Moat Index Surprisingly Underperformed S&P 500 Index by More than 2%. Is There Semblance of Common Sense on Markets?

Legendary investor Warren Buffett believes that the most critical factor in picking a successful investment is by identifying the durability of a company's competitive edge or "moat." An economic moat refers to a company's ability to maintain a competitive advantage over its competitors to protect its profits and market share. Interestingly, the so-called Moat Index lagged the S&P 500 Index by more than 2% in November marking the first time since the Index’s inception in February 2007 that it has underperformed by more than 2% in two consecutive months marking the first time since the Index’s inception in February 2007. The Moat Index is a high conviction index targeting undervalued stocks, so periods of underperformance are not uncommon, and this has been just one of them.

A company can create a moat through cost advantages, having a size advantage, ensuring high switching costs and possessing unique intangibles, such as patents and brand recognition. For example, Apple Inc. (AAPL) has created an economic moat through its perceived quality and brand recognition that has allowed the company to protect market share from competitors offering lower-priced products.

The Morningstar Wide-Moat Focus Index is composed of the most undervalued (trading at the lowest current market price/fair value ratios), highest-quality companies under coverage. The companies in this index must have an economic moat rating of wide (meaning they may have advantages that will deter competitors and competition for at least the next 20 years), and their shares must be trading below their fair value estimates, which are determined through independent research conducted by the Morningstar Equity Research team.

Morningstar’s ratings for economic moat show how likely a given company will defend itself from the existing or emerging competitors for an extended period. One of the keys to finding superior long-term investments is buying companies that will be able to stay one step ahead of their competitors, and it’s this characteristic that Morningstar is trying to capture with the economic moat rating.

But so-called Moat ETF has a relatively high expense ratio of 0.75% but has rewarded investors with a strong performance over an extended period with a 10-year return of 13.47%, a five-year return of 12.54%, and a three-year return of 14.7%, which means it’s been pretty decent and interesting growth & value investment.