Brocker.Org: The Advantages of Wide Moats

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It often pays to invest in companies with wide economic moats. Investopedia defines wide economic moats as “a type of sustainable competitive advantage that a business possesses that makes it difficult for rivals to wear down its market share and profit. The term is derived from the water-filled moats that surrounded medieval castles. The wider the moat, the more difficult it would be for an invader to reach the castle.”

There are exchange-traded funds (ETFs) for many things, including companies with wide moats. The leader of that group is the VanEck Vectors Morningstar Wide Moat ETF (MOAT). MOAT, which turned five years old earlier this week, follows the Morningstar Wide Moat Focus Index, “which is intended to track the overall performance of attractively priced companies with sustainable competitive advantages according to Morningstar’s equity research team,” according to VanEck. (See also: Invest Like Warren Buffet With This ETF.)

A key element to wide-moat investing is that companies with such distinct competitive advantages offer investors the potential for superior returns because these firms keep competitors at bay via barriers to entry, powerful brand recognition and hard-to-copy products, among other traits.

A particularly potent combination is picking attractively valued wide-moat stocks, something MOAT’s underlying index attempts to do. “What this means is that even in an overvalued market such as the one we’re experiencing today (Morningstar’s Market Fair Value graph indicates that the market is about 4 percent overvalued based on our estimates), investors should still be able to generate superior long-term returns by cherry picking undervalued stocks with moats,” said Morningstar. (See also: How to Tell If a Stock Is Overvalued or Undervalued.)

Although MOAT is a broad-market ETF, its roster is small with just 48 holdings, indicating that the wide-moat label is hard to come by. MOAT employs an equal-weight methodology, which diminishes single stock risk. However, the ETF is top heavy at the sector level, as healthcare and consumer discretionary names combine for almost 57 percent of the ETF’s weight.

“Some areas ripe for the picking can be found in the healthcare sector – specifically among wide-moat drugmakers,” said Morningstar. The bulk of MOAT’s healthcare holdings are pharmaceuticals makers or medical device manufacturers. Year to date, the ETF is topping the S&P 500 by 200 basis points. (See also: Economic Moats: A Successful Company’s Best Defense.)

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