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.
By focusing on these five factors, Morningstar has been able to build a strategic beta index through the strong investment thesis of outperformance in companies with wide economic moats or the ability to sustain their market advantages.
For instance, among its top holdings, MOTI includes established and stable names like Enn Energy Holding 2.3%, Iluka Resources 2.2%, Capitaland 2.1%, Kion Group 2.1% and Elekta 2.1%.
The portfolio’s indexing methodology also provides a more diversified mix of sector allocations. As compared to the benchmark MSCI ACWI ex-US Index, MOTI take a smaller tilt toward the financial sector, but the international moat ETF includes larger tilts toward healthcare, real estate and telecom services.
MOTI also has a noticable overweight allocation toward China, Australia and Singapore, compared to a traditional market cap-weighted index.
For more information on alternative index-based strategies, visit our Smart Beta Channel.