ETF investors who are thinking about filling out their core portfolio can consider the benefits of moat investing strategies that enhance portfolios through a smarter investment style.
On the recent webcast (available On Demand for CE Credit), Moat Investing through a Factor Lens, Edward Lopez, Head of ETF Product Management at VanEck, highlighted the fact that Morningstar’s moat investing approach has generated impressive long-term performance, with the Morningstar Wide Moat Focus Index significantly outperforming the S&P 500 Index and the average active and passive mutual funds and ETFs in the Morningstar Large Blend category since 2007. The Morningstar moat methodology has target companies trading at attractive prices relative to their fair value, helping investors enhance returns over time.
However, the methodology is not without its drawbacks. Lopez warned that the wide economic moat theme is generally short momentum by nature since it targets undervalued companies, which has hurt the strategy in recent years, but the investment style may prove beneficial if momentum breaks down.
To help better define the Morningstar investment methodology, Andrew Lane, Chairman of Economic Moat Committee for Morning Star, explained that an economic moat is a “durable competitive advantage that allows a company to generate positive economic profits for the benefit of its owners over an extended period of time.”
When it comes to a company’s moat or competitive advantage, Morningstar would highlight five specific factors, including High Switching Costs, Cost Advantage, Intangible Assets, Network Effect and Efficient Scale. Companies rated with a wide economic moat are seen to have a long-term competitive position. Lane argued that it is “more than just finding rapid-growth business or buying cheap stocks” but “also evaluating whether a business will stand the test of time.”
Specifically, Intangible Assets refers to things such as brands, patents, and regulatory licenses that block competition and/or allow companies to charge more.
Switching Costs determines whether in time or money, the expenses that a customer would incur to change from one producer/provider to another.