Quality is an investment factor while moat investing is a style, but there are intersections between the two as many stocks that fit the bill as wide moat fare are also quality names.
Thanks to exchange traded funds such as the (MOAT ) – the pioneer and leader of the wide moat ETF category – investors can efficiently access quality wide moat stocks under one umbrella while eliminating the need to stock pick to this effect. Alone, that’s good, but many market participants are inquisitive and want to know the “secrets” behind the potency of wide moat investing.
Interestingly, that includes the point that wide moat investing usually often outpaces quality over long holding periods. For example, MOAT has easily beaten the S&P 500 Quality Index and the MSCI USA Sector Neutral Quality Index over the past three years.
Look Forward With MOAT
In financial markets, a crystal ball is no more than a metaphor, which is to say no one can tell the future. That said, wide moat investing is forward-looking while the quality factor relies heavily on history.
“Morningstar’s Economic Moat methodology assesses the ability of a company to sustain its competitive advantages over a very long time frame: at least 10 years for a narrow moat, and 20-plus years for a wide moat,” noted Morningstar analyst Adam Fleck. “This is a forward-looking rating based on in-depth fundamental research that is designed to disregard market or economic cycles, investment cycles, and statistical quirks.”
Another point for investors to consider is that index providers and ETF issuers have a variety of ways of defining quality. On the other hand, there are consistent hallmarks in defining wide moats. The point is some companies can miss the quality designation simply due to an index provider’s definition, but those firms can maintain the wide moat label.
That’s an important point because as Fleck points out, while some wide moat stocks may have quality hallmarks, many of the names residing in quality ETFs are not wide moat equities and might not qualify for entry into MOAT.
“Despite the difference in processes, you might expect that there would be a strong overlap between index providers’ measures of quality and the moat rating—after all, they’re asserting similar underlying goals. But a review of the three major quality ETFs shows that each holds an average of 9% in no-moat stocks and 35% in narrow-moat stocks as of June 30, 2023,” concluded the analyst.
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