essays pieces of the puzzle
Thursday, September 27th, 2012
measuring the moat

Morningstar credits Warren Buffett with the idea of a “moat” around very good businesses.  When the firm started doing equity research, it adopted that concept into its methodology.  Why?  “A wide-moat company has a sustainable competitive advantage that enables it to keep competitors at bay for an extended period of time,” says the construction rules for its Wide Moat Focus Index, which it started a few years later.

Shortly thereafter, an ELEMENTS ETN (WMW) linked to the index started trading and this spring Market Vectors introduced an ETF (MOAT) based upon it.

So, from an investing principle to a research methodology to an index to an ETN to an ETF.  I’ll let the research side of it go for now, other than to quote an old posting from The Psy-Fi Blog that said, “Sometimes the moat becomes less a defense and more a prison.”

In the top panel of the chart, you can see how the index has done against the S&P 500.  Great overall, with bursts of outperformance, normally when the market is under pressure.  To assess this as an investment by itself or in concert with others, you’d want to spend time analyzing whether this particular period might be representative of the years ahead.

You can start by looking at the history of the discount to fair value for wide-moat stocks.  It has been narrowing, according to this interview from Morningstar.

In the comments on that interview, someone wrote (twice), “I have done very well with WMW.”  Its performance relative to the index is shown the middle panel.  The persistent downward trajectory is due to the 75 basis points of fees per year.  You can see that during times of volatility it doesn’t track the index very well, so you’d have to be careful trading it, but it tends to “trade by appointment,” as they say.  You also have to be comfortable with the credit risk of Deutsche Bank, the issuer.

MOAT has just a brief history and somewhat lower fees, but already has larger assets than WMW and higher trading volumes.  It seems like a much better vehicle to play the concept, but the key consideration is whether now is the time to play the concept.  That’s a much harder question.  (Chart:  Bloomberg terminal.)

the providers of investment advice

My latest article for the CFA Institute looks at investment advisors and the range of attributes that one might (or might not) bring to the table.

trillions for the taking

As the progression of the wide-moat example above indicates, there are lots of new ways an old idea is adapted by the investment world.  But what of new ideas?  The business needs a jolt of creativity.