Morningstar Misses Boat with Wide Moat ETFs

Includes: DGT, DIA, NY, VIG, WMW, XLG
by: Gary Gordon

For years, Morningstar reigned supreme as the mutual fund rating company. It still does. And that's in spite of a notoriously unreliable 5-star system.

Yet people need "stars" or "thumbs up/down" or rotten tomatoes. In fact, we spend a great deal of our lives relying on the grades that others assign, even when those opinions amount to little more than noise.

Mutual fund ratings failed the folks at Morningstar in the first 21st century bear (2000-2002). So, after many years of bad mouthing the benefits that individual securities might bring, they diversified by grading individual stocks. Similarly, after years of bad-mouthing ETFs, they have begun the process of rating some ETFs as well as writing features on them.

Unfortunately, Morningstar remains stuck in a world of buy-n-hold, fundamental valuation-only theory. For instance, in their most recent feature, the author talks about an environment characterized by higher inflation, slower growth and government intervention; the writer described this investing environment as the "new normal."

And Morningstar's answer to investing in the "new normal?" Buy ETFs that hold stocks of companies with "wide moats" -- competitive advantages like pricing power, strong brand name awareness, bargaining power over suppliers and solid balance sheets.

Now... here is where an astute reader has to chuckle. Morningstar recommended the same wide moat strategy before, during and after the current 2008-2009 bear -- old normal, new normal or old new normal? So wide moat companies were good before... but now they're really good for you?

Here's Morningstar's list of 5 Wide Moat ETFs that the author maintans will help "long-term investors" sleep at night:

Rydex Russell Top 50 (NYSEARCA:XLG)
Diamond Trust (NYSEARCA:DIA)
Vanguard Dividend Appreciation (NYSEARCA:VIG)
iShares NYSE 100 (NYSEARCA:NY)

Morningstar etfs

So people who have lost 30%-40% of their money over the last 2 years with these ETFs... Morningstar says that as a long-term investor, you can sleep at night with these 5? Really? If you're sleeping like a baby with a buy-n-hold approach, please let me know. I haven't met anyone who is comfortable with losses this severe.

Perhaps more ironically, the folks at Morningstar didn't even mention an exchange-traded investment that wears their namesake, the Elements MORNINGSTAR Wide Moat Focus ETN (NYSEARCA:WMW). It's particularly ironic when you look at the fact that WMW has held up far better than the 5 aforementioned "moaty" ETFs since the bear's inception. (Talk about missing the boat... a golden opportunity to make a point!)

Wide moat etf 2009

To be clear, there's absolutely nothing wrong with the ETFs themselves. A catastrophic bear can destroy any type of investment in any asset category.

Wide moat or no moat, investors can evaluate a variety of reasons (e.g., technical, fundamental, historical, economic, contrarian, etc.) for selecting a particular stock fund. Yet the only way to "sleep at night," is to have a plan for avoiding big losses. Use stop orders and low-correlating assets!

Full Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. The company may hold positions in the ETFs, mutual funds and/or index funds mentioned above.