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Long only, value, momentum, bonds
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Roughly 10 years ago, Morningstar launched a stock valuation star system based their proprietary Discounted Cash Flow analysis. Unlike the backward looking star system for mutual funds that is wildly popular but only moderately useful, the star stock system ranks individual stocks is based on how cheap Morningstar’s analysts believe a stock is compared to their estimate of the company’s intrinsic value.
Hoping to capitalize on the explosive demand for Exchange Traded Products, Morningstar launched their Wide Moat Focus Total Return Index, which Elements turned into an Exchange Traded Note (ETN) under the ticker WMW. Unfortunately, they launched the product near the height of the market, literally nine days before the market peak in 2007.
Although an article on Seeking Alpha criticized the strategy, the data thus far shows that the strategy has been very successful despite the unfortunate timing of the ETN launch. For the 38 complete months beginning with November 2007 and ending December 2010, the fund has earned a total return of 15.68%, or 4.71% annualized. During that same period, the S&P 500 lost 12.78%, or -4.23%.
The Wide Moat Index underperformed last year, gaining 7.68% while the S&P 500 grew 15.05%. That doesn’t mean that the strategy can’t win in up markets – it gained 46.71% in 2009 while the S&P gained 26.45%. In 2008, when the S&P 500 lost 37%, the fund only lost 20.30%.
The volatility for WMW was substantially higher at 32.22% versus 21.68% for the S&P 500, but this was largely due to a very large positive return in April, 2009 when the market was turning positive. That one month enjoyed a 31.49% gain when the S&P 500 rose by 9.57%.
I calculated the Sortino ratio, or downside deviation, which penalizes large draw-downs without equally punishing large upswings, unlike the normal standard deviation calculation. In other words, it gives more weight to negative deviations than positive deviations thinking that investors are more concerned about losing money than having a big month.
To calculate the Sortino ratio, you need to estimate a required rate of return, which I set at eight percent annually, which is lower than the long-term market average but still reasonably high. Measured this way, the Sortino ratio is 4.53% for WMW and 4.40% for the S&P 500 during that time period.
In my opinion the performance last year only proves that the strategy isn’t a ‘’free money machine,” which we all know doesn’t exist. It also suggest to me that both in nominal and risk-adjusted terms, the results for WMW over the past three (plus) years demonstrates that the Morningstar mechanism for selecting top quality companies at discount prices has been successful.
While some claim that buy and hold is dead, the earning a profit while the market loses suggests that high-quality fundamental analysis combined with a disciplined buy and sell strategy never goes out of style.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: The views expressed do not necessarily represent the views of Acropolis Investment Management, LLC. or its members. While we do not own WMW for our clients, we do subscribe to Morningstar Select, an institutional stock research platform.
Source: Elements Morningstar Wide Moat Focus ETN Successfully Navigates Tough Waters