Continued Outperformance for Our Wide-Moat Focus Index

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 fourth quarter of 2018, the Wide-Moat Focus Index outperformed its benchmark, the Morningstar US market index, by 383 basis points. For the full year of 2018, the strategy beat its benchmark by 431 basis points, having delivered an absolute total return slightly better than negative 1%. Since the index's February 2007 live inception date, it has beaten its benchmark by 3.7% annually, an impressive long-term track record.

High-quality, wide-moat stocks typically hold up well in downward-trending markets but don't participate fully during upward-trending markets. Perhaps most interesting about this particular strategy's performance is that this has not really been the case. Instead, the index has performed roughly in line with the benchmark when markets have moved lower but has outperformed when markets have traded higher. This would seem to indicate that our emphasis on valuation has outweighed effects related to quality as a factor.

In the fourth quarter from a sector weighting perspective, the Wide-Moat Focus Index benefited most from being overweight consumer defensive names, although a slight underweight position in the real estate sector served as a modest headwind. From a stock selection standpoint, the consumer cyclical sector stood out as a positive contributor, while the top three performers overall on a selection effect basis were Starbucks, Hershey, and Twenty-First Century Fox. The portfolio also benefited from not holding Apple, a stock that detracted materially from the benchmark's performance. Granted, we assign only a narrow-moat rating to Apple, so it is not currently eligible for index inclusion.

With strong momentum headed into 2019, we're hopeful that the Wide Moat Focus Index will deliver another year of solid results.