Morningstar’s approach to moat investing starts with companies with sustainable competitive advantages and targets those trading at attractive valuations. We explore in this Q&A.
Moat investing is based on a simple concept: invest in companies with sustainable competitive advantages. Morningstar builds on this philosophy by seeking out moat stocks trading at attractive valuations relative to their equity research team’s forward-looking estimate of fair value. This approach has stood the test of time, with the live track record for the Morningstar® Wide Moat Focus IndexSM (“Moat Index”) exceeding 15 years. This blog is intended to address frequently asked questions about Morningstar’s moat investing philosophy and the VanEck Morningstar Wide Moat ETF (MOAT).
Q: How is Morningstar’s equity research incorporated into the Moat Index?
A: The Moat Index is fueled by Morningstar’s forward-looking, rigorous equity research process, driven by over 100 analysts globally. All of Morningstar’s equity analysts follow a single, consistent research methodology. Morningstar’s economic moat rating serves as the cornerstone of Morningstar’s equity research philosophy. The goal is to determine which companies have competitive advantages that will lead to returns on invested capital in excess of the companies’ weighted cost of capital. Just as important is determining how long those companies can maintain their advantages. The exclusive group of wide moat rated companies are expected to maintain their competitive advantages for more than 20 years into the future.
Morningstar considers a company’s economic moat rating when forecasting future cash flow and discounting those future cash flows to arrive at a current intrinsic per share value for each company. Their valuation process does not take shortcuts, and cash flows are regularly forecasted well into the future.
The Index leverages Morningstar’s economic moat ratings and fair value estimates to systematically assemble the Index’s portfolio each quarter.
Q: How does Morningstar identify moat companies?
A: Morningstar has identified five attributes that may contribute to a company’s moat: switching costs, intangible assets, network effect, cost leadership and efficient scale. Companies may demonstrate one or a combination of these five sources of moat. Evaluating companies against these attributes are a key part of how Morningstar’s equity research team gauges the strength of a company’s competitive advantage. This assessment results in one of three economic moat ratings: none, narrow or wide. A wide moat rating is assigned to a company that is likely to sustain its competitive advantage for at least the next 20 years, while a narrow moat rating means a company is likely to do so for at least 10 years. A company with no moat has either no advantage or one expected to dissipate relatively quickly.
A wide economic moat rating from Morningstar’s equity analysts is rare. Morningstar’s equity coverage universe skews toward companies with economic moats, yet only 10-15% of those companies receive the elusive wide moat rating. That percentage would likely be far lower for a more comprehensive group of U.S and global companies. Stated differently, it is very difficult to find companies that possess the attributes Morningstar requires to assign a wide moat rating and therefore very few receive that designation.
Q: Is MOAT an actively managed ETF?
A: No, MOAT is an index-based ETF. MOAT seeks to replicate, before fees and expenses, the price and yield performance of the Moat Index. The Index is unique in the world of index investing because it leverages Morningstar’s 100+ person equity research team to systematically identify what Morningstar equity research analysts considers attractively priced companies with sustainable competitive advantages.
Q: What has most influenced the Moat Index’s performance historically?
A: This long-term, core investment approach has resulted in excess returns relative to the broad U.S. equity markets since 2007, and often displays excess returns following periods of sizable market declines. The Moat Index’s focus on companies with competitive advantages and attractive valuations results in a dynamic portfolio that has potential to outperform on both the upside and down side. Historically, the Index has benefited primarily from strong stock selection as opposed to sector, size or style over/underweights.
Q: What style exposure does MOAT offer?
A: MOAT has historically provided a large blend exposure to U.S. equities. Morningstar’s valuation methodology allows the Moat Index to target opportunities among wide moat stocks regardless of style exposure. Therefore, both the Index and MOAT have seen their style exposure drift between growth and value through time.
Q: Does MOAT pay capital gains?
A: As a regulated investment company, MOAT must pass through income and capital gains to shareholders each year. Despite turnover in excess of typical index-based U.S. equity ETFs, MOAT has never paid a capital gain distribution. This has held true despite its 2012 launch corresponding with the early years of a sustained bull market in U.S. stocks.
Q: How does MOAT fit in a portfolio?
A: MOAT offers investors a diversified portfolio of U.S. equities that can serve as a core portfolio building block. Investors should consider MOAT for long-term exposure as opposed to opportunistic tactical market exposure. The Moat Index has historically had more success relative to broad beta indexes over longer-periods of time than short time periods.
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Originally published by VanEck on 15 August 2022.
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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.
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