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December 02, 2019VanEck's Murphy On MOAT (3:25)
VanEck’s Matt Murphy sits down with RIA Channel CEO Julie Cooling discuss moat investing and Morningstar’s approach to identifying U.S. companies with sustainable competitive advantages at attractive valuations.

JULIE COOLING: Hi, I'm Julie Cooling, Founder of RIA Channel and contributor with Forbes. I'm here with Matthew Murphy, Director of National Accounts for VanEck. Matthew, thanks so much for being with me today.

MATTHEW MURPHY: Thanks for having me, absolutely.

COOLING: So we're here today and we're going to talk about MOAT – M-O-A-T – which is the MOAT ETF that you run with Morningstar – Morningstar is the index provider – one of the most successful ETFs in our industry, both from a flow standpoint as well as performance. Tell us a little bit about the investment strategy.

MURPHY: Sure. I think from a philosophical point of view moat investing is really based on owning companies with sustainable competitive advantages that are trading at attractive valuations. We leverage the intellectual horsepower from Morningstar. Morningstar has an equity research desk that's been around since 2002, and what they're doing when they're recommending their buy list is they're looking for companies that have some sort of a barrier to entry or competitive advantage relative to their peer group. They've identified a number of different sources of economic moat – things like high switching cost, things like an intangible asset – and throughout their research they cover 1,500 stocks globally.

What they do is they go through and they assign one of three different moat ratings to an individual equity – either no moat, narrow moat, or wide moat – and the difference between those categories is really the confidence interval and the amount of time that they can forecast it into the future. So we're looking specifically for wide moat companies. We're looking for companies that we can forecast out their competitive advantage 20+ years into the future. And step two is really to own those companies at the right price. So across different sector coverages for Morningstar's team they have one consistent methodology whereby they value securities using cash-flow modelling and really just owning the most deeply discounted relative to their fair value analysis within the portfolio.

COOLING: So what you end up with is 40 to 50 stocks, so pretty concentrated portfolio.

MURPHY: Fairly concentrated.

COOLING: And it's an ETF, so it's passive, but it's really quarterly adjustments on the index. Talk about that.

MURPHY: That's right, there is a quarterly rebalance with the ETF. Primarily, the majority of the turnover is driven by valuation changes. On occasion, there are re-ratings that happen with the Morningstar team determining that a business model might have changed, but most of the turnover takes place at the valuation level. As stock prices go up and down, you'll see the relative valuation measure for individual securities within the portfolio change, and that's the majority of the way that the turnover is driven.

COOLING: Talk about how advisors are using this in their portfolios.

MURPHY: There's really two different ways that advisors are incorporating this into their portfolios. The first is that – no surprise – we've heard a lot about the shift from active to passive in recent years, and really over the past five years. Advisors are looking to lower overall costs into client portfolios. At 49 basis points, it is a relatively low-cost strategy, and you still benefit from that active tilt. It's still leveraging all of Morningstar's equity research in terms of making allocation decisions. And the second is to add some sort of an alpha generator to any low-cost, core S&P 500 allocation for their clients.

COOLING: Wonderful, really insightful. Thank you so much for being with me today.

MURPHY: Thanks for having me. I appreciate it.

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