ETF growth in the U.S. equity market has been somewhat slow after the blistering pace that investors saw in the earlier part of the decade as more issuers have been focused on global or international markets instead. Nonetheless, a few issuers are continuing to pump out new products in the space including Russell and its factor-based funds and Direxion’s volatility response ETFs. Beyond these few additions, new pickings have been quite slim but investors could soon see a fresh entrant from Van Eck as well (read Are Telecom ETFs In Trouble?).
The New York-based firm best known for its sector ETFs, has recently announced, in an SEC filing, plans to launch a new ETF targeting the U.S. market. This proposed fund looks to have a focus on firms that have ‘wide moats’ and proposes to be based on an index from Morningstar. While details remain few and far between—ticker symbol and expense ratio info was not released—we have highlighted some of the key points from the filing below:
The proposed fund looks to track the Morningstar Wide Moat Focus Index which is an equally weighted benchmark that looks to give exposure to a series of companies that have sustainable competitive advantages that can persist over the long-haul. Morningstar selects these companies from the Morningstar US Market Index which is a broad market index that represents roughly 97% of the U.S. market. Out of these companies, the index provider will select 20 that rate the most favorably in terms of estimates of fair value to the stock price for inclusion in the underlying benchmark (see Three Outperforming Active ETFs).
Firms are considered ‘wide moat’ companies if they have at least one of the following characteristics inherent to their businesses; internal cost advantages, intangible assets, network effects, or scalability. Meanwhile, in order to assign fair values to companies, the index provider will use a standardized valuation model across three distinct periods. In each period, the manager will calculate the free cash flow and then calculate an enterprise value in order to determine the most attractive securities for inclusion in the benchmark.
While the method may sound intriguing to some investors, it should be noted that an ETN already exists targeting the exact same space. This note from ELEMENTS, which is also linked to the Morningstar Wide Moat Focus Total Return Index ETN (WMW - ETF report) , offers investors a way to play the space in ETN form. This means that there isn’t any tracking error but investors do have to worry about the credit risk from the underlying institution, Deutsche Bank (see ETFs vs. ETNs: What’s The Difference?).
WMW, after cratering—along with most equity based ETFs—in 2008, has been on an absolute tear since then, gaining close to 90% in the past three year period. Despite this quality long term performance, in addition to beating out the market by a wide margin in 2011, the product has failed to attract a decent following among investors. In fact, the product has less than $15 million in AUM and trades less than 7,000 shares a day. While these low figures could suggest that there is little interest in the wide moat space, it seems more likely that investors are still somewhat skittish about the ETN structure. As a result, the proposed fund from Van Eck, if ever approved by regulators, could see decent inflows if it hits the market at some point this year (also read Five ETFs to Buy in 2012).
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