Just like a moat surrounds and protects a castle, so does an economic “moat” surround and protect a firm.
According to Morningstar, “only companies with an economic moat — a structural competitive advantage that allows a firm to earn above-average returns on capital over a long period of time — are able to hold competitors at bay.”
An economic moat provides a margin of safety because if a firm can fall back on a structural competitive advantage, it’s more likely to recover from temporary troubles.
Brandon Rakszawski, product manager with Market Vectors ETFs, and Morningstar’s Michael Hodel held a conference call last week to discuss recent wide moat trends and the results of the Morningstar Wide Moat Focus Index quarterly review.
“Market Vectors Morningstar Wide Moat ETF was listed for trading in April 2012. Over the past two and a half years the ETF and its index’s underlying methodology has gained a great deal of acceptance,” said Rakszawski during the conference call, adding that the fund has attracted more than $250 million in net new flows year-to-date.
He said the fund’s assets under management stood at $850 million at the end of September.
Market Vectors Morningstar Wide Moat ETF’s underlying index, the Morningstar Wide Moat Focus Index, consists of the 20 securities in the Morningstar US Market Index with the most attractive prices (or highest ratios of fair value to their stock price as determined by Morningstar) and a sustainable competitive advantage (or wide moat).
Morningstar gives a narrow or wide moat rating to a firm if it has the prospect of earning above average returns on capital, some competitive edge that prevents these returns from quickly deteriorating and a competitive advantage inherent to its business.
And, of course, the wider the moat, the more sustainable the competitive advantage. Currently about 10% of the broad equity world analyzed by Morningstar receives a wide moat categorization.