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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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“Competitive advantage” is a very subjective term. In my decades as an engineer in the computer industry, I’ve seen many companies which appeared to have unassailable positions (including a couple I worked for), only to have them disappear due to disruptive technology and to, what in retrospect, were management missteps.
For the two examples you give:
Pfizer is in a high-stakes industry where new drugs and patent expirations can quickly change a company’s fortunes. It would be unlikely that they could repeat the unexpected boost they got from COVID vaccines.
With Charlie Munger’s recent passing and Warren Buffet being 93, Berkshire Hathaway will be at a major transition point in the not-too-distant future. No matter how good their successors are, they will need to prove themselves before the market gives them the same deference.
I also suspect that the success of this ETF could be self-limiting. If it grows too big, they could have trouble finding enough investments that meet their objectives.
Thanks for the discussion. I was not familiar with this fund. Here are a few features I noticed:
1) The fund has equal weighting rather than market capitalization weighting. If we assume each company has independent management, this is a form of risk control.
2) Lower valuation indirectly slants toward value over growth. It’s been a good 10 years to be on the value side of the market. For example, https://www.composer.trade/etf-comparisons/SPYG-SCHD
3) I remember Robert Schiller saying we get 90% of the diversification of owning the whole market with 20 stocks and 95% with 25. At 50 stocks, MOAT (stock symbol for the fund) gets most of that benefit that we’re looking for in an index fund.
I have a website that allows me to compare my list of 24 stocks to indexes, like DJI and INX over various periods of time. 0.5% annually is within the variance as these shift from day to day, week to week, etc., and yes, my equal-weighted list hangs right in there with the indexes over time :-), which is how I noticed the above three features of MOAT.
One way to use a fund like this is as a set of ideas to evaluate for investment. One thing I note when looking at its holdings is that it includes a lot of relatively smaller companies, which may be a plus or a minus, but does give it some independence, with the equal weighting, from typical market capitalized index funds, which often end up quite similar to each other by proportion.
We used to watch Wall Street Week as a family. My son who turns 45 today had a special dance he would do to the music every week- maybe the WSW Hustle? I actually don’t remember if we had a name for it. It was always a special treat when Louis would bring his dad on. Thanks for the memory.
Me too. Despite what I said, I looked forward to each show and picked up a few tidbits of wisdom amid all the self-serving bombast. It’s always nice to get back in touch with a past pleasure. Glad I did that for you!
Interesting Article. Thanks for a fun read.
I am currently reading the updated version of Poor Charlie’s Almanack – The Essential Wit & Wisdom of Charles T. Munger. Mr. Munger, who recently died, referred to a company’s competitive advantage as its moat: the virtual physical barrier it presents against incursions from competitors.
One of many factors Mr. Munger considered in deciding on an investment was how wide and enduring was the protection the moat offered. Given the high expense cost and investment turnover of the VanEck fund my initial reaction is to wonder where this fund would would have fallen in Mr. Munger’s initial investment selection criteria of yes, no or too tough to understand.
For my investment decisions I think I have neither the life span nor the risk tolerance for this and many other funds which fall into my personal no or too tough to understand baskets.
I hear in my head Mr. Munger’s trademark quote “I have nothing to add.”
I understand where you’re coming from. One of the advantages of a fund is that the managers will (hopefully, though unfortunately rarely) will do the heavy lifting for you or, better yet, the fixed composition of an index fund will have that built-in. MOAT has been a true rarity and, as I mention, possibly a statistical fluke.
Show me an active fund and I’ll show you a virtually identical index fund that will match or beat it with less fanfare and much less expense. I think the frugal Mr. Munger would have agreed!
It appears that active ETF’s are starting to attract more assets.
Thanks for sharing.
I remember the manager from Legg Mason with a great track record, but I’m pretty sure he lost his touch for a period of time?
Need to be careful though with active ETFs. The fund families are trying to replace the income lost from the gradual demise of their expensive mutual funds with them. T. Rowe Price has a suite of ETFs that look promising, but, boy, they are more costly than Vanguard’s mutual funds.
Yes, Bill Miller had a great run, only for his fund’s performance to turn atrocious.
I think the one active ETF that possibly over the long haul might be worth it is QQQ? Any thoughts?
I wouldn’t buy it. I get all those stocks within my total stock market funds and, in the absence of a crystal ball, I’m not inclined to overweight tech.