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Moat Index Q3 Review: Shift Towards Value Tilt

October 12, 2023

Watch Time 5:40 MIN

Following its quarterly index review, the Morningstar Wide Moat Focus Index shifted further away from growth towards value. Despite short-term fluctuations, the index’s year-to-date performance remains ahead of the S&P 500. Find out more.

The third quarter of 2023 saw downside volatility re-enter the market after a very strong beginning of the year for the S&P 500 index here in the United States. The Morningstar Wide Moat Focus Index (“the Moat Index” posted a period of underperformance in the third quarter of 2023, the first significant period of underperformance for quite some time. After starting off the quarter in July with strong relative returns versus the broad market, the S&P 500, the [Moat] index posted underperformance in both August and September.

However, despite the underperformance in the third quarter, the Index remains ahead of the S&P 500 on a year-to-date basis by approximately 300 basis points. And if you look further in history on the 1, 3, 5, and 10-year time horizons, the index remains well ahead of the S&P 500 through September. This is notable, because the story with the Morningstar Wide Moat Focus Index is all about long-term holding periods. When you look at the success rate of the Morningstar Wide Moat Focus Index versus the S&P 500, it increases as you extend holding periods.

So this index and the ETF that seeks to track it, the VanEck Morningstar Wide Moat ETF, ticker MOAT, is not necessarily a short-term exposure vehicle for broad U.S. equity exposure. It is meant to be a core long-term holding in a portfolio and over long periods of time, it has posted that excess return on a more regular basis.

If you look at the index since inception in 2007, all 10-year rolling periods since February of 2007, the index has posted excess returns over the S&P 500, a 100% success rate for 10-year time horizon. So a very long-term core holding in a portfolio, despite some of the underperformance we saw in the third quarter of 2023.

The drivers of excess return for the Morningstar Wide Moat Focus Index, relative to the S&P 500, came in the form of stock selection in the third quarter of 2023. That is typically the case. That's what we've grown to expect with this strategy. Stock selection has been what has driven returns relative to the S&P 500 on the upside, as well as on the downside. It's not about sector allocation—over-or underweight certain sectors— style allocation, et cetera, really is mostly explained by stock selection historically. This quarter was no exception. The underperformance was driven by a number of companies that had a poor performance quarter and impacted the Morningstar Wide Moat Focus Index in a negative way. Companies like Equifax, Zimmer Biomet, and Etsy all contributed to underperformance for the Morningstar Wide Mote Focus Index in the third quarter.

There were some bright spots within the index. A few companies that were added to the portfolio in recent quarters did perform very well. We've talked a lot about Domino's Pizza, was a very strong performer for the portfolio in the third quarter, and a handful of other names in various sectors also performed very well, some of which were removed from the index at its quarterly review in September.

This is when the index reassesses the eligible universe of high-quality wide moat companies and targets the most attractively priced of the bunch. At this quarterly review, we saw a shift further away from growth to a value bias, slight value bias. I'd say a value tilt.

Whereas the index had been shifting slightly toward growth through 2022 as valuation opportunities presented themselves in a very volatile, difficult market for growth stocks last year. That trend has essentially reversed itself. The index has moved away from sectors on the growth spectrum, like tech, to be a very significant underweight tech, almost 12% underweight to the market currently.

And the index has shifted more to value-oriented sectors like financials, health care, industrials and consumer defensive. So, it's an interesting shift as valuations have informed the selections of the wide moat companies included in the index. And it's very timely as we try to navigate the uncertainties of 2023 and into 2024, following the most recent Fed meeting in which it was announced that we should most likely expect higher for longer rates and the market’s now reacting accordingly.

So, we think amidst the volatility that's reintroduced itself in the market this review, it will be proved to be very timely, as the index has repositioned away from growth away from big tech to more defensive areas of the market more cyclical areas of the market that may stand to potentially benefit from some of the Fed policy moving forward. Time will tell and we'll see where the index moves in December.


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