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Elements launches exchange-traded notes based on ‘wide moat’ index

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Independent investment research provider Morningstar has announced that the Elements platform is launching exchange-traded notes based on its proprietary Wide Moat Focus Total Return Index

Independent investment research provider Morningstar has announced that the Elements platform is launching exchange-traded notes based on its proprietary Wide Moat Focus Total Return Index on the NYSE Arca electronic trading system.

Elements ETNs are brought to the market through industry-wide relationships among index providers, issuers, distributors and securities exchanges. Deutsche Bank will issue the Wide Moat Focus ETNs, and they will be distributed by Nuveen Investments and Merrill Lynch.

Elements ETNs seek to track the total return of specific market indices and provide convenient access to strategies and markets that traditionally have not been readily available to individual investors.

The Elements ETNs are the first investment vehicle to track the Wide Moat Focus Total Return Index, which was officially launched under the current rules with real-time calculations in April, although the index dates back to 2002. The term ‘wide moat’ was coined by Warren Buffett in referring to companies with sustainable competitive advantages.

The index is composed of the 20 wide-moat stocks with the best valuations as measured by the Morningstar price/fair value ratio. Analysts determine the price/fair value relationship by using Morningstar’s discounted cash-flow model to estimate fair values for each of the companies they cover, and comparing the price of each stock to its fair value estimate.

Morningstar identifies various sources of economic moats including high customer-switching costs, patents, copyrights and other government protections, economies of scale, and the ability to produce goods or services at low cost.

‘The Wide Moat Focus Total Return Index illustrates Morningstar’s long-term approach to stock analysis,’ says Pat Dorsey, director of stock research at Morningstar, which has assigned moat ratings to stocks since 2002. ‘The index exposes investors to high-quality companies that consistently generate high returns on capital.’

Morningstar’s 100 stock analysts assign moat ratings of wide, narrow, or none to the 2,000 stocks in their coverage universe. ‘When we evaluate a stock, one of the first things we examine is whether or not it has a moat, because an enduring competitive advantage is essential for a company’s – and a shareholder’s – long-term success,’ Dorsey says.

‘Typically, companies have moats if they can generate returns on capital higher than their cost of capital for many years. We also examine carefully the source of those profits to see if they are sustainable.’

Morningstar will reconstitute the index quarterly to reflect changes.  Because economic moats reflect firms’ underlying competitive advantages which don’t change often, any changes to the make-up of the index will likely result from changes to a firm’s price/fair value ratio rather than a change in its moat status.

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