VanEck has expanded its suite of “Moat” equity ETFs with a new fund focused on mid and small-cap stocks listed in the US.
Economic moats refer to firms with long-term structural competitive advantages.
The VanEck Morningstar SMID Moat ETF (SMOT US) has been listed on Cboe BZX Exchange with an expense ratio of 0.49%.
Similar to the firm’s existing Moat strategies, SMOT harnesses insights from Morningstar’s equity analysts to select firms considered to possess ‘wide moats’ – a significant, structural, competitive advantage that has the potential to provide long-term, above-average returns.
The term ‘economic moat’ was coined by Warren Buffett and can refer to brand loyalty, cost advantages, economies of scale, or regulatory protection, among others, as potential avenues whereby firms establish a strong market position.
VanEck offers a further four Moat funds providing exposure to US large-cap, ESG-focused US large-cap, global, and global ex-US stock market universes. The suite houses around $6.1 billion although the majority of those assets are found within the original, US large-cap fund – the $5.9bn VanEck Morningstar Wide Moat ETF (MOAT US).
SMOT is the first ETF to apply the Moat strategy to mid and small-cap stocks which have considerably less analyst coverage than their large cap-counterparts, creating greater potential for dispersions between stock prices and fair value. VanEck believes that this potential for mispricing reinforces the value of an index that applies a nuanced approach based on the collective insights of Morningstar’s extensive equity research team.
Brandon Rakszawski, Director of Product Management at VanEck, said: “Mid and small-cap stocks are an attractive segment of the US equity market as they’ve historically provided greater return potential than large caps. We’re currently seeing mid and small-cap valuations at a 20-year low relative to their large-cap counterparts, offering investors a timely and attractive entry point.
“The key with this category is to approach it through a research-driven lens as the dispersions in performance, valuations, and more can be stark. That is why we’re so pleased to continue our collaboration with Morningstar on these efforts, and why we see SMOT as a highly differentiated vehicle through which to add exposure to this category.”
Methodology
SMOT tracks the Morningstar US Small-Mid Cap Moat Focus Index which screens a universe of US-listed mid and small-cap equities for companies with a ‘Wide Moat’ Morningstar analyst rating.
The Morningstar Wide Moat methodology focuses on five key sources of competitive advantage. These include network effects (the increase in customer value as more customers use the service – eBay being a good example), intangible assets (including brand loyalty, patents, and regulatory licenses), cost advantages (which allow firms to undercut potential rivals), switching costs (the expense of money or time borne by customers who wish to switch providers), and efficient scale (whereby natural positioning or sunken infrastructure costs deter new firms from entering the market).
Once the pool of Wide Moat constituents has been identified, the index conducts a momentum screen that removes 20% of the eligible universe with the lowest share price performance over the past year.
The index then selects at least 75 of the remaining Wide Moat companies, choosing those that are trading at the most attractive valuations relative to Morningstar’s estimate of fair value.
Each constituent is equally weighted in the index, although reconstitution and rebalancing occur on a staggered schedule, meaning the fund is likely to always hold stocks with varying weights.
In economic theory, the competitive advantages attributable to moats are generally eroded over time. A firm with a competitive advantage often earns significant profits, encouraging new firms to enter the market and reducing the firm’s dominant position.
The index’s regular rebalancing, however, helps to eliminate firms whose dominant position is deteriorating, thereby maintaining the advantageous qualities offered by economic moat firms.