Stage Set for Moat Stocks Rebound?

By Coulter Regal, CFA, Product Manager

Despite a rough October for equities, there is optimism heading into yearend. In particular, moat stocks have a history of rebounding, so this may be an opportune time to invest in them.

October was a punishing month for U.S. equity markets. Stocks capped off their worst October performance in five years, while clinching a third-straight monthly loss, the longest such streak since March 2020. Increasing Treasury yields and the outbreak of war between Israel and Hamas continue to undermine demand for riskier assets like stocks. A volatile third quarter earnings season, among other factors, also weighed on the U.S. equity markets during the month. Despite the challenges faced in October, there remains a sense of seasonal optimism looking toward the year’s end, a period which has traditionally exhibited some of the best performance for the stock market.

In October, the Morningstar Wide Moat Focus Index (the “Moat Index”) trailed the S&P 500 by about 2.5% (-4.69% compared to -2.10%, respectively), which was buoyed some by its tilt towards the mega-cap Magnificent Seven¹. Comparing the S&P 500 to its equal weighted variant, the S&P 500 Equal Weighted Index, which returned -4.08% in October, illustrates the bifurcation of the market, which has been a story-line in recent months. However, despite a series of challenging months for equal-weighted strategies, the Moat Index remains ahead of the S&P 500 year-to-date, posting an 11.67% return through October, compared to the S&P 500’s 10.69%.

Looking to smaller-cap companies, the performance was more negative in October for this segment of the market compared to large-caps. Mid-cap companies, as represented by the S&P MidCap 400 Index, dropped by 5.34%, and the S&P SmallCap 600 Index decreased by 5.74%, both ending the month further into negative territory relative to larger companies. Echoing the Moat Index’s struggles, the Morningstar US Small-Mid Cap Moat Focus Index (the “SMID Moat Index”) also had a tough October, recording a return of -7.53% for the month. Year-to-date, through October, the -2.30% return of SMID Moat Index falls between the pure small- and mid-cap segments.

Risk-Off Environment Leads to Punishing October for U.S. Equities

As of 10/31/2023

Source: Morningstar. As of 10/31/2023. Past performance is no guarantee of future results. Index performance is not representative of fund performance. It is not possible to invest directly in an index. Fund performance current to the most recent month end is available by visiting vaneck.com or by calling 800.826.2333.

Weathering Storms Has Led to Long-Term Outperformance

While the Moat Index still remains ahead of the S&P 500 year-to-date, the last few months have been challenging. Its lead over the market has narrowed by about 400 basis points in the last six months. While it can be tough to weather periods of underperformance, patrons of the Moat Investing philosophy have often been rewarded on the other side of the storm. Historically, the Moat Index has had its strongest relative performance following periods of notable underperformance.

During the more than 15 years of live history for the Moat Index, when it has underperformed the S&P 500 by more than 2.5% in any six-month period, the Index has gone on to substantially outperform in the following 1- and 3-year periods. In fact, the Moat Index has outperformed the S&P 500 by an average of 4.50% annually in the 3 years following six-month periods with greater than -5% relative performance. Given this historical pattern, now may be an opportune moment to consider allocating to moat stocks, potentially capitalizing on the rebound strength that has been shown in past cycles.

Outperformance Historically Followed Underperformance

2/28/2007 – 9/30/2023

Source: Morningstar, September 2023. Past performance is no guarantee of future results. Index performance is not illustrative of fund performance. Effective 6/20/2016, Morningstar implemented several changes to the Morningstar Wide Moat Focus Index construction rules. Among other changes, the index increased its constituent count from 20 stocks to at least 40 stocks and modified its rebalance and reconstitution methodology. These changes may result in more diversified exposure, lower turnover and longer holding periods for index constituents than under the rules in effect prior to this date.

Moat Stock Selection Drives Performance

As is customary, the prospects of the Moat Index were once again driven largely by stock selection as opposed to an overweight (or underweight) to any particular sector. One name in particular, TransUnion, was an outsized contributor to negative absolute returns in October.

TransUnion (TRU)

TransUnion struggled tremendously in October following its disappointing third-quarter earnings and outlook. Its -38.9% return for the month placed it squarely at the bottom within the Moat Index. Morningstar equity analyst Rajiv Bhatia, who covers custody banks, credit bureaus, and life insurers, believes the sharp decline was an overreaction by the market and views TRU an attractive valuation opportunity.

Morningstar Analyst Comments | by Rajiv Bhatia, CFA – October 24, 2023
Wide-moat TransUnion reported disappointing third-quarter results as well as a disappointing fourth-quarter outlook. Third-quarter revenue, adjusted EBITDA, and adjusted EPS were respectively 2%, 3%, and 4% below the FactSet consensus estimates. TransUnion saw a really weak September and meaningfully took down its full-year outlook as a result. Making matters worse, it took a write-down of goodwill from its U.K. business (Callcredit) amid a challenging economy and regulatory environment there. A key debate, in our view, is if the firm is taking a big bath and thus resetting expectations, which sets up the stock favorably, or if a worsening macroeconomic environment with student loan payments resuming and interest rates spiking will result in further revenue misses. We take the former view. We expect to reduce our fair value estimate by about 10%, but we view the shares, trading at a five-year low, as cheap and offering a positive risk/reward profile.

Top contributors in October included fixed-income trading and data platform Tradeweb Markets (TW), the popular footwear and apparel brand Nike (NKE), as well as aerospace and defense industrial company RTX Corp. (RTX).

Top Contributors and Detractors from Moat Index – October 2023

 

Source: Morningstar, October 2023. Past performance is no guarantee of future results. Index performance is not illustrative of fund performance. Not intended as a recommendation to buy or to sell any of the securities mentioned herein.

Market Downturn Hits Smaller Caps Hardest

In October, larger-cap firms held their ground better compared to their smaller counterparts, with mid-caps faltering more than large caps, and small-caps faring the poorest. The composition of moat-rated firms typically includes larger, well-established entities, leading to a tendency for the SMID Moat Index to skew towards mid-cap preferences when compared to other SMID-cap indices. This characteristic, along with the Moat Index’s unconstrained approach, can result in some commonalities between these indices at times. This is particularly evident this month, as we again find TransUnion (TRU) as the largest contributor to negative returns in October, this time for the SMID Moat Index. Other negative contributors this month include motorcycle manufacturer Harley-Davidson (HOG) and medical care facilities company DaVita (DVA).

On the accretive side, October top contributors included online product and commerce platform Pinterest (PINS), fixed-income trading and data platform Tradeweb Markets (TW) and credit services company Capital One Financial Corp. (COF).

Top Contributors and Detractors from SMID Moat Index – October 2023

 

Source: Morningstar, October 2023. Past performance is no guarantee of future results. Index performance is not illustrative of fund performance. Not intended as a recommendation to buy or to sell any of the securities mentioned herein.

Accessing Moat Stocks

VanEck Morningstar Wide ETF (MOAT) seeks to replicate as closely as possible, before fees and expenses the price and yield performance of the Morningstar Wide Moat Focus Index.

VanEck Morningstar SMID Moat ETF (SMOT) seeks to track as closely as possible, before fees and expenses, the price and yield performance of the Morningstar US Small-Mid Cap Moat Focus Index.

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Important Disclosures

Source for all data unless otherwise noted: Morningstar.

¹ Magnificent Seven refers to the group of seven mega-cap tech stocks in the S&P 500 that consists of Alphabet, Amazon, Apple, Meta, Microsoft, NVIDIA and Tesla.

Fair value estimate: the Morningstar analyst’s estimate of what a stock is worth. Price/Fair Value: ratio of a stock’s trading price to its fair value estimate.

This is not an offer to buy or sell, or a recommendation to buy or sell any of the securities/financial instruments mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results, are valid as of the date of this communication and subject to change without notice. Information provided by third party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. VanEck does not guarantee the accuracy of third party data. The information herein represents the opinion of the author(s), but not necessarily those of VanEck or its employees.

Holdings will vary for the MOAT ETF and its corresponding Index. For a complete list of holdings in the ETF, please click here: https://www.vaneck.com/etf/equity/moat/holdings/.

Holdings will vary for the SMOT ETF and its corresponding Index. For a complete list of holdings in the ETF, please click here: https://www.vaneck.com/etf/equity/smot/holdings/.

An investor cannot invest directly in an index. Returns reflect past performance and do not guarantee future results. Results reflect the reinvestment of dividends and capital gains, if any. Certain indices may take into account withholding taxes. Index returns do not represent Fund returns. The Index does not charge management fees or brokerage expenses, nor does the Index lend securities, and no revenues from securities lending were added to the performance shown.

The Morningstar^® Wide Moat Focus Index^SM and Morningstar^® US Small-Mid Cap Moat Focus Index^SM were created and are maintained by Morningstar, Inc. Morningstar, Inc. does not sponsor, endorse, issue, sell, or promote the VanEck Morningstar Wide Moat ETF or the VanEck Morningstar SMID Moat ETF and bears no liability with respect to the ETFs or any security. Morningstar^® is a registered trademark of Morningstar, Inc. Morningstar^® Wide Moat Focus Index^SM and Morningstar^® US Small-Mid Cap Moat Focus Index^SM are service marks of Morningstar, Inc.

Effective June 20, 2016, Morningstar implemented several changes to the Morningstar Wide Moat Focus Index construction rules. Among other changes, the index increased its constituent count from 20 stocks to at least 40 stocks and modified its rebalance and reconstitution methodology. These changes may result in more diversified exposure, lower turnover, and longer holding periods for index constituents than under the rules in effect prior to this date. Past performance is no guarantee of future results.

The Morningstar moat-driven indexes represent various regional exposures and consist of companies identified as having sustainable, competitive advantages and whose stocks are attractively priced, according to Morningstar.

The Morningstar^® Wide Moat Focus Index^SM Intended to track the overall performance of attractively priced companies with sustainable competitive advantages according to Morningstar’s equity research team.

The Morningstar^® US Small-Mid Cap Moat Focus Index^SM is intended to track the overall performance of small- and mid-cap companies with sustainable competitive advantages and attractive valuations according to Morningstar’s equity research team.

The Morningstar^® US Small-Mid Cap Index^SM is a broad based index intended to track the overall performance of U.S. small- and mid-cap companies according to Morningstar.

The S&P SmallCap 600 Index represents small-cap US companies. The S&P Midcap 400 Index provides investors with a benchmark for mid-sized US companies. The S&P 500 Index consists of 500 widely held common stocks covering industrial, utility, financial and transportation sector. The S&P 500 Equal Weighted Index which is an equally weighted version of the market-cap weighted S&P 500 Index.

The S&P 500^® Index is a product of S&P Dow Jones Indices LLC and/or its affiliates and has been licensed for use by Van Eck Associates Corporation. Copyright © 2023 S&P Dow Jones Indices LLC, a division of S&P Global, Inc., and/or its affiliates. All rights reserved. Redistribution or reproduction in whole or in part are prohibited without written permission of S&P Dow Jones Indices LLC. For more information on any of S&P Dow Jones Indices LLC’s indices please visit www.spglobal.com/spdji/en/. S&P^® is a registered trademark of S&P Global and Dow Jones^® is a registered trademark of Dow Jones Trademark Holdings LLC. Neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors make any representation or warranty, express or implied, as to the ability of any index to accurately represent the asset class or market sector that it purports to represent and neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors shall have any liability for any errors, omissions, or interruptions of any index or the data included therein.

An investment in the VanEck Morningstar Wide Moat ETF (MOAT^®) may be subject to risks which include, among others, risks related to investing in equity securities, consumer discretionary sector, health care sector, industrials sector, information technology sector, financials sector, medium-capitalization companies, market, operational, high portfolio turnover, index tracking, authorized participant concentration, no guarantee of active trading market, trading issues, passive management, fund shares trading, premium/discount risk and liquidity of fund shares, non-diversification and index-related concentration risks, all of which may adversely affect the Fund. Medium-capitalization companies may be subject to elevated risks.

An investment in the VanEck Morningstar SMID Moat ETF (SMOT^®) may be subject to risks which include, among others, risks related to investing in equity securities, small- and medium-capitalization companies, consumer discretionary sector, financials sector, health care sector, industrials sector, information technology sector, market, operational, high portfolio turnover, index tracking, authorized participant concentration, new fund, no guarantee of active trading market, trading issues, passive management, fund shares trading, premium/discount and liquidity of fund shares, non-diversified, and index-related concentration risks, all of which may adversely affect the Fund. Small- and medium-capitalization companies may be subject to elevated risks.

Investing involves substantial risk and high volatility, including possible loss of principal. An investor should consider the investment objective, risks, charges and expenses of a Fund carefully before investing. To obtain a prospectus and summary prospectus, which contain this and other information, call 800.826.2333 or visit vaneck.com. Please read the prospectus and summary prospectus carefully before investing.

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Originally published 9 November 2023. 

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