The Takeaway
Just as moats were dug around medieval castles to keep enemies at bay, economic moats protect the high returns on capital enjoyed by the world’s most successful companies.
Even the highest-quality company could turn out to be a value-destructive investment if it’s purchased at an excessive price.
Though the moat focus index methodology has been broadened and globalized over the years, its core remains: high-quality companies at good prices, harnessing forward-looking, analyst-driven insights.
When the Morningstar Wide Moat Focus Index launched in 2007, the term smart beta had yet to enter the investment lexicon, factor-based indexing was new, and passive strategies with active goals had yet to proliferate. The moat focus index approach traced its origins to the world of active management. It would aim for above-market returns by building concentrated portfolios of competitively advantaged companies with attractive share prices.
Within the index universe, the moat focus methodology remains unique. Though the moat focus targets high-quality companies at good prices, rather than defining corporate quality through backward-looking quantitative measures like return on equity or balance sheet strength, it uses the concept of economic moat, or sustainable competitive advantage, as determined by the Morningstar Equity Research team. Instead of screening on traditional value metrics like price/book, the indexes rely on valuation, which compares a company’s share price with Morningstar analysts’ estimate of the business’ intrinsic value. Embedding forward-looking, analyst-driven insights in an index format is far from typical.
The index methodology has been tested by a variety of market environments. It has weathered up and down markets. It has ridden out cycles in housing and commodities. It has endured regimes led by both growth and value. This stands in contrast to the many investment strategies launched on the back of stellar back-tests, academic theories, or compelling narratives. The moat focus indexes combine fundamental inputs with disciplined portfolio construction to target stocks with durable competitive advantages and attractive valuations as opposed to bets on sectors, factors, or regions driving performance over the long term.
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