High-Quality Held Up During Rally

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 cheapest U.S. wide-moat-rated stocks under our coverage. Typically, the strategy holds 40 to 50 stocks, with reconstitutions 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 2017, the strategy performed closely in line with its benchmark, the Morningstar US market index. However, for 2017 as a whole, the Wide Moat Focus Index outperformed the benchmark by 2.3 percentage points, delivering an absolute total return just shy of 24%. This builds on even more encouraging results from 2016, when the strategy outperformed its benchmark by roughly 10 percentage points.

Perhaps most interesting about this performance is the fact that high-quality, wide-moat stocks often underperform during upward-trending markets like those witnessed the last couple years. However, fighting against the grain of this factor-based headwind, the Wide Moat Focus Index still outperformed.

In 2017 from a sector weighting perspective, the Wide Moat Focus Index benefited most from being underweight energy stocks, although being underweight technology names detracted from performance. From a stock selection standpoint, consumer cyclical holdings performed very well, with L Brands and Twenty-First Century Fox being the index’s top two performers overall.

Thus far into 2018, the Wide Moat Focus Index remains overweight the healthcare and consumer cyclical sectors and underweight the technology sector. With the strategy having generated an annual 4.2 percentage points of relative outperformance since its October 2007 live inception date, we're hopeful that 2018 will be another strong year.