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    Defensive Positioning into 2020: Solving Your U.S. Large Cap Equity Problem

    Ed Lopez, Head of ETF Product
     

    You may not have realized it, but you have a large cap problem. The current bull market that started in March 2009 is now the longest bull market in modern stock market history. By many metrics the market could be considered overvalued, which presents investors and their advisors with a dilemma: how do you continue allocating to U.S. equities in a prudent way?

    Forward-Looking Focus on Valuation

    At this point of the market cycle, it may be hard for some investors to justify putting new money to work in companies whose valuations have been stretched to elevated levels. A more selective approach that seeks to allocate to companies trading at a lower relative valuation may provide more of a cushion in the event that markets take a tumble while also offering the potential for greater upside if equity markets continue to rise.

    Traditionally, most valuation strategies are backward looking, in that they incorporate historical fundamental metrics such as earnings and book values to determine current valuations. We believe valuations should also include an assessment of a company’s business and its prospects for future profit generation.

    Index Name Annualized Return
    (15/2/2007-31/10/2019)
    Max Drawdown
    Morningstar Wide Moat Focus IndexTM 12.08% -42.43%
    S&P 500 Index  8.22% -50.95%

    Source: Morningstar Direct as of 31 October 2019. Past performance is no guarantee of future results.

    Morningstar Wide Moat Focus IndexTM is designed to include companies with Wide Economic Moats, or companies Morningstar deems to have competitive advantages that are sustainable for at least the next 20 years. The Morningstar Wide Moat Focus IndexTM incorporates a forward-looking price-to-fair value metric to select at least 40 stocks trading at the lowest relative price, and rebalances quarterly. By including a forward-looking valuation metric into its investment thesis, investors may be able to better protect themselves from high-flying valuations, potentially boosting returns and allowing for a more favorable risk/return profile.

    All of the Up, None of the Down….Doesn’t Exist

    Unfortunately, there is no magic bullet that will solve late-cycle investment questions for investors. Predicting the future is impossible. A bear market is inevitable, and trying to time the market using human intuition is a fruitless project.

    Instead of trying to call the top, or catch a falling knife, we believe that investors should thoughtfully consider a range of options to account for numerous outcomes. Those options could include incorporating more robust forward-looking valuation metrics that helps to protect against overvalued companies. Rather than trying to predicting a bear market, we believe investors should instead position themselves to be prepared for one.


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