So you think you want to invest in "wide moat" companies? There's nothing wrong with that. Plenty of investors look for companies with a major competitive edge. The Wall Street Journal even makes "the case for wide moat stocks":
When investors talk about a "wide moat" company, they mean one able to defend its profits from marauding competitors.
Such companies are worth watching. One gauge, the Morningstar Wide Moat Focus index, has returned 6.3% a year since it began in 2007, versus 0.6% for the Standard & Poor's 500-stock index.
Moat-based investing isn't new. Warren Buffett has used the term 20 times since 1986 to describe his investment process in annual letters to Berkshire Hathaway (NYSE:BRK.B)
If you have an index like the Wide Moat Focus Index, can an ETF be too far behind? Not these days. Now you can put money into wide moat stocks with just one investment - for example the recently launched Market Vectors Wide Moat Research ETF (NYSEARCA:MOAT).
While I'm fine with the basic premise of the fund and the index, the problem is that no two people will agree exactly on how wide a moat needs to be and which companies have the widest moats at any point in time. So how does this Morningstar Wide Moat Focus Index work?
According to Morningstar,
The Morningstar Wide Moat Focus Index consists of the 20 securities in the Morningstar US Market Index with the highest ratios of fair value, as determined by Morningstar, to their stock price, and which have a sustainable competitive advantage (i.e. wide moat). Securities in the Wide Moat Focus index are assigned equal weights.
20 wide moat stocks - a fluctuating list
Membership in the top 20 spots on this index seems to be subject to a fair amount of fluctuation - not in stock prices, but in the list of stocks itself.
I found a PDF online from Morningstar that explains how the index works and shows the companies on the index as of December 31, 2011. I also looked at the Market Vectors fact sheet on the ETF (also a PDF) dated May 31, 2012. And I looked at the ETFs holdings as of June 29, 2012.
Here's the list of companies in the index as of those dates. The companies are listed alphabetically with a green dot indicating their presence on the index as of these various dates since December 2011.
On this list of 20 companies, only 12 of them - those with pink check marks - stayed on the index throughout the entire period. And we're not talking about years here, only six months or so.
I realize that the index caps out at 20 companies and that fluctuations can bump a company down in rank for a quarter or two, but it's difficult for me to believe that a wide moat investor would move completely in and out of a stock in this manner every quarter. So yes, I was surprised at the high turnover in this index.
Don't get me wrong. Wide moats do provide a competitive advantage that I think bumps up long-term portfolio performance. Just be aware that the turnover might be more than you'd expect from a fund that embraces a wide moat investment strategy.