MOAT ETF: Invest In Sustainable Competitive Advantages

Thesis

The VanEck Morningstar Wide Moat ETF (BATS:MOAT) exemplifies a strong ETF with a robust strategy, designed to cater to discerning investors seeking to capitalize on companies with sustainable competitive advantages. These so-called “moat” companies are not just leaders in their respective fields but have established durable business models that offer the potential for stable long-term returns.

The underlying philosophy of MOAT is grounded in the ‘wide moat’ concept, a term popularized by Warren Buffett, which refers to the ability of a company to maintain competitive advantages over its peers in order to protect long-term profits and market share. MOAT’s selection criteria focus on companies that are not only leaders today but have the strategic positioning to continue their dominance for years to come. This focus on quality and sustainability can be particularly appealing in volatile market conditions where short-term gains may be unpredictable.

Fundamental analysis of MOAT reveals its robust performance history, which has often outpaced broader market indices. The ETF is composed of stocks that are a part of the Morningstar Wide Moat List, which has been known as a strong security selection criterion. The curation is based on a framework that evaluates five key areas: the company’s network effect, cost advantage, intangible assets, customer switching costs, and efficient scale.

Background

MOAT stands out for its strategic focus on companies that possess what is commonly referred to as a ‘wide moat’. The concept of an economic moat, popularized by Warren Buffett, refers to a business’s ability to maintain competitive advantages over its peers to protect its long-term profits and market share from competing firms. MOAT aims to capitalize on this principle by investing in companies that not only have wide moats but are also believed to be priced attractively relative to their fair value.

Regarding its composition, MOAT tracks the Morningstar Wide Moat Focus IndexSM, a compilation of companies fulfilling the wide moat criteria as determined by Morningstar’s equity research team. These companies are from various sectors, reflecting a diverse range of industries in the U.S. economy. The selection criteria for the index are rigorous, ensuring that only companies with sustainable competitive advantages and attractive valuations are included. This methodical approach aims to deliver a portfolio of high-quality stocks positioned to outperform in the long term.

The ETF’s approach is especially appealing to investors who are focused on long-term capital appreciation. By investing in companies with wide moats, MOAT positions itself to potentially benefit from the sustained success of its constituent companies. The emphasis on fair value also means that the ETF is mindful of not overpaying for these quality assets. This discipline can be particularly advantageous during times of market volatility or overvaluation.

MOAT’s strategy is distinct from other ETFs that might focus purely on growth, value, or size metrics. Instead, its blend of quality and value investment philosophies offers a balanced approach, aiming to offer investors growth potential while minimizing downside risks.

Why Moats Matter

In the realm of investing, a “moat” refers to a business’s ability to maintain competitive advantages over its rivals, thus protecting its long-term profits and market share from competing firms. Understanding the concept of a moat is crucial for investors as it underpins the sustainability and growth potential of a business.

When a company has a strong moat, it implies that it possesses certain qualities or attributes that are difficult for competitors to replicate or overcome. This can include a variety of factors like brand recognition, patent protection, unique technology, regulatory licenses, network effects, or cost advantages. For example, a tech company might have a moat in the form of advanced proprietary technology, while a retail brand might have a moat through strong brand loyalty.

From an investor’s perspective, companies that have a moat form strong long-term risk/reward trade-offs. Such companies are likely to be more resilient to competition, thus offering more predictable and stable returns over time. For instance, a company with a strong brand name can often command higher prices for its products, leading to higher profit margins. Similarly, a business that benefits from network effects, like many in the tech industry, becomes more valuable as more people use its services, creating a barrier for new entrants.

Investing in companies with strong moats also aligns with the philosophy of value investing, where the intrinsic value of a business is a primary consideration. Buffett often emphasizes the importance of investing in businesses with deep and wide moats, as these companies are likely to withstand economic downturns and maintain a competitive edge over the long term.

Portfolio Construction

MOAT’s portfolio management style can be characterized as index-oriented and generalist, with a low turnover rate and a concentration in large-cap stocks. According to FactSet, the top 10% of its holdings have an average price-to-book (P/B) ratio of 5.36x, a dividend yield of 1.68%, sales growth of 10.65%, a beta of 0.92, a relative strength of 0.97, and an average price-to-earnings (P/E) ratio of 39.65x. These statistics indicate a portfolio that seeks to balance growth and stability, with an emphasis on companies having robust financials and market positions.

The fund’s top holdings reflect its investment philosophy, focusing on companies with substantial market influence and growth potential. Notable among these are Salesforce (CRM), Allegion (ALLE), Equifax (EFX), Teradyne (TER), and Masco (MAS). Each of these companies commands a significant presence in their respective sectors, ranging from technology to industrial manufacturing. The concentration in these top holdings is a testament to the fund’s strategy of investing in companies with enduring competitive advantages.

The ETF’s largest buys over the last six months include Keysight Technologies (KEYS), RTX Corp. (RTX), Campbell Soup (CPB), MarketAxess Holdings (MKTX), and Agilent Technologies (A). Conversely, it trimmed positions in Domino’s Pizza (DPZ), Meta Platforms (META), ServiceNow (NOW), Polaris (PII), and Guidewire Software (GWRE).

Overall, the fund has the highest allocations to the Healthcare and Tech sectors:

Performance Versus S&P 500

Over five years beginning January 23, 2019, MOAT has demonstrated a strong price return of 16.95% annually, showcasing its resilience and alpha-generation investment approach that identifies companies with sustainable competitive advantages. This performance is notably juxtaposed with the S&P 500 (SPY), a broad market index ETF, which has delivered a return of 15.69% in the same period, serving as a benchmark for the average market performance. As you can see, MOAT does tend to track similar returns as the SPY ((if not slightly outperform)) over this period, displaying its strong overall strategy.

Over the longer term, since its inception, MOAT has outperformed the S&P 500 by over one percent:

MOAT or MOTG

MOAT Is not currently the only VanEck ETF that targets this strategy, and they offer a global version of this strategy in their VanEck Morningstar Global Wide Moat ETF (MOTG). MOTG seeks to broaden the investment horizon by including companies with wide moat characteristics on a global scale. This global approach allows for diversification beyond the U.S. market, tapping into the potential of companies that have carved out dominant positions within emerging markets and other developed economies.

The main geographic focus of this fund, however, remains the United States:

Offering a global perspective can broaden the opportunities for an investor to deploy capital, but also raise risks regarding currency and liquidity issues. Investing in other countries also opens investors to the regulatory risk of the local jurisdictions in which they have holdings, something that I believe favors MOAT for the superior corporate governance profiles that the US provides.

Verdict

I firmly believe that MOAT represents a vital component that should be included in every investor’s portfolio. This conviction is rooted in MOAT’s strategic focus on companies that not only have sustainable competitive advantages but also are positioned to offer long-term value creation, which is essential for robust and diversified investment strategies.

MOAT represents a carefully picked collection of companies that have built strong defenses in their markets, allowing them to stay successful and profitable in the long run. These companies are diverse, coming from different parts of the U.S. economy, and they’re chosen because they’re good quality and are priced just right in the market.

Looking at its track record, MOAT has done quite well, slightly outperforming the broader market as represented by the SPY over a five and ten-year span. This shows that MOAT’s method of picking strong companies is successful.

For those looking for a global touch, there’s also MOTG, which is like MOAT but includes companies from all over the world. This gives investors a chance to make money from top companies not just in the U.S. but also from other parts of the world. However, with this wider reach comes more factors to think about, like changes in currency value and different market rules.

In short, MOAT’s strategy of choosing companies with strong market positions and reasonable prices makes it a smart addition to any investor’s portfolio.