Emma Rapaport: Hello, and welcome to Morningstar. I'm Emma Rapoport. Today, joining us is Jody Fitzgerald. He is in our Morningstar Investment Management team.

Jody, thanks for joining us.

Jody Fitzgerald: Hi. How are you today?

Rapaport: Good. Thanks. Jody, we don't do a lot of videos with you. So, our audience is a little less familiar with you and what you do. So, can you walk through your position and the role that you play within Morningstar Investment Management?

Fitzgerald: Sure. So, I'm Head of Institutional Portfolio Management and Solutions in our Investment Management Division, which basically means I'm a portfolio manager. So, I manage portfolios for our larger institutional clients in Morningstar Investment Management.

Rapaport: Yeah. So, the reason I wanted to chat with you today is I've just done a review of some of the robo-advisor portfolios, looking at how they allocate assets across various asset classes and geographies and sectors. And I guess, I was a little surprised about how different they were. I was really expecting them to be pretty similar, sort of, like a baseline, you know, an easy entry point for investors. But some of them had just made some really big calls on asset classes like gold or emerging markets, or they've chosen to only invest in Asia and things like that. So, maybe just quickly, can you walk through what Morningstar Investment Management's approach to asset allocation is?

Fitzgerald: Yeah. Sure. So, the way that we determine how to allocate money between asset classes is, fundamentally, we believe that the value of any asset is cash flows that that asset can generate and the growth of those cash flows. So, what we're looking at is what is the price that people are willing to pay for those cash flows. Now, obviously, we want to buy a dollar's worth of assets for $0.50. We would like to buy assets for less than they're worth. So, that's how we make a determination of where we actually invest at any particular point in time.

Rapaport: And how do you approach a growth and defensive split? How do you approach the risk profiles for the various portfolios?

Fitzgerald: Yeah. So, look, we have varying risk profiles that vary the growth exposure and clients use those in different ways, so depending on their timeframes, so do they have years or do they have decades. Obviously, the longer the time frame you have, the more growth assets that make sense to hold. And it also depends on how the client feels about risk. With regards to any particular point in time though, we can vary the growth asset exposure and there's a lot of different elements that we take into consideration. So, one of the key considerations is the forward-looking return profile of markets. Now, at the moment, we're in a very low interest rate world. Now, the level of interest rates impacts the returns that you can earn from all markets. So, the return of some defensive assets – and by defensive assets I mean things like cash or fixed income portfolios – the returns on some of those assets are not going to keep pace with inflation. So, this isn't ideal because the future value of your money in purchasing power terms will have gone backwards. So, to earn a reasonable return and keep pace with inflation, we believe that structurally investors may need to hold more growth assets over the coming years. There's a double-edged sword to this though, because at the moment, markets are expensive. So, it's super important to have a reasonable exposure to growth assets but making sure you're exposed to the right aspects of the market.

Rapaport: How much risk do you think investors need to be taking on to get the most growth or the most risk-rated reward in their highest-risk portfolios?

Fitzgerald: Yeah. You know, as I said, that's a tricky one. In some respects, that depends on the timeframe of the client. And there isn't really a single answer to that question because you need to take into consideration how long am I willing to invest for. Because obviously, the more growth assets you take, the higher the probability that you may experience some big negative returns for shorter timeframes. So, you need a decent timeframe if you're going to have large exposure to growth assets. But as I mentioned, at the moment, we think structurally it's important to have a reasonable exposure to growth assets because things like cash when you take off inflation, you're really not earning anything. And that's also the case in some fixed income portfolios as well.

Rapaport: Yeah. So, in the lowest risk portfolios are you investing in any other asset classes that you weren't before? You spoke about taking on maybe some more equity risk. But are there any other asset classes that you think are providing defensive characteristics for more conservative investors?

Fitzgerald: So even though bonds at the moment, the government bonds, corporate bonds are expensive, they still do play an important role in a portfolio. They do offer diversification benefits over, sort of, the market cycle. So, our portfolios have good diversification across asset classes. So, not only are we spreading out equities across, sort of, Australian equities and international markets, but within the defensive assets, we're looking at both domestic fixed income, international fixed income, even things like inflation-linked bonds and cash within those portfolios. Some of our portfolios will also have an exposure to alternative assets as well, which are typically aiming to do well irrespective of the direction of the market.

Rapaport: Can you just give a quick example of what an alternative asset is?

Fitzgerald: Yeah. Alternative assets is quite a broad category. It can include lots of different things from managers who are trying to profit from merger and acquisitions to managers who are trying to generate returns from currency exposures from being long-short equity portfolio, So, it's a very, very diverse category. But effectively, it is anything that is looking to generate a positive return irrespective of the market cycle.

Rapaport: So, one of the portfolios I looked at had quite a large allocation to gold and the suggestion from the portfolio manager was that gold was a great defensive asset class. And I've heard this before. I know that Morningstar Investment Management doesn't invest in gold and that there's some debate about whether it's a true defensive asset class or not. So, can you just explain why you've chosen not to invest in this asset class, but also why it may be considered defensive by someone else?

Fitzgerald: Yeah. So, the reason why we don't hold gold in our portfolios is, as I mentioned earlier, to us it's really important that we have a firm understanding of what's an asset really worth. Now, gold doesn't generate cash flows and therefore, it's hard for us to actually put a firm valuation on it and therefore, difficult for us to actually say is it overvalued or undervalued. So, it doesn't really fit into our investment processes, which is why we don't hold it. Some people obviously have traditionally held gold as a defensive play, seeing it as an inflation hedge in portfolios, et cetera. I think the real question becomes, you know, how do you know what it's worth? And unless you can answer that question, then realistically, it doesn't have a place in your portfolio.

Rapaport: Right. Yeah, it's a difficult conversation. When you are looking out for defensive assets, they're not as well readily available as they used to be. I think another question that investors face is, you know, how many asset classes is too many. With access to products like ETFs we can really invest in, kind of, wherever we like. Alternatives may be off the cards, but there are so many available asset classes. How do you know that you've got too many or too few? Is there a perfect mix that investors can hold onto?

Fitzgerald: Look, I think there's a target mix that you can sort of aim for to know that you've got the right level of diversification in your portfolio. So, asset classes will perform differently at different points in the market cycle. So, in general, a well-diversified portfolio will be spread across equities. Now, preferably, across Australian and international markets. Don't just stick to Australian equities because you can, you know, walk past Westpac Bank and know what it is. It's important to have that international diversification. And by holding international equities as well you will also then get some currency exposure, which is a really good diversifier in the portfolio. I think then also having things like property and infrastructure. Now, your property could actually be the physical property that you actually own, or it could be listed investments. And then, moving into the defensive asset classes of fixed income and cash. So, all of these are available through ETF structures, through direct investments and so forth. I think they're the high-level asset classes that it's important to have some sort of exposure to, to have that diversification in your portfolio.

Rapaport: Okay. Well, thank you so much for joining us today and giving your insights. It's a complicated area for investors to think about building multi-asset portfolios, but obviously, quite an important topic. So, thank you for giving us your insights.

Fitzgerald: No problem. Pleasure.