Time to Consider Wide Moat ETFs

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The first half of 2012 has been very volatile for the world stock markets, given slowing U.S. economic growth and worsening European debt problems.

By Zacks Investment Research

With the announcement of another round of quantitative easing (or QE3) by the Federal Reserve to spur economic growth, the markets have surged to a new high, suggesting more upside potential in the year ahead as the full impact of this program is felt (read: Are the Troubled European ETFs Back on Track?).

Investors looking to put more in the market could tap the current opportunity by investing in wide moat stocks. These stocks have easily beaten the S&P 500 since the inception of the wide moat concept in exchange-traded product form in late 2002 and have outperformed the S&P 500 by at least 5% over the last three to five years.

Given their robust track record, these stocks have been the biggest gainer from QE1 and QE2, beating the broader market returns. As a result, we expect these stocks to benefit from the QE3 implementation as well (read: Commodity ETFs in Focus as Fed Unleashes QE3).

Concept of Wide Moats

The term was widely used by the famous investor, Warren Buffett, who describes “wide moats” as sustainable competitive advantages that enable companies to produce outsized returns over time. In other words, a wide moat offers solid returns, ensuring safety of income, as it is harder for the rivals to overcome the companies with these advantages.

Generally, the competitive advantages can be in any form such as brand power, high switching costs, network effects, cost advantages or efficient scale. Any of these factors, or better yet a combo of them, look to make it very difficult for new entrants to steal share and unseat firms

The wide moat companies not only warrant rapid growth but also preserve value via returns on invested capital (ROIC) over the long term. These companies are well positioned compared to rivals, especially if they possess other strengths such as huge liquid cash reserves or strong balance sheet.

Wide Moat ETFs in Focus

Investors could play the wide moats in the ETF form that provides ample flexibility as well as tax and diversification benefits when compared to individual stocks or mutual funds (see more ETFs in the Zacks ETF Center). The funds honing in on the stocks that have wide competitive moats are doing better than the other funds in the space.

Investors have only two options in the wide moat ETF space to choose from, each having different structures, both of which we have briefly highlighted below:

Market Vectors Morningstar Wide Moat Research ETF (MOAT)

Launched by Van Eck, this fund has recently made its debut in the space in April 2012 (read: Van Eck Launches Morningstar Wide Moat Research ETF (MOAT)). It seeks to match the price and yield of the Morningstar Wide Moat Focus Index, before fees and expenses. The index has been generating exceptional returns relative to the overall market.

The fund provides exposure to 20 U.S. securities that have sustainable competitive advantages. None of the stocks occupies more than 6% of the share in the basket, suggesting higher diversification benefits.

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