Funds That Go Moatless

In a free-market economy, capital seeks the areas of highest return, and whenever a firm develops a profitable product or service, competitive forces are fast to drive down economic profits. Only firms with economic moats--a structural competitive advantage that allows firms to earn long-term above-average returns on capital--are able to fend off competition, the theory goes.

To help investors identify firms with moats, our equity analysts assign one of three Morningstar Economic Moat Ratings: none, narrow, or wide. Some attributes that drive economic moats include network effects, intangible assets, cost advantage, high switching costs, and efficient scale. Firms that do not receive a narrow or wide moat rating do not possess durable competitive advantages, in the view of Morningstar analysts, and hence they may not earn above-average returns over the long term.

While investing in no-moat companies brings risks, price discipline can offset them. Listed below are three value-oriented funds that invest heavily in no-moat companies: All but one have Morningstar Medalist ratings.

As of June 2017, 30% of the fund’s assets were in energy and basic-materials stocks, and all but two of those 10 holdings had economic moat ratings of none. That bet on energy and basic materials was the main source of outperformance during a stellar showing in 2016 as commodity prices rebounded, but it has been the main drag on performance for the year to date.

Silver-rated

Oftentimes, this deep-value approach leads the team to bet on companies and/or sectors that have fallen out of favor. The team increased exposure to energy stocks such as Devon Energy DVN,

More recently, the fund added no-moat

Despite lackluster performance over short periods, Holt’s record speaks for itself: Since he joined the fund in August 1999, the fund’s 7.3% annualized gain through June 2017 outpaced the Russell 1000 Value Index’s 6.4% return and the typical large-value peer’s 5.4% return.

Neutral-rated

Recently, that approach has led them to healthcare-oriented names such as drugmaker

He also favors domestic airlines, as industry consolidation and lower oil prices have improved operating metrics; no-moat

The fund has been a top performer in the bull market that’s reigned for most of the trailing five years through June 2017, outperforming the Russell Midcap Index by an annualized 582 basis points and 98% of its mid-blend peers. But the fund’s elevated risk profile still leaves it prone to substantial declines during market downturns.