Decade of Dominance: The ETF that Quietly Beats the S&P 500
April 11, 2023
Read Time 2 MIN
In the piece, Brandon Rakszawski, Director of Product Management at VanEck, explained that the MOAT ETF can choose to invest in a select group of about 145 companies with economic moats identified by Morningstar analysts. These companies are narrowed down based on intrinsic value, which is calculated using a long-term discounted cash flow model. The MOAT ETF currently holds 49 stocks, focusing on undervalued companies. Morningstar analysts assign economic moat ratings based on five competitive advantages: switching costs, intangible assets, network effect, cost advantage, and efficient scale. By prioritizing these factors, the MOAT ETF aims to create a well-rounded portfolio that can consistently outperform the S&P 500.
The Five Sources of Economic Moats
Economic moats are durable competitive advantages expected to allow companies to fend off competition and sustain profitability into the future. Morningstar has identified five sources of economic moats:
|Switching Costs||Intangible Assets||Network Effect||Cost Advantage||Efficient Scale|
|Switching costs give a company pricing power by locking customers into its unique ecosystem. Beyond the expense of moving, they can also be measured by the effort, time, and psychological toll of switching to a competitor.||Though not always easy to quantify, intangible assets may include brand recognition, patents, and regulatory licenses. They may prevent competitors from duplicating products or allow a company to charge premium pricing.||A network effect is present when the value of a product or service grows as its user base expands. Each additional customer increases the product’s or service’s value exponentially.||Companies that are able to produce products or services at lower costs than competitors are often able to sell at the same price as competition and gather excess profit, or have the option to undercut competition.||In a market limited in size, potential new competitors have little incentive to enter because doing so would lower the industry’s returns below the cost of capital.|
Are the Companies' Moats Built to Last?
Companies may demonstrate one or a combination of the five sources of moat. Evaluating a company against these attributes is a key part of how Morningstar’s equity research team measures the strength of a company’s competitive advantage. Based on this assessment, Morningstar assigns a company one of three economic moat ratings: none, narrow or wide.
In turn, these ratings help inform Morningstar analysts’ long-term forecasting decisions, which impact bottom-up fair value estimates. A wide moat rating is given to a company that is more likely than not to sustain its competitive advantage for at least the next 20 years, while a narrow moat rating means a company is more likely than not to do so for at least 10 years into the future. A company with no moat has either no advantage or one expected to dissipate relatively quickly.
When companies are successful and earning excess profits, they often become targets for competitors, which may threaten their profits. Companies with a wide moat tend to be best equipped to hold off competitors, which may help defend profitability over the long term.
Over time, this approach has led to attractive long-term returns, making moat strategies an effective component of core portfolio stock allocations.
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Effective June 20, 2016, Morningstar implemented several changes to the Morningstar Wide Moat Focus Index construction rules. Among other changes, the index increased its constituent count from 20 stocks to at least 40 stocks and modified its rebalance and reconstitution methodology. These changes may result in more diversified exposure, lower turnover, and longer holding periods for index constituents than under the rules in effect prior to this date. Past performance is no guarantee of future results.
The Morningstar moat-driven indexes represent various regional exposures and consist of companies identified as having sustainable, competitive advantages and whose stocks are attractively priced, according to Morningstar.
The Morningstar® Wide Moat Focus IndexSM Intended to track the overall performance of attractively priced companies with sustainable competitive advantages according to Morningstar's equity research team.
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