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Morningstar New Business Unit on Schedule

Nearly one year after setting out to build a new asset management business, fund researcher Morningstar has weathered dismal markets and a short spate of criticism over potential conflicts of interest.

And it's on schedule, according to a Morningstar executive. By year end, the firm expects to have $500 million of assets under management and to grow the business to as much as $5 billion by 2005.

Art Lutschaunig, the CIO for the Chicago firm's asset management unit, Morningstar Investment Services, said the division hopes to enlist 10,000 financial advisors to use its services and products by year end. It currently has about 6,500 advisors signed up, he said.

In addition, the unit has been trying to build a network of at least 30 firms that will distribute its investment products by the end of the year. It currently has 27 signed on, including Commonwealth Financial of Cincinnati, Ohio, and Jefferson Pilot Securities Corp. of Greensboro, N.C.

"We're ahead of where we wanted to be," Lutschaunig said.

Morningstar began building the asset management division in April. It's the first time the well-known fund researcher has stepped into the game of managing assets.

The unit provides a fee-based service called Managed Portfolios, which is geared primarily toward financial advisors. It offers portfolios of mutual funds that are researched and monitored by Morningstar. So far, the initiative will cost in the neighborhood of $10 million, Lutschaunig said. And the Investment Services unit now invests in 60 funds across its 10 portfolios.

Average account sizes total $113,000, and total assets under management are sparse. However, Morningstar has big plans for the division by three years from now. "We're in the tiny stage right now," Lutschaunig said. He did not disclose the exact amount the unit currently oversees, but he said it hopes to manage $500 million by year end and between $3 billion and $5 billion in three years.

The firm also provides back-office services and other support. And the unit plans to offer a bevy of managed accounts that will be used to supplement investors' portfolios.

But despite the mostly positive response from the industry, the initiative hasn't been without its troubles and surprises.

Growing Pains

Turbulent markets have made the prospect of launching a new asset management business difficult. "It's choppy from an investment point of view," Lutschaunig said. But "it could be a lot uglier. I wouldn't even put us in the ugly camp."

In addition, as the firm has begun to sign on clients, it decided on the fly to build a team to connect users with Morningstar's data and services. Charged with making sure that the Morningstar software integrates seamlessly with financial planners' computer programs, Morningstar found that it needed "to treat this as a full computer system installation," Lutschaunig said. In December, the firm decided to appoint a team to oversee the process, which Lutschaunig describes as "a tweak that was unexpected."

Competition, meanwhile, is stiff. "There are certainly a number of firms that have beat them to the table, SEI being the primary one of those" said Matt McGuinness, a senior analyst at the Boston financial research firm Cerulli Associates.

In fact, Lutschaunig headed the mutual fund management group at SEI in the 1980's. That firm now has more than $200 billion under management, according to its Web site. Lutschaunig called SEI "one of the most dominant competitors" in the marketplace. "They're very good," he said. But he added, "Some advisors are a little less enamored of them now than historically."

That, and advisors' apparent hunger for Morningstar's new products and services, suggests that there is room for new players in the marketplace. Morningstar Investment Services has decided to target insurance agents, broker dealers and independent agents while eschewing wirehouses.

"We knew we didn't want to be a retail player," Lutschaunig said.

In addition, he said the unit isn't too choosy about its clients' size. "Some of the smaller players are as good clients to us as some of the larger ones," he said. But "large [clients] are saying that Morningstar has a brand name that they can market."

All this strategy aside, Morningstar's plan to build an asset management business was greeted with vocal skepticism when the company initially announced its intentions. Last August, critics were concerned that the researcher, whose "style box" rating system for mutual funds has become ubiquitous across the industry, would taint its own credibility by suddenly investing in some of the products it rates and reviews.

That is partly because many people don't know that Morningstar's style boxes are calculated quantitatively rather than being dreamed up by the company's editorial staff, Lutschaunig said.

For example, a user of the company's Advisor Work-

station tool, which provides data and analysis to financial planners, called to complain about just that issue. "I spent an hour on the phone with this guy," Lutschaunig said. "He didn't know the system was quantitatively derived."

Within a week, the concern, at least the vocal protests, died down, he said.

"We've done everything we can to act like any other manager," Lutschaunig said. "I'm not going to tell you we're the greatest thing in the world. I don't know if we are. Talk to me in three years."