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.