Andrew Lane: Within the Morningstar equity research department, we keep a close eye on the performance of the Wide Moat Focus Index, a collection of the most undervalued U.S. wide-moat rated stocks under our coverage. Typically, the strategy holds roughly 50 stocks, with the reconstitution and rebalancing process taking place four times per year. The index is important to us, as its construction represents the cross section of our differentiated economic moat methodology and our rigorous bottom-up valuation work.
In the first quarter of 2019, the Wide Moat Focus Index generated a 13.4% total return but modestly underperformed its benchmark, the Morningstar US Market Index, by 67 basis points. This comes on the heels of a very strong performance in 2018, during which the strategy outperformed its benchmark by 431 basis points. Since the index’s February 2007 inception date, it has beaten its benchmark by 358 basis points annually, an impressive long-term track record.
Since the strategy’s inception, stock selection, rather than sector positioning, has driven the lion’s share of excess returns. Along these lines, in the first quarter, a favorable stock-selection effect was more than offset by a negative allocation effect from sector positioning. Unfavorable sector positioning proved to be a headwind across most sectors, with an overweight exposure to healthcare the most significant. Regarding stock selection, the impressive performance of the index’s consumer defensive holdings stood out as technology and basic-materials names also performed well. In terms of total contribution to the portfolio, the top three performers were General Mills, KLA-Tencor, and Philip Morris. The index continues to hold a number of materially undervalued, wide-moat stocks, and we’re hopeful that the strategy’s positive momentum will be restored in the second quarter and beyond.