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Morningstar Replaces Third-Party Funds with Their Own in Managed Portfolios

The company will begin converting assets to nine Morningstar funds approved by the SEC.

Morningstar plans to swap out third-party mutual funds in its managed portfolios for funds of their own, after regulators gave nine Morningstar funds the green light this week.

The Securities and Exchange Commission on Wednesday approved nine mutual funds filed by Morningstar Funds Trust, part of the research firm’s Morningstar Investment Management unit. In turn, Morningstar held a conference call late Thursday to say it plans to replace the roughly 20 third-party active mutual funds currently used to construct the Morningstar Managed Portfolios with their own.

Since Morningstar filed for their own mutual funds late last year, critics have claimed the new vehicles created a potential conflict of interest between the researcher-turned-investment manager and investors. Morningstar said the decision to create and use its own funds will remove a layer of costs in the fee structure of its Managed Portfolios and give managers more flexibility.

“The key driver was bringing cost down for investors,” Daniel Needham, the global chief investment officer of Morningstar Investment Management, said during Thursday’s call.

Morningstar’s funds will also be sub-advised by many of the same investment managers used in the portfolios, allowing them to better express investment ideas and adjust the portfolios, the company said.

Marta Norton, who manages the new Morningstar Alternatives Fund, said during Thursday’s call that financial advisors have been asking about the process to choose sub-advisors and assured listeners it was rigorous. Among the things considered when choosing managers, Norton said fund strategy and the durability of that strategy, expenses and management turnover are all important.

Sub-advisor candidates are also submitted to the broader Morningstar Investment Management group to be evaluated.

The nine mutual funds, which will not be offered as standalone investment vehicles, include the Morningstar U.S. Equity Fund, Morningstar International Equity Fund, Morningstar Global Income Fund, Morningstar Total Return Bond Fund, Morningstar Multisector Bond Fund, Morningstar Defensive Bond Fund, Morningstar Municipal Bond Fund, Morningstar Unconstrained Allocation Fund and Morningstar Alternatives Fund.

The Morningstar funds will also not receive qualitative or quantitative Morningstar ratings, at least to start. The company said once a fund has a three-year performance record, it will be eligible to receive the firm’s star rating, a measure based on a fund’s trailing risk-adjusted returns versus category peers.

Morningstar Investment Management is the third largest product based on revenue for the financial services firm, and contributed for $105 million, or about 11.6 percent of Morningstar’s consolidated revenue in 2017. The business’s contribution to consolidated revenue has shrunk in recent years. It accounted for 12.3 percent and 12.5 percent of consolidated revenue in 2016 and 2015, respectively.

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