Many advisors are undoubtedly familiar with moat investing – an investment discipline made famous by Warren Buffett.
For those not familiar or in need of a refresher, an economic moat is a competitive advantage possessed by a company that allows it to protect and grow market share and profitability. It doesn't necessarily mean a company has a monopoly, but many prime examples of wide moat firms feel that way. Think Apple (NASDAQ:AAPL), Google parent Alphabet (NASDAQ:GOOG), Microsoft (NASDAQ:MSFT) and Buffett's own Berkshire Hathaway (NYSE:BRK-B).
Those are just a few examples, but that's an impressive quartet. Still, moat investing – like anything else in financial markets – isn't a foolproof plan. Take the case of the Morningstar Wide Moat Focus Index, a widely followed benchmark of moat-advantaged companies.
Last year, that benchmark “ended its four-year streak of outperforming the broad U.S. equity market (as represented by the Morningstar US Market Index) in 2020—returning 15.1% vs 20.9%, respectively,” according to VanEck research.
Fortunately, moat investing is still a persistent, rewarding long-term strategy and one advisors can discuss with a wide variety of clients.
One Year Doesn't Determine Everything
Yes, the moat index's 2020 showing, much of is attributable to a value lean, is disappointing relative to the broader market, but that's not a nail in the coffin for this style. Far from it.
“For any strategy that involves the active element of analyst-driven valuation assessments, unfavorable stock selection is certain to rear its head from time to time,” notes Morningstar. “However, despite underwhelming stock-picking results in 2020, favorable stock selection has been the driving force behind the strategy's impressive excess returns since its live inception date. Thanks to this dynamic, the Wide Moat Focus Index has outperformed its benchmark by roughly 300 basis points annually since its live inception. This represents a highly attractive track record over a lengthy period.”
The VanEck Vectors Morningstar Wide Moat ETF (NYSEARCA:MOAT) tracks the aforementioned index. The fund has $4.5 billion in assets under management and track record of nearly nine years.
Part of the issue that confounded MOAT last year was a shift to value following the March market meltdown at the hands of the coronavirus pandemic. Though cyclical value stocks came alive late in the year – a scenario that's holding firm to start 2021 – March 2020 was, with the benefit of hindsight, too early to embrace value. Today, the bulk of MOAT's value exposure is sourced through a 37% combined allocation to healthcare and financial stocks – sectors exhibiting some quality traits.
Long-Term Results Matter
As advisors well know, it's often said that long-term horizons are important. Fortunately, moat investing backs up that assertion.
“The Wide Moat Focus Index has performed well on a risk-adjusted basis. Our research indicates a Sharpe ratio of 0.74 and an information ratio of 0.55 since live inception, based on a quarterly data frequency,” according to Morningstar.
Add to that, over the long haul, the index has an upside capture of 108 while its down capture is just 86. Those impressive for long-term clients and enough to help them get past 2020's relative under-performance by moat investing.
Again, 2020 was just one year and data confirm the rolling five-year performances for the moat index are quite compelling and worth discussing with clients.
“The batting average rises to 93% over the 107 five-year holding periods on a monthly rolling basis since live inception,” says Morningstar.