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With markets struggling as of late, some investors are taking more of a value approach as we close out the year. One way to do this is by focusing in on so-called ‘wide moat’ stocks which can potentially be safer companies that have huge leads over their peers.

These firms have sustainable competitive advantages that make new entrants into a particular space nearly impossible or unwise at best. Generally speaking, these advantages fall into one of several categories; intangible assets, switching costs, network effect, cost advantage, or efficient scale.

When a company has one of these advantages—or a few of them—it usually can pass on costs and develop pricing power, or it can maintain its edge with less effort than firms with a great deal of even competition. For this reason, these firms are generally considered solid investments and are a favorite of investing legend Warren Buffett among others (see Small Cap Value ETF Investing 101).

While investors can certainly buy up a few wide moat stocks for their portfolio, a more diversified way to accomplish this task could be via ETFs. For these investors, a look at the relatively new Market Vectors Wide Moat ETF (MOAT - ETF report) could be ideal.

The product tracks the Morningstar Wide Moat Focus Index which gives equal-weighted exposure to 20 companies with sustainable competitive advantages, or moats, according to Morningstar’s research team. The ETF charges just 49 basis points a year for this service and it rebalances and reconstitutes the index on a regular basis.

Not only does the fund have an interesting methodology, but it has been a solid outperformer as well. In fact, the product has handily outperformed broad markets since its inception in late April, while it has been able to keep its gains better during the recent turmoil, suggesting it could be a lower risk pick (read Three Excellent Dividend ETFs for Safety and Income).

Yet when one looks at the holdings choices, one might be a little puzzled. After all some seemingly questionable picks—at least at first glance—dominate the top ten stocks of MOAT.

This includes a number of technology and materials firms, not exactly the two sectors that one thinks of when the words ‘wide moat investing’ are mentioned. So what gives with some of the choices in the product’s top holdings? For example, here is a list of the fund’s top ten stocks, as of the end of October:

 

Stock

Industry

Lowe’s (LOW - Analyst Report)

Building Products

Facebook (FB - Analyst Report)

Internet Services

Compass Minerals (CMP - Snapshot Report)

Chemicals- Diversified

Bank of New York Mellon (BK - Analyst Report)

Banks- Major

C.H. Robinson (CHRW)

Transportation Services

Maxim Integrated Products (MXIM)

Semiconductors

Sysco (SYY)

Food- Wholesale

Exelon (EXC)

Utilities

Vulcan Materials (VMC)

Building products- cement/concrete

Northern Trust (NTRS)

Banks- Major

If that wasn’t enough, the ETF does have a relatively high turnover, with many of the top holdings finding their way completely out of the fund at the start of a new quarter. While there is nothing necessarily wrong with that, wide moat investing is definitely a long term concept so this constant shifting may be somewhat strange to at least a few investors out there.

What Gives?

Well, first off it is important to remember that not only does the product look at wide moat stocks, but it also takes valuations into account as well. The ETF invests in only the 20 most attractively priced securities when taking into account the price vs. the Morningstar fair value.

So, this valuation stipulation has the effect of removing some of the more well-known wide moat names which are not as attractively priced right now. This reason is also why some companies like Lowe’s (LOW - Analyst Report) are included, but its arch-rival Home Depot (HD) is not (see Three ETFs to Watch in Hurricane Sandy’s Aftermath).

Beyond that, some stocks which at first glance might not appear to have many wide moat characteristics, actually do upon closer inspection. For those curious, we have determined which of the factors correspond to each of the top holdings:

 

Stock

Industry

Wide Moat Factor

Lowe’s (LOW - Analyst Report)

Building Products

Cost Advantage

Facebook (FB - Analyst Report)

Internet Services

Network Effect

Compass Minerals (CMP - Snapshot Report)

Chemicals- Diversified

Cost Advantage

Bank of New York Mellon (BK - Analyst Report)

Banks- Major

Switching Costs

C.H. Robinson (CHRW)

Transportation Services

Network Effect

Maxim Integrated Products (MXIM)

Semiconductors

Intangible Assets

Sysco (SYY)

Food- Wholesale

Efficient Scale

Exelon (EXC)

Utilities

Efficient Scale

Vulcan Materials (VMC)

Building products- cement/concrete

Cost Advantage

Northern Trust (NTRS)

Banks- Major

Switching Costs

 Lastly, for those who are curious as to the breakdown of the fund among the various wide moat factors, Brandon Rakszawski of Van Eck Global has provided a list of the weights to each factor below (it adds up to more than 100% due to some companies having more than one factor):

 

Cost Advantage

44%

Switching Costs

34%

Efficient Scale

19%

Intangible Assets

58%

Network Effect

22%

As you can see, the ETF tilts towards low cost producers and firms that have a great deal of intangible assets. Meanwhile, network effects and efficient scale aren’t as important to the overall portfolio.

Still, with a little digging beyond the stocks and their various industries, it is easy to see why many of the firms were included after all. Furthermore, it is important to keep in mind the valuation metric and how this criteria point can create higher turnover and eliminate some of the more famous wide moat stocks from inclusion (see The Truth about Low Volume ETFs).

Either way, it does appear that MOAT offers investors a diversified play across industries into a number of wide moat factors. Not only that, but the fund has been outperforming since inception, giving further credence to the idea that wide moat ETF investing could be a great idea for many investors, and especially when broad markets are in trouble.

Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report >>

Follow @Eric Dutram on Twitter

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