As more think about foreign market exposure to capture more cheaply valued areas and to diversify away from the loftier valuations in U.S. markets, investors should consider an outperforming smart beta or factor-based international exchange traded fund designed to targets quality companies.
Specifically, the VanEck Vectors Morningstar International Moat ETF (NYSEArca: MOTI) has increased 16.9% year-to-date, outpacing the 12.1% gain in the MSCI ACWI ex USA Index and the 7.9% rise in the S&P 500.
Fueling the recent momentum in the MOTI strategy, French aerospace firm Safran SA jumped 10.5% in April. French equities and the broader European equities market, in general, have been supported by a relief rally in light of diminished political concerns after centrist and pro-EU Emmanuel Macron won the French presidential elections.
MOTI includes a 27.5% tilt toward European markets, including France 7.2%, Germany 6.3%, United Kingdom 6.2%, Belgium 3.1%, Sweden 2.2% and Spain 2.1%.
Among sector bets, international real estate investment trusts or REITs, such as Hong Kong property firms like Swire Properties and Cheung Kong Property, and industrial firms were among the top performers in April. MOTI includes a 12.2% tilt toward REITs and 12.3% in industrials.
Compared to the widely observed MSCI ACWI ex USA Index, MOTI is less top heavy when it comes to its sector plays and includes a smaller tilt toward the financial sector. Consequently, MOTI has overweight positions in international sectors like health care, real estate and telecom.
Moreover, MOTI only has a 0.8% position in energy, which can allow it to relatively evade the growing weakness in oil & gas exploration & production companies.
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.