MOTI tries to reflect the performance of the Morningstar Global ex-US Moat Focus Index. The index includes companies outside the U.S. with sustainable competitive advantages and targets 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. For starters, intangible assets that include brand recognition to charge premium prices. Other characteristics include patents to protect pricing power legally barring competition, and government regulatory licenses that hinder competitors from entering the market.
Switching costs that make it too expensive to stop using a company’s products. The value of switching exceeds the expected value of the benefit. For instance, razor and blade models entrench repeat consumables, and price is not the only determinant as there are indirect costs like hassle and distraction of using an alternative.
Network effect that occurs when the value of a company’s service increases as more use the service. As more customers use the good or service, the value for the good or services rises for both new and existing users. Furthermore, companies have the ability to increase the number of potential connections and grow exponentially.
A cost advantage helps companies undercut competitors on pricing while earning similar margins. Companies are able to sustainably lower costs than competitors. Additionally, wide moat companies with a cost advantage enjoy irreplaceable process advantages, superior locations, hard-to-amass scale or access to a unique asset.
Lastly, efficient scale associated with a competitive advantage in a niche market. A market of limited size is effectively served by a few companies where incumbents generate economic profits and newcomers are discouraged from entering due to lower profit margins.
By focusing on these factors, Morningstar has been able to build a smart beta index through the strong investment thesis of outperformance in companies with wide economic moats. The underlying index is comprised of companies with a wide economic moat or sustainable competitive advantages and targets the most undervalued moat stocks, which have helped generate significant excess returns relative to the overall market.