The VanEck Vectors Morningstar Wide Moat ETF (MOAT | A-66) is a perfect example of that. The stock-picking fund that looks for outperformance by focusing on only 20 high-quality companies was designed to outperform the S&P 500.
But in all of 2015 and in the first quarter of 2016, it fell short of the broad index by roughly half, as the chart below shows (the index being represented by the performance of the SPDR S&P 500 (SPY | A-98)):
That underperformance was linked to the exposures the fund offered during that time period. The Morningstar index underlying MOAT selects stocks based on two main criteria. First, it looks for a moat rating—or the quality companies that have built a sustainable competitive advantage.
‘Sustainable’ Business Models
The crucial word here is “sustainable.” The index looks only for those companies that can maintain that competitive advantage for 10 or 20 years with the purpose of avoiding companies where high profitability was an abnormal, one-off event.
The index also looks at the fair-value assessment of each company—the per-share value of those companies. In other words, MOAT is a value strategy at heart because it looks to own stocks that are cheaply valued, or valued below their fair price, at the time of inclusion in the index.
The ETF portfolio, which is equal-weighted, with each stock representing about 5% of the mix, is rebalanced quarterly. That rebalancing often sees the best-performing stocks in the portfolio eliminated, and new, low-valued quality stocks brought into the mix.
That constant remixing of the portfolio holdings due to the valuation screen results in major shifts in sector exposures, turnover in individual stocks, and leads to a pattern of returns in the short term that is different from the returns long term.
For example, in the first quarter of 2016, MOAT’s largest sector allocations were industrials and consumer discretionary at about 25%, and information tech at 15%. Some of the best-performing names in the fund in the same period were industrial companies such as Kansas City Southern, Polaris Industries, Emerson Electric and Spectra Energy.
But in the S&P 500, the best-performing sector year-to-date is energy, with gains exceeding 12%. Industrials and consumer discretionary currently rank No. 4 and No. 6, respectively, in terms of sector year-to-date performance.
The Batting Average
According to Van Eck statistics, these fluctuations in performance tied to the valuation aspect of the portfolio are to be expected.
In fact, a measure of MOAT’s index success rate versus the S&P 500 shows that the MOAT index tends to outperform the S&P 500 only about half the time on a rolling one-month period. It’s a 50/50 chance of outperformance—a coin flip.
If you expand that holding period to one year—12 rolling months—that number rises to a 60% average of outperformance versus S&P 500.
And if you go out three to five years, you are looking at an 80-90% average. Over the long haul, the index underlying MOAT almost always outperforms the broad market in a longer time period.
So far, that has been the case. Since the fund’s inception in 2012, the fund has outperformed SPY by more than 3 percentage points:
Charts courtesy of StockCharts.com
That batting average holds true, according to Van Eck, because it is in the longer holding period when you start to see the outperformance due to the value tilt. MOAT is essentially buying stocks that have experienced some negative performance leading up to their inclusion in the index, so in the short term, these stocks may not look or do so great.
But that’s the goal—to buy quality stocks low, and sell them high at some point down the road. MOAT is not designed to be an ETF trading tool for short-term investors.
The Latest Mix
Looking ahead, the latest rebalancing of the portfolio in late March shifted the fund’s sector allocations dramatically, putting health care and financials at the top, as the chart below shows:
MOAT’s current sector allocation is significantly different from SPY’s, where information technology leads, with 21% of the portfolio, followed by financials, at 15%. Health care comes third, at 14% of SPY’s portfolio.
These divergences in sector exposures, coupled with MOAT’s value tilt and relatively high stock-specific risk—given its concentration on only 20 securities—should almost certainly translate into performance divergence relative to SPY in the near term.
But to the long-term investor, the ups and downs of rolling 30-day performance windows doesn’t matter. It’s all about keeping the eye on the prize long term.
Contact Cinthia Murphy at [email protected].