A “wide moat” smart beta ETF style has been an outperforming strategy, providing access to many quality global companies.
The wide moat strategy “offers global exposure to Morningstar’s best ideas, which are really rooted in their equity research process of identifying quality companies – those companies with economic moats as Warren Buffett coined that term, but also identifying their attractiveness in terms of valuations, so making sure you’re not overpaying for those quality companies,” Brandon Rakszawski, Product Manager at VanEck, said at the recent Morningstar ETF Conference.
Specifically, the VanEck Vectors Morningstar Wide Moat ETF (NYSEArca: MOAT), which implements Morningstar’s economic moat rating to identify strong companies with wide economic moats, and VanEck Vectors Morningstar International Moat ETF (NYSEArca: MOTI), which takes a similar moat rating methodology to select overseas component holdings, can help investors achieve improved long-term, risk-adjusted return by focusing on quality companies that help limit downside risk while still participating in potential gains.
The Morningstar Economic Moat Rating methodology assign an economic moat rating to companies, but it also focuses on those that show attractive valuations or are more attractively priced. Beyond factor effects, stock selection is also an important driver as the underlying indices combine both quality and valuation to help investors potentially generate improved returns.
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.
“It’s a very dynamic portfolio,” Rakszawski said. “They’re trying to capture these valuation opportunities and quality companies on a regular basis, so the index team is leveraging Morningstar research to capture those top picks from their equity research team, but not overpaying.”
An investor would end up with the most attractively priced stocks among the companies that have garnered the “wide moat” rating.
“Two points that really differentiate the strategy is the performance and the process,” Rakszawski added. “Both ETF form as well as in the underlying index have outperformed not only the broad market but in many periods it’s outperform both a passive ETF and active mutual fund peers in the space.”
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