Expert Analysis: MOAT

Many market indices are an accident of history. They were not initially designed for investment purposes, rather they were created to provide an update, or a health check of the market.

When Charles Dow first published the Dow Jones Industrial Average (The Dow Jones) in 1896, he allocated weightings to the top 12 stocks of the day based on their prices.

The Dow Jones is still widely quoted today. Let’s take a look at how it is constructed. It is a price-weighted index, which means that the stocks with the highest price have the largest weighting. Currently, UnitedHealth Group, which has a price of US$486 per share, has the highest weighting in the portfolio. Let’s contrast that with Apple. Apple is a company that is five times larger than UnitedHealth, yet it only makes up 3.2% of the Dow Jones compared to the 9.2% of UnitedHealth.

The Dow Jones provides a general barometer of US equity performance, but does not make any sense from an investment perspective because a share price could be a function of having less (or more) shares on issue.

As a result, the next index innovation was ‘market capitalisation’, which was pioneered by Henry Varnum Poor and the Standard Statistics Co. The result was the 1926 predecessor of the United States’ S&P 500. A market capitalisation index uses the size of a company for inclusion. Therefore, in a market capitalisation index, the larger companies have bigger weights. In the S&P 500, Apple makes up around 7.0%, UnitedHealth around 1.2%. Market capitalisation indices were considered better barometers of the market. Again though, the intention of the index is to be a market barometer, not a tool for investment.

Market capitalisation indices have become the source of market performance reported in the media all over the world. In Australia, for example, the S&P/ASX 200 contains the 200 largest companies in Australia by market capitalisation.

Many funds follow market capitalisation indices. Therefore, funds that track market capitalisation indices allocate more to bigger companies than smaller companies. So when the market overvalues a stock, a fund tracking that index buys too much of the overpriced stock. Conversely when the market undervalues a stock, the fund sells too much of the under-priced stock.

Innovative indices beyond market capitalisation
Innovations in index design for passive funds have delivered above market benchmark returns over the long term while retaining low costs. It is this approach that VanEck offers that is being used by savvy investors as a way to invest in US equities. VanEck has collaborated with Morningstar to bring a unique approach to Australian investors.

Morningstar has turned a well-known investment philosophy and approach into an actionable investment strategy. This philosophy is based on the concept of economic ‘moats’ that was popularised by Warren Buffett.  Buffett is quoted as saying, "In business, I look for economic castles protected by unbreachable 'moats'."

Morningstar assigns each company it analyses an Economic Moat Rating of ‘wide’, ‘narrow’ or ’none’. Companies assigned a wide moat rating are those in which Morningstar has very high confidence that excess returns will remain for 10 years, with excess returns more likely than not to remain for at least 20 years. Companies with a narrow moat rating are those Morningstar believes are more likely than not to achieve normalised excess returns for at least the next 10 years. A firm with either no sustainable competitive advantage or one that Morningstar thinks will quickly dissipate is assigned a moat rating of ‘none’.

Our US equity ETF (MOAT) tracks the Morningstar® Wide Moat Focus Index™ (MOAT Index) that is a rules-based, equal-weighted index intended to offer exposure to attractively priced companies with sustainable competitive advantages according to Morningstar’s equity research team.

So let’s walk through the difference between the MOAT and the market capitalisation index for US equities, the S&P 500 Index

As you would expect, MOAT has lower debt to equity and is more attractive on a price to earnings and price to book value perspective.

MOAT vs S&P500 Index - Performance
Moat investing has served Australian investors well. Since its inception, MOAT has outperformed the S&P 500 Index – testament to MOAT’s value and quality approach.

Chart 1: Cumulative performance since MOAT ASX listing date

Chart 2: MOAT holdings based style map                  Chart 3: S&P 500 Index holdings based style map

Chart 2 & 3 source: Morningstar Direct, as at 28 February 2022
  
While each US equity index has its merit for portfolio inclusion, you should assess all the risks and consider your investment objectives.

Past performance is no guarantee of future performance. The above is not a recommendation. Please speak to your financial adviser or stock broker.

For further information you can contact us via email or on +61 2 8038 3300.

Key risks
An investment in MOAT carries risks associated with: financial markets generally, individual company management, industry sectors, ASX trading time differences, foreign currency, country or sector concentration, political, regulatory and tax risks, fund operations and tracking an index. See the PDS for details.