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Kunal Kapoor on different paths to investor success

Introduction: Kunal Kapoor, CFA, is CEO of Morningstar. Prior to taking this role in 2017, he served as President, responsible for product development and innovation, sales and marketing, and driving strategic prioritisation. He joined Morningstar in 1997 as a data analyst and has served as Director of Mutual Fund Research and was part of the team that launched Morningstar Investment Services, Inc.

Morningstar, Inc (NASDAQ:MORN) is a global financial services firm headquartered in Chicago, Illinois, United States and it currently has a market capitalisation of about USD7 billion (over AUD10 billion).


GH: You run a publicly listed company, but its main aim is to empower investor success. Can you give examples where you've had to reconcile differences between various stakeholders?

KK: We certainly have situations where we have to reconcile the way we work, such as the independence of our analysts when some clients have opinions on what our analysts ought to be saying. But when I was an analyst, I had carte blanche to deliver whatever opinion was researched and thoughtful as long as I could defend it. And I certainly delivered opinions that from time to time upset our clients.

GH: And maybe the commercial interests.

KK: Right, but it's no different today. Our analysts have the independence to say what they want to as long as it's well researched and thoughtful. Now I'm on the other side of the fence, I receive calls when people are mad. And I listen to them, but I cannot tell the analysts to change their opinions. In fact, I had one just in the last week where a CEO was upset with something and I was not able to pacify the individual. But I don’t change the language. I may ask the analysts to double check their work to ensure it is factually correct, but an opinion is an opinion.

As a public company, we operate very differently. We have a strong belief in democratising investing. In 2005 when we became a public company, we did an auction IPO (initial public offering). Everyone had access to it. We do not talk to any analysts or researchers during the year, except at our annual meeting when any investor can attend.

GH: So as a CEO, you don't do regular roadshows to investors or meet major shareholders in private?

KK: None of that. We don’t do earnings estimates, but nor do we do earnings calls. We set up our company for the long term, taking inspiration from people like Warren Buffett. It goes to the heart of what we believe around fairness and democratisation of the investing process. We answer questions monthly in regulatory filings. People can send us questions and we take time to answer these questions.

GH: Is that linked to something you say that a company gets the shareholders it deserves?

KK: Yes, I always say that. If you're managing the business for the short term, you're going to attract people who are chasing short-term returns. But if you are clear about how you want to operate and the rules you set up, you will get the right set of investors. Plenty of investors understand that management's time is better spent running the business versus spending time on road shows.

I believe the markets are efficient over time and that the value of a company in the public markets reflects the discounted value of future cash flows over periods of time.

GH: Do you say to investors, 'this is the way we run the company, if you don't like it then don't invest'.

KK: Yes, I’m totally comfortable to say that to people. I love that some of our largest institutional investors have been long-time shareholders for a decade or more.

Reaching all investors

GH: How is Morningstar addressing the fact that most of our engagement is either with financial advisers or sophisticated investors but the majority of people who probably need guidance are not receiving it?

KK: It's a challenge, but as someone who loves investing, it took me a long time to appreciate that many people are not particularly interested in investing. They don't live and breathe it in the way we do. So you have to meet people where they are. For us, that's meant doing things such as having a robo-adviser business, Morningstar Retirement Manager, in the 401k (US retirement saving) space in the US.

That's a perfect example of where somebody may not have much interest in investing, but they are looking for a thoughtful, fantastic long-term option that will help them reach their goals. We can reach a larger audience like that.

The other thing we think about is how to help younger investors. When you're young, you have a tendency to want to enjoy yourself, spending your money. But those are the years where you should lay the foundation for saving. Even if you're a great investor pumping out returns of say 100% a year, but it’s on a base of $1,000, it will not change your life. But for most of us, if we save well while we're young and we earn normal market returns, the power of compounding will work. But you need that base of savings.

Morningstar has a long history of using technology and design to explain financial concepts that sometimes come across as complex to the average person. We must make sure people feel information is accessible to them, which is why something like fund ratings are so helpful because they’re a snapshot that can guide their investment process.

GH: Do we need new ways of talking to younger generations? I sometimes feel my publication is too highbrow and we should have another at a different level with a younger voice.

KK: With any investor, younger or older, it must resonate for them before they will engage in an activity. For example, people approaching retirement have to figure out how they will live on their savings and pensions, they have a big incentive. But for younger people, it's hard to imagine what retirement looks like.

The most important way you can engage a younger investor is through the lens of personalisation. Technology allows you to personalise a portfolio in a more interesting way. For example, we have gone deeply into ESG because it makes investing resonate to more investors than ever before. You do ESG because you have a view of the future and you want your portfolio to succeed in a way that's aligned with the view of that future. It's not about what used to be called socially responsible investing, which is where people don't like tobacco or alcohol. This is about the future. You may believe that we're transitioning to a low-carbon world, so why would your portfolio not reflect that.

As transaction costs and barriers are coming down and people can invest with smaller amounts of money, they need to be educated. They need to understand why investing is important at any age, including help with behavioural biases that prevent a lot of people from being successful investors.

GH: Morningstar is devoting far more resources into behavioural coaching for advisers. What is some of the work being done there?

KK: We are modifying our software tools to include behavioural nudges that will help people reach better outcomes. There are some obvious wins such as making investors stick to a portfolio in difficult times, which is one of the most important ways to guarantee success. Or it can be more nuanced such as our new ESG preferences tool that considers the trade-offs being made in portfolios. Retirement tools can automatically encourage people to contribute more to their superannuation.

GH: Too many people buy at highs as the market rallies but sell after a market fall.

KK: Yes, sometimes it’s envy or the madness of crowds or getting scared by a headline. Ultimately, investing is about reaching a goal and sometimes doing less equals doing more for yourself. Anyone buying a financial product should ask what they are paying for and how it compares with what else is available. They should always ask about the incentives of the people selling the product, to understand how it fits into representing your best interests.

GH: Do you expect Morningstar employees to call it out if they see something in the market which they think is a poor product – for example, the wrong assets targeting the wrong people and too expensive?

KK: Yes, our analysts are often doing that in the fund space. Others should raise issues with the research team. Our ultimate goal is to empower investors and to make them successful and it's important to call out products we think are both good and bad.

All styles of investing have their merits

GH: Many active managers who have struggled to keep up with the index in a strong growth market have said that their day will come when the market falls and their quality will protect investors on the downside. Do you buy that argument?

KK: I personally believe active management has a strong case and passive management has a strong case. It's not like one versus the other, which is how it's often framed. I would reframe your question into a high-cost versus low-cost issue. If you're an active manager, your day is not coming if you're high cost, but there are plenty of good index and active options that will do well even in a bear market. And part of the reason they will do well is because they are low cost.

Good active offerings should be bought for the long term with expectations of periods of underperformance. That's the nature of the beast. Active management leads to some deviation from the index, hopefully, but are they doing things in the way they said they would, regardless of cycle? Are their incentives aligned to investors and are they doing it in a low-cost manner?

GH: If an investor chooses an active manager, how long do you believe they should persevere if there is a period of underperformance? Is it a 10-year decision?

KK: It's a personal preference, but three years is not long enough. They should give it somewhere between five to 10 years to judge properly. A deep-value investor may be in a five-year funk right now.

Supporting advisers and investors

GH: The financial advice industry is struggling at the moment with most advisers reconsidering their business model. What role do you see for Morningstar in helping advisers?

KK: For long-term advisers, it's a fantastic opportunity. Certainly, there's turbulence in the short run, but the end investor will win at the end of the day. The ecosystem will support them with great investment options, great advice and great tools. I view us as playing an important role in providing great research that people can use, taking the investment planning and linking it to their financial planning. We recently made the investment in AdviserLogic because as we think about how advisers work and their value proposition, they're under tremendous pressure because investors are demanding more value.

When you put together the pieces, advisers add a lot of value but they need to be thoughtful in the way they talk about it. ESG is a great topic when you talk about adviser value. For example, an adviser helping a retiree decide where to live 15 years ago would not have been looking at water tables in a seaside town. But now, part of the value proposition is the extra data that will help retirees consider what water tables may look like 15 years from now. It's a different decision given some of the changes that we're experiencing.

GH: The problems advice is facing with increasing compliance obligations and regulatory burdens, and the removal of vertical integration subsidies, means that full-service financial advice is increasingly for the wealthy. A lot of people are being left behind. There are quality advisers but it'll be for the top end.

KK: It's certainly true that's playing out exactly how you described it right now. But out of necessity is born innovation, and some of the advisers now serving wealthy households have not thought enough about newer business models. Today, adviser technology can automate parts of a practice so they can serve a midsize client more effectively and profitably than previously. It might take a while to shake out but I have great faith in the necessity, the technology and human ingenuity.

The Australian market is dynamic and firms like ours will step up and ensure that people get the advice they need. We must be open to the fact that it may not look exactly like what it looked like five years ago, but that's not a bad thing.

GH: One of the messages that Morningstar gives through Christine Benz, a thought leader in the business, is the priorities in an investment journey. She rightly talks about goals and saving and behaviour. Then she says, at the end, at the top of her of her pyramid, comes the investment decision and a legitimate way of investing is to hold some index funds. And yet Morningstar devotes considerable resources to fund and individual share research which may not be part of this journey.

KK: It's reflective of our culture that appreciates there are different kinds of investors. Christine is fantastic for onboarding investors who find investing is too complicated. She’s thoughtful about what it takes to make investors successful particularly if they do not have a deep-seated interest in doing investing day and night. But she also recommends active funds as well. It's our way of saying there are different paths to success, and you can choose the path that you like best.

GH: It’s a great way of communicating with people who may otherwise be left behind.

KK: Some people in Morningstar believe in 100% active and others believe in 100% passive and that's okay. The question is: does the portfolio that gets built ultimately measure up to the risk profile investors are seeking, and then ultimately does it get investors to achieve their goals? The only thing that matters is, does the investor have a successful outcome? Most investors don't sit around comparing results against benchmarks. They want to know if they have enough money to repay their college loan or take a vacation in Italy or buy that seaside home. That's what people care about. Success is hitting your goals and we should celebrate that.


Graham Hand is Managing Editor of Firstlinks, a Morningstar company. This discussion is an edited transcript which forms part of our Interview Series with leading executives around the world. This article is general information and does not consider the circumstances of any individual.



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