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Morningstar Wide Moat Focus Index Performance Analysis for Advisors

From 2007 to 2017, the Morningstar Wide Moat Focus Index averaged an 11.85% return compared to the market’s 7.73%. Learn how.

By Dan Lefkovitz
Read Time: 4 Minutes

When we launched the Morningstar® Wide Moat Focus Index℠ in October 2007, we were not anticipating the boom in smart-beta ETFs, factor investing, or rules-based passive indexes. We were simply looking to package the work of Morningstar equity analysts into a strategy we would invest in ourselves.

What Makes the Wide Moat Focus Index Unique

Buying great businesses at great prices isn’t a novel approach to equity investing. But the Wide Moat Focus Index is unique in its use of active inputs in a passive format. Instead of screening stocks with backward-looking accounting measures like return on equity, we use the Morningstar® Economic Moat™ Rating—a Warren Buffett-inspired, analyst-assigned gauge of sustainable competitive advantage. Rather than determining whether stocks are cheap on price/book or price/earnings ratios, we employ valuation—share price relative to the intrinsic value of the business.

In constructing the Wide Moat Focus Index, we subscribed to the philosophy that investing with the herd will deliver market-like returns. So the index takes a contrarian approach, selecting a compact group of high-quality companies when their stocks are unduly out of favor. Stock and sector weights deviate significantly from those of the market.

How the Wide Moat Focus Index has performed

The Wide Moat Focus Index now has a 10-year track record. That’s a rare distinction in an industry rife with back-tested returns. The index has weathered up and down markets, ridden out cycles in housing and commodities, and withstood markets led by both growth and value.

The graph below illustrates how $10,000 invested in the Wide Moat Focus Index at launch would have fared compared with our measure of the broad U.S. market. The Wide Moat Focus Index turned $10,000 into $30,663 over 10 years, while the same investment in the Morningstar US Market Index would have become $21,052. In terms of annualized return, the Wide Moat Focus Index averaged 11.85% compared with 7.73% for the market.

From 2007 to 2017, the Morningstar Wide Moat Focus Index averaged an 11.85% return compared to the market’s 7.73%.

Source: Morningstar Direct

Earlier this year, Morningstar® Equity Research Services℠ examined the index’s performance in the white paper “A Wide-Moat Focus Outperforms the Market Over Time.” The authors demonstrate that the index can undergo periods of underperformance, such as 2013-15. But as high-conviction strategies often do, the index made up lost ground quickly. It gained 22.4% in 2016 versus 12.4% for the market.

The authors also conducted performance attribution and found that excess return has almost exclusively come through stock selection. The biggest contributors of 2016 included stocks as disparate as LinkedIn, St. Jude Medical, Harley Davidson, and Norfolk Southern. Further, the index has benefited from both the moat screen and the valuation input. A strategy focused simply on high-quality stocks would not have performed as well.

Why it pays to be selective

Today’s stock market looks pricey. Aggregating analyst-assigned valuations to the market level, U.S. equities appear roughly 7% overvalued. But there are always pockets of undervalued opportunity. The aggregate price/fair value ratio for the constituents of the Wide Moat Focus Index is 0.87, implying a 13% discount. For the long-term investor, the index has proved that it pays to be selective.

Want to explore the Morningstar Wide Moat Focus Index, or another index, in more detail? Visit Morningstar Indexes.

Dan Lefkovitz is a strategist for Morningstar's Indexes product group.