process, I think, is rooted in an understanding of companies and an asset's corporate fundamentals. And I think that has served many investors well over decades and that's certainly the North Star that we're focused on here at Morningstar.

VanDerSchie: And there you have it, another episode of Simple But Not Easy. As always, we're grateful to Philip for spending time with us today. And once again, if you'd like to know more about how Morningstar can support you, please drop us a note at simple@morningstar.com or me personally at Nicholas.VanDerSchie@Morningstar.com. That wraps up this week's episode. Before we depart, if you enjoy hearing the insights on our podcast, please consider leaving us a 5-Star review on Apple Podcasts or Spotify. Until next time, thanks for listening.