About the Editor
Samuel Lee is an ETF strategist for Morningstar and editor of Morningstar ETFInvestor, a monthly investment newsletter. Prior to becoming editor, Lee was a fund analyst on Morningstar's passive funds research team, where he covered alternative, dividend, and actively managed ETFs and performed quantitative modeling of ETF strategies.

Lee joined Morningstar in 2008 as a data analyst, where he evaluated ways to measure and improve the firm's data quality.

Lee holds a bachelor's degree in economics, with honors, from Grinnell College.


Investment Strategy
Morningstar ETFInvestor scans the globe for value and improving fundamentals across virtually all asset classes. Editor Samuel Lee draws upon academic and practitioner research — including Morningstar's sizeable bench of stock, bond and fund analysts — to find reliable drivers of outperformance.

Morningstar ETFInvestor features two real-money portfolios.

The ETF Income Portfolio assembles a high-quality collection of income-generating ETFs with the goal of earning 5% in excess of the 30-day T-bill rate over a full business cycle. The portfolio adheres to a benchmark-agnostic strategy in its search for absolute returns.

The ETF Global Asset Allocation Portfolio, on the other hand, is more benchmark sensitive. It seeks undervalued asset classes with improving fundamentals. The strategy seeks to beat the 60/40 MSCI ACWI/Barclays US Aggregate benchmark over a full business cycle, with the least risk possible.

 
 
Aug 21, 2014
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Samuel Lee,
Editor, Morningstar ETFInvestor
Samuel Lee is an ETF strategist for Morningstar and editor of Morningstar ETFInvestor, a monthly investment newsletter. Prior to becoming editor, Lee was a fund analyst on Morningstar's
Featured Posts
Kinder Morgan, Efficient Markets, and the Power of Incentives
On Sunday, Kinder Morgan, Inc. KMI announced it is acquiring Kinder Morgan Management KMR, Kinder Morgan Energy Partners KMP, and El Paso Pipeline Partners EPB for stock, some cash, and the assumption of their debts. All four Kinder Morgan entities have risen in value. Normally, when one company buys another, the acquiring company’s price falls to account for the transfer in value to the acquired company’s shareholders. KMI claims it will be able to more quickly grow its dividend. Analysts have greeted the move with rapturous applause.

But where’s this growth coming from? Kinder Morgan’s explanation is that by eliminating incentive distribution rights, or IDRs, the payments the partnerships made to the general partner, KMI’s cost of capital will go down, making it easier to find “accretive” acquisitions. Were this true, it would be a violation of market efficiency. In this case, all that happens by eliminating IDRs is the same cash stream simply gets divvied up in a different way. Without actually altering the cash flows, financial engineering cannot add value in an efficient market.

The most plausible explanation I’ve seen for the aggregate rise in value is the tax savings the consolidated firm will enjoy--some $20 billion in over the next 14 years, according to Kinder Morgan’s projections. KMI is buying the assets of the partnerships KMP and EPB on a stepped-up basis, allowing it to shield future income through bigger depreciation and amortization deductions.
 
Tax law professor Victor Fleischer points out the drawback to this financial legerdemain:

Those future tax savings come at a current cost, just not one borne by KMI shareholders. As a result of the roll-up transaction, many existing unit holders will face a hefty tax bill. The deal will be treated as a taxable transaction, with existing unit holders treated as selling their units in exchange for stock and cash. Because of earlier tax deductions attributable to depreciation and amortization, many unit holders will have a low basis in their units. For those unit holders, the transaction will trigger recognition of a large amount of gain, much of it taxed at ordinary rates rather than capital gain rate.

Ouch. It’s perverse that the most loyal, earliest investors will be paying the heftiest taxes and subsidizing Mr. Kinder. Many, if not most unitholders are retail investors.

Fleischer points out that Kinder Morgan could have structured the acquisitions to avoid hitting current unitholders with a taxable event. But doing so would have removed the tax benefit to Kinder Morgan.

As of August 9, Rich Kinder owned 243,059,533 shares in KMI, or around 23.6% of shares outstanding, and relatively little in EPB and KMP. KMI’s price rose 9% from Friday’s close to Monday’s close, netting him a cool $780.9 million. The transaction transfers much of the tax benefits from the numerous small MLP unitholders to KMI shareholders, of which Rich Kinder is the biggest.

Now, unitholders will also benefit from KMI’s future tax savings, should they elect to hold onto their newly issued KMI shares. However, each dollar in taxes they’re going to pay now on the units isn’t necessarily going to come back in whole as faster dividend growth in KMI. A big chunk of the benefits will be shared with the original KMI owners, who didn’t have to take a tax hit, and newer unitholders, whose cost bases are much higher.

Agency costs, the frictions induced by managers behaving in ways that enrich themselves at the expense of shareholders, are not adequately priced by the market. We have a good example at hand: KMP and KMR are economically identical, but Rich Kinder himself owns a lot more KMR than KMP, and KMR doesn’t come with the hassle of filing K-1 forms. But because KMP paid its dividend in cash rather than shares, it frequently commanded a premium to KMR. Investors assigned little to no premium for the stronger alignment of interest between KMR and Rich Kinder. In the consolidation, KMR shareholders will not be forced into a taxable event; KMP investors will be.

It almost never makes sense to bet against someone who knows more than you and has both the means and motive to take advantage of you. A simple but powerful way to filter out investments is to look for substantial inside ownership, honest managers, and shareholder-friendly boards.

Best regards,

Samuel Lee
Strategist
Editor, Morningstar ETFInvestor
Portfolio Holdings
Income Portfolio
ETF
YTD Ret %
Price $
4.5
109.2
CASH$
N/A
1.0
7.6
62.7
6.2
65.4
5.9
12.4
-0.1
23.0
15.4
32.7
6.2
35.2
5.3
23.0
Global Asset Allocation Portfolio
ETF
YTD Ret %
Price $
4.3
109.2
CASH$
N/A
1.0
7.6
62.7
2.0
23.0
13.5
32.7
6.2
35.2
0.0
41.7
2.6
78.0
5.3
23.0
Most Popular ETFs
ETF Name
YTD Rtn %
3 Yr Rtn %
Trading Vol.
NASDAQ 100 Trust Shares
-10.76
1.45
125,000,944
SPDRs
-3.64
2.68
87,466,496
Semiconductor HOLDRs
-6.23
-11.66
26,838,700
iShares MSCI Japan Index
-6.59
7.18
17,256,500
iShares Russell 2000 Index
-7.46
6.43
16,210,700
Energy Select Sector SPDR
15.88
15.50
14,900,000
Financial Select Sector SPDR
-8.42
2.61
11,612,800
DIAMONDS Trust, Series 1
-3.75
2.21
7,350,600
Utilities Select Sector SPDR
6.84
6.82
3,848,200
Materials Select Sector SPDR
-4.31
8.50
2,179,300
 
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