Morningstar Heightens Competition with Asset Managers

Story written by Madison Marriage at Financial Review

Morningstar is considered to be one of the most powerful influences in asset management.

The company, which was founded three decades ago by former stock analyst Joe Mansueto in his one-bedroom flat in Chicago, started out as a boutique research provider that compiled data on 400 mutual funds.

In the 32 years since, the Nasdaq-listed company has evolved into a vast organisation that employs 4,200 staff, oversees $US200 billion of assets, and publishes data on 100,000 mutual funds.

Morningstar is now embarking on arguably its biggest strategic change since Mr. Mansueto set up the company shortly before his 28th birthday.

The Chicago-born executive, who has built an estimated $US2.1 billion fortune on the back of the success of Morningstar as well as investments in several large media companies, this month handed the reins of the company to his protégé, Kunal Kapoor.

Mr Kapoor, a Kolkata-born former data analyst, has spent the past 20 years climbing the ranks at Morningstar. He has moved from president to chief executive of the company he joined straight after university.

Mr Mansueto, who retains a 56 per cent stake in Morningstar, has relinquished the chief executive role to becomes executive chairman.

Differences on the way

Speaking in a small meeting room at Morningstar's UK headquarters in London's fashionable Shoreditch area, the duo are at pains to emphasise the leadership changes will cause minimal disruption – and that the pair will not clash over important strategic decisions.

"It is going to be business as usual," says Mr Mansueto. "I have worked with Kunal for 20 years. He has worked in just about every part of our organisation, he is a passionate investor [and] he lives and breathes Morningstar. [We] have many similarities as leaders, and so it will be a very seamless, drama-free, transition."

Nonetheless, the 60-year-old acknowledges that there will be "differences" in how his successor runs the business, and the asset management community is likely to watch any new developments closely.

The data provider is widely seen as one of the most influential organisations in determining the fate of an asset management company. Damning analyst reports or poor fund ratings issued by Morningstar often trigger sharp outflows from clients, while investors tend to flock to the highest-rated funds.

Although the two executives do not expect Morningstar's operational style to change, they highlight several strategic initiatives the company is exploring that will take it further away from its traditional revenue source - data - and place it in more direct competition with the companies it rates: asset managers.

Mr Mansueto appears most excited by the growth potential of Morningstar's retirement services business, which accounts for $US40 billion of assets and caters to US companies that want to provide defined contribution pension schemes for their staff.

Retirement growth opportunity

Morningstar has been in talks with regulators and potential distribution partners about expanding the business in the UK for the past two years, according to Mr Mansueto.

"The retirement opportunity is enormous as more of the baby-boom generation moves into retirement. We don't offer [retirement services] in the UK, but we are looking at how we might bring that to [this] market. We think there is a great opportunity," he says.

The company is also planning to expand its "managed portfolio service", which enables financial advisers to outsource investment decisions to Morningstar. This division accounts for $US28 billion of assets and is available in the US, the UK, South Africa, and is expected to launch imminently in India.

Most of those assets are outsourced to external fund managers selected by Morningstar, but a chunk of that money is invested directly in equity markets. Morningstar is considering expanding into the provision of multi-asset investments, according to Mr Kapoor.

"Multi-asset investing is important. We would certainly look at that. What we try to stay away from is the faddish stuff. We are not big fans of chasing something just because it's got a good story and can be sold. We want to do it because it actually makes sense," says the 41-year-old.

Morningstar's push towards becoming a provider of asset management products, rather than simply analysing them, has sparked criticism of the company due to concerns that this has created inherent conflict of interests.

One asset management professional, speaking privately, says: "There is a perception that there are no significant firewalls to prevent conflicts of interest at Morningstar. What is Morningstar doing to ease asset managers' real to imagined concerns?"

Morningstar was the only rating provider explicitly named by the UK regulator in a damning report on the industry last year, which was critical of how the fund rating system operates.

Funds with the best ratings "do not significantly outperform their benchmark net of charges", according to the Financial Conduct Authority. The concern is that rating companies are commercially incentivised to assign generous ratings to funds in a bid to retain business from asset managers.

Mr Mansueto and Mr Kapoor are quick to defend Morningstar's business model, which involves asset managers paying to use a fund rating in their marketing materials. Investment companies do not pay to have a rating carried out in the first place.

Mr Mansueto says the ratings are done by computer and has no human intervention. He adds: "We are totally independent. We don't take fees for rating mutual funds. We never have. We create our ratings first, independently, and then we license them after we have created them."

In fact, both executives seem keen for Morningstar to become more recognised as an asset manager than it is at present, despite the question marks around the impact this shift has had on the company's independence.

Morningstar has never been included in the prestigious ranking of the world's largest asset managers compiled annually by Willis Towers Watson, the investment consultancy. This is something Mr Mansueto would like to see change. "We should be considered an investment manager," he says.

Mr Kapoor adds: "We are very conscious that [conflicts of interest] could take place and we manage our organisation in a way to prevent that. It starts by bringing people in here who can think independently, who are not worried about raising their voices, [and who are] dedicated to preserving the brand. Ultimately, it is a brand built on trust. If you do surveys about the industry, it is not viewed favourably by the broader public, yet the Morningstar brand is. We know that, we are conscious of it, and our goal is to make sure it stays that way."

Posted by: The Trust Advisor


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