A Moat That Works?

Steve Abramowitz

IN THE VALLEY OF FEAR, Sherlock Holmes searches a moat to shed light on a puzzling murder, only to be surprised by what he finds. Among today’s exchange-traded index fund (ETF) cognoscenti, another moat has become the focus of inquiry.

“Holmes, which moat are you investigating now?”

“Too much chronicling of our little capers, Watson, and not enough reading. It’s the VanEck Morningstar Wide Moat ETF.”

“The who?”

“Shame, shame, Watson, you’re so ill-informed about popular culture. The Who was an English rock band in the ’60s. VanEck is a global money manager headquartered in New York. It’s one of the oldest investment firms in the U.S. and runs some 70 ETFs. And even you, my friend, have heard of Morningstar, the fund research outfit.”

“You are still so insufferable, Holmes. What’s with this VanEck fund, anyway?”

“Not a typical actively managed fund, but more active than most index funds. Been around since 2012. Has about $12 billion in assets. It’s the company’s second-largest ETF.”

“Never heard of it.”

“You will soon, Watson. It has outperformed Vanguard’s S&P 500 ETF over the past 10 years—and it’s kicked up a brouhaha worthy of my inspection.”

Stocks in VanEck Morningstar Wide Moat ETF (symbol: MOAT) are chosen based on two criteria: a business’s competitive advantage and its stock’s valuation. According to Morningstar, the defining features of competitive advantage include intangible assets, strong barriers to a competitor’s entry and economies of scale. Companies like Pfizer and Warren Buffett’s Berkshire Hathaway come to mind. Meanwhile, attractive valuation is measured by the gap between a stock’s current price and Morningstar’s estimate of its fair market value. About 50 stocks, which are equal weighted in the fund, make the cut.

As a retiree, I prefer funds with above-market yields and below-market volatility. Since the VanEck fund isn’t notable in either category, I don’t own it. But the fund is a core holding in an account I manage for a family member who has more laps left to run than me.

The VanEck ETF has accomplished a rare feat. Over the 10 years ending Nov. 30, it has outperformed Vanguard Group’s S&P 500 ETF (VOO), as well as the funds in Morningstar’s large-company blend category. Moreover, it’s done so even after adjusting for the fund’s risk level—and despite an eyebrow-raising expense ratio of 0.46%, or 46 cents a year for every $100 managed.

The VanEck fund’s holdings are rebalanced quarterly. It has no portfolio manager per se, but the fund is considered active because it is rules-based. About half of the holdings are replaced in a typical year, a high turnover rate for what’s sometimes labelled an index fund.

What should we make of the VanEck fund’s outperformance? Many of us graybeards remember Wall Street Week, the breakthrough television show that brought the stock market into our homes. One of the program’s highlights was a reckoning of the prior picks of the acclaimed pundits sitting around a conference table. Celebrated host Louis Rukeyser would announce with wonder the results of his “most successful” guest. The profit was usually extraordinary, often approaching 100%.

But every roll of the dice yields a distribution of possible results, a few falling at the extreme low end and a few at the extreme high end—all due to luck. The program’s producers, and surely Rukeyser, should have known to tell viewers the average gain among all the participants, not the largest.

Exaggerating the “skill” of the stock pickers, intentional or not, had the unfortunate effect of wowing the audience, undoubtedly increasing viewers’ faith in the prescience of market “experts,” their dependence on brokers’ dubious advice, the allure of star mutual fund managers—and, of course, boosting the program’s ratings. Though 10 years of data suggest the VanEck Morningstar Wide Moat ETF isn’t simply lucky, it could be an outlier that benefited from chance.

A second takeaway: The stellar performance of index funds often flows from their low expenses, while high expenses may mask the success of active funds’ actual portfolio management. If it’s not a statistical fluke, then the VanEck fund’s accomplishment, with its 0.46% expense ratio, is quite remarkable—because Vanguard S&P 500’s minuscule 0.03% expense ratio gives it a significant advantage right out of the box.

“Well done, Holmes,” offered Watson, after listening to Holmes’s analysis. “A quizzical episode, and unlike the certainty of The Disappearance of the Load Fund,” which I recently recounted in Financial Exposé.

“You are, as usual, Watson, so kind but also so shortsighted. Too much memorization in medical school and too little steeped in finance. Ten years in the life of the market is a mere pittance, only 20 years will solve the case.”

Steve Abramowitz is a psychologist in Sacramento, California. Earlier in his career, Steve was a university professor, including serving as research director for the psychiatry department at the University of California, Davis. He also ran his own investment advisory firm. Check out Steve’s earlier articles.

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