International equities have begun to pull ahead of U.S. domestic markets, and one smart beta exchange traded fund strategy that focuses on quality companies trading at an attractive price may be an opportune way to gain access to momentum in foreign equities.
The VanEck Vectors Morningstar International Moat ETF (NYSEArca: MOTI) has increased 13.9% year-to-date, outpacing the 10.6% gain in the MSCI ACWI ex USA Index and the 7.3% rise in the S&P 500.
Supporting the outperformance, MOTI’s large weights in China and Singapore have helped strengthen the portfolio – China makes up 18.0% and Singapore is 11.1% of MOTI’s underlying index.
While many have focused on the U.S. markets with earnings and potential policy changes out of the Trump administration, international equities have begun to outpace domestic equities, and investors are only just beginning to make the shift. For instance, MOTI has only gathered $6.1 million in net inflows year-to-date, according to XTF data.
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: 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.