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5 Great Wide-Moat Funds

Vanguard Dividend Growth and four other funds that focus on high-quality stocks.

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Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. At Morningstar, we're fans of companies that have wide economic moats. Such high-quality firms have competitive advantages that allow them to effectively fight off competitors. Several mutual funds keep a large portion of their assets in wide-moat stocks. Here today to share some of his favorite wide-moat funds is Russ Kinnel. Russ is Morningstar's director of manager research and editor of Morningstar FundInvestor.

Hi, Russ. Nice to see you today.

Russ Kinnel: Glad to be here.

Dziubinski: Now, Morningstar's stock analysts spend a lot of time talking about economic moats. So, let's start there, talking in general terms about what makes a wide-moat company and why that's attractive.

Kinnel: Yeah. So, this is a concept popularized by Warren Buffett and borrowed with love by us. The basic concept is companies that are hard to compete with because they have big competitive advantages, they're established and therefore hard to compete with, and that gives them a great defensive quality because it's hard to make a company like that go to zero or really take away their business. So, that could be a thing like a name brand, like a Procter & Gamble or Coca-Cola, very hard to get them off the grocery store shelves. It could be something like entrenched software like a Microsoft, or it could be something like both--like an Apple or Facebook. If you have a better product than Apple or Microsoft, it still doesn't mean you're going to actually get all of their business because there's so much high cost to switching over, whether it's for an individual like, say, who wants to go from Facebook to something else; a business, imagine telling an IT person get rid of all your Microsoft. So, those make for very big competitive advantages, and we see that those are the sort of companies that endure.

Dziubinski: We're going to talk today about a handful of funds that own a lot of wide-moat stocks specifically. So, is it intentional on the part of these funds in general to own wide-moat stocks, or is it more of just a byproduct of their overall strategies?

Kinnel: It's very intentional. They might call it quality rather than wide moats, but it's very much a part of their process. They're looking for companies that have these really strong characteristics because they are good long-term investments. It's no accident that most of these funds have very low turnover because moats endure. Procter & Gamble had those advantages for a long time, as have some of these other companies. So, you can find a good company like this and hold on for a long time.

Dziubinski: Let's dig into some of the funds. The first one is BNY Mellon Appreciation (DGAGX). This fund lands in Morningstar's large-cap blend category. And the fund has a little bit more of a growth-tinged portfolio of about 50 names. Tell us a little bit about it.

Kinnel: Yeah. This is a fund that was formerly named Dreyfus Appreciation, but it's subadvised by Fayez Sarofim, a well-known firm out of Houston. And they're very much focused on finding very high-quality names that they can hold on for a very long time. But they are valuation-aware, at least relative to some of the other moat-oriented funds. So, they end up in large blend. They even will hold a little bit of energy. But again, it's very well-established brands and a very patient approach that has really worked well over time, and it's a pretty stable firm as well. So, you have stability working on a couple of levels there.

Dziubinski: The next fund is Jensen Quality Growth (JENSX). This one also lands in the large-blend category. And based on the latest portfolio, it seems like it has a little bit better dispersion or balance between value and growth. But it's a little bit more concentrated--it holds about 30 stocks, right?

Kinnel: That's right. This is a really nice, quality fund. I own it. It's, again, very much focused on quality names, but you mentioned the concentration, and concentration in quality socks to me is much lower risk than, say, concentration in high-beta names. If, say, you've got really high-risk stocks, whether it's a gold miner or a superfast growing company, that can make for a very risky portfolio. But when you're talking about wide-moat names, again they endure, so I think it's a pretty reasonable approach to just focus on the very best names you can find. So, Jensen is another one that has been a very consistent performer. If you look at their record, generally when there is a recession, they do quite well. In markets like the downturn we saw just recently, these wide-moat funds don't do as well because wide moat in a case like this, it's more of a valuation correction and moats don't help you so much there. But they're more of a recession defense.

Dziubinski: And then, the last fund that lands in that large-blend category for Morningstar is Vanguard Dividend Growth (VDIGX). It has more of that true blended approach to portfolio building and also has a dividend focus.

Kinnel: That's right. Dividend growth is another way to get at wide-moat stocks, because to find a dividend growing name you need a strong balance sheet but also the potential to grow that dividend and that leads you naturally to these wide-moat names that are well established, have big robust balance sheets, lots of cash, but also the ability to grow. And so, maybe technically they're not saying "moats," but dividend growth gets you to the same place, and it still has those really nice defensive characteristics that I think gives you a lot of appeal. In equities, obviously, there's a lot of risk. These have less risk in general because of that, whether it's dividend growth or wide moat, you're just ending up with companies with a lot of good defenses.

Dziubinski: And now, we're going to talk about a couple of funds that land in our large-growth category, the first being Polen Growth (POLRX). And this one is really quite concentrated. This only owns about two dozen stocks, right?

Kinnel: That's right. So, it's our most concentrated fund. Again, I don't worry about it too much. We rate it Silver because we think it can manage that concentration. They place maybe a greater emphasis on the ability to grow, and that gets them in their growth box, but they also care about--they call it fortress balance sheet--so very huge cash stakes, which of course means could be a tech company or a brand-name company. But at the end of the day, this is a really nice growth strategy. Again, when you have wide moats, it's OK to concentrate, I think.

Dziubinski: Russ, our last pick today, also, in that large-growth category is actually undergoing a name change. Let's talk a little bit about that first. At the time of this taping, the fund is actually called Laudus U.S. Large Cap Growth (LGILX). Tell us about the name change and why it's happening.

Kinnel: Yeah. Schwab Select Large Cap Growth is the new name. It's not really changing. It's just a rebranding. Laudus has always been Schwab's brand name for actively managed funds. So, they're just renaming. It's an accurate name: It is a large-cap growth fund. What we like is Lawrence Kemp is a very seasoned investor who is very much a focused growth investor. It's a little more aggressive than some of the other ones we've named, so maybe not quite as much defensive characteristics, but very much focused on good wide-moat names with good growth characteristics. I think a pretty attractive large-growth option out there.

Dziubinski: And then, lastly Russ, I took a look at the year-to-date performance of these five funds and, with the exception of Vanguard Dividend Growth, the other four are landing in the bottom half of their respective categories this year, which may strike some investors as odd because they might be thinking in terms of wide-moat stocks, defensive plays, why aren't these funds doing better in a choppy market? Can you talk a little bit about that?

Kinnel: Yeah, it's a great illustration of the ways they provide defense and don't. So, this latest correction is mostly growth names who had very high valuations getting cut. And price risk is not a thing that quality really protects you from. It protects you from recessions because in recessions these kind of companies look great because, say, in the financial crisis in '08, they weren't dependent upon banks because they have robust cash balances, but also they have brand names that endure and hold up very well often. So, if you think about--people still buy Procter & Gamble or Microsoft or whatever, even in a downturn. So, economic recessions, these are great defense, but they're not great defense against all types of sell-offs. 

Dziubinski: Well, Russ, thank you for your time today and for doing this deep dive into some of these wide-moat funds. We appreciate it.

Kinnel: You're welcome.

Dziubinski: I'm Susan Dziubinski with Morningstar. Thanks for tuning in.


Russel Kinnel has a position in the following securities mentioned above: JENSX. Find out about Morningstar’s editorial policies.