As the value style comes back in vogue, exchange traded funds that track quality stocks with a competitive advantage have been leading the recent market rebound.
The Market Vectors Morningstar Wide Moat ETF (NYSEArca: MOAT) rose 5.3% year-to-date while the SPDR S&P 500 ETF (NYSEArca: SPY) returned 0.7%.
Additionally, looking at international markets, the Market Vectors Morningstar International Moat ETF (NYSEArca: MOTI) gained 1.7% so far this year while the iShares MSCI ACWI ETF (NasdaqGS: ACWI), tries to reflect the performance of the MSCI All Country World Index, declined 1.4%.
MOAT and MOTI’s underlying indexing methodology that targets quality names with wide economic moats, or sustainable competitive advantages, have helped the ETF strategies outperform the broader markets. The Morningstar’s moat philosophy tries to identify companies with structural competitive advantages that could help investors earn above-average returns on capital over a long period of time.
Specifically, the Morningstar Moat Focus Indices target companies with a wide economic moat or sustainable competitive advantages and focuses on the most undervalued moat stocks, which have helped generate significant excess returns relative to the overall market.
According to Morningstar’s indexing methodology, there are five sources of economic moats: Intangible assets that include brand recognition to charge premium prices. Switching costs that make it too expensive to stop using a company’s products. Network effect that occurs when the value of a company’s service increases as more use the service. A cost advantage helps companies undercut competitors on pricing while earning similar margins. Lastly, efficient scale associated with a competitive advantage in a niche market.
MOAT frequently makes shifts from four to nine additions and deletions to its portfolio at each quarterly rebalance. The ETF tracks an index that uses Morningstar proprietary methodology to identify companies with long-term advantages, which allows companies to earn sustainable excess economic profits, as measured by the return on invested capital relative to the company’s cost of capital.