VanEck Vectors Morningstar US Wide Moat UCITS ETF has celebrated its third anniversary, reporting an annualised performance of 17.5 per cent since launch.
The firm writes that investors should rethink their investment process for US stocks after the S&P 500 reached a new all-time high in September.
Dimitri Klymenko (pictured), Product Manager at VanEck, says: “The US continues to provide interesting opportunities for investment thanks to its strong economic growth and higher employment levels. Following the longest uptrend in the history of the US stock market, valuations are tense. In this setting, simply following the market means buying equities at valuation highs, which means that they are potentially overpriced. This inevitably reduces the earnings potential.”
In a market with high valuations investors should consider whether they want to gear their portfolios to indices which consider and weight equities on the basis of market capitalisation, the firm writes. “As we see it, it is more advisable to choose models which work with a number of relevant criteria,” says Klymenko.
Economic moats enable sustained competitive advantages and the potential for outperformance. Morningstar’s moat analysis process is based on a universe consisting of around 1,500 US equities. From this universe, more than 100 Morningstar analysts, as a first step, filter out all companies which possess sustained competitive advantages and use them to protect their market shares against the competition.
In this context, competitive advantages may include intangible assets, cost benefits, switching costs, network effects or efficient scaling. In addition, the analysts establish the extent to which these ‘moats’ or competitive advantages can be maintained over the long term. Companies whose competitive advantages are forecast to protect them against the competition for 20 years or more are given a Morningstar Economic Moat rating of ‘Wide’ and are thus eligible for inclusion in the index.
One example of such a stock is drinks’ manufacturer Coca Cola, which has become a brand worth billions. The company writes that it is for good reason that the brand value is put at USD73 billion in the balance sheet, equivalent to more than 40 per cent of the company’s market capitalisation.
A strong competitive advantage, or wide moat, does not make for an attractive on its own. Buying an economic moat is good business only if the price is right. Based on the assumption that each stock has a long-term inherent value, Morningstar carries out a multi-tier analysis that provides a detailed forecast of the company’s future cash flows.
This produces the so-called fair value. This fair value is then put in relation to the current price of the stock. If both figures correspond, the current valuation is appropriate, which means that the projected cash flows are factored into the current stock price. If the current price is below the fair price, however, this suggests a favourable valuation. Otherwise, the stock is probably too expensive and thus has no more than limited return potential.
Ultimately, between 40 and 80 US stocks with a corresponding ‘Wide’ moat rating and whose current stock price is the furthest below their long-term fair value make it into the Morningstar Wide Moat Focus Index.
A rebalancing takes place every quarter. Investors who have focused on this index with the VanEck Vectors Morningstar US Wide Moat UCITS ETF (ISIN: IE00BQQP9H09) have in the past outperformed the broader market as represented by the S&P 500. The firm writes that this success is not a simple matter of course. “After all, according to data provided by Standard & Poor’s, over the past 10 years around 90 per cent of all actively managed US large cap funds that track the S&P 500 as their benchmark have underperformed it (as at 29 December 2017).
