By The Sizemore Letter<\/u><\/p>\n
For an ETF dedicated to companies with sustainable competitive advantages\u2014or \u201cwide moats\u201d to borrow a term from Warren Buffett<\/a><\/strong>\u2014you might expect relatively low turnover.\u00a0 After all, moats don\u2019t dry up overnight.<\/p>\n Yet in its annual reconstitution last month, the Market Vectors Wide Moat ETF<\/b> (<\/span>MOAT<\/a>)<\/span>, which is based on the Morningstar Wide Moat Focus Index, replaced 9 of its 20 holdings.\u00a0 Sizemore Investment Letter<\/i> favorite Kinder Morgan<\/b> (<\/span>KMI<\/a>)<\/span> was a new addition, as was longtime Buffett holding Coca-Cola Co<\/b> (<\/span>KO<\/a>)<\/span>.\u00a0 And rounding out the newbies were Spectra Energy Corp<\/b> (<\/span>SE<\/a>)<\/span>, Sysco Corp <\/b>(<\/span>SYY<\/a>)<\/span>, CSX Corp <\/b>(<\/span>CSX<\/a>)<\/span>, Allergan Inc<\/b> (<\/span>AGN<\/a>)<\/span>, Covidien PLC<\/b> (<\/span>COV<\/a>)<\/span>, ITC Holdings<\/b> (<\/span>ITC<\/a>)<\/span> and Medtronic<\/b> (<\/span>MDT<\/a>)<\/span>.<\/p>\n Getting booted off the list were Expeditors International <\/b>(<\/span>EXPD<\/a>)<\/span>, Qualcomm<\/b> (<\/span>QCOM<\/a>)<\/span>, National Oilwell Varco <\/b>(<\/span>NOV<\/a>)<\/span>, Schlumberger<\/b> (<\/span>SLB<\/a>)<\/span>, Vulcan Materials<\/b> (<\/span>VMC<\/a>)<\/span>, Maxim Integrated Products <\/b>(<\/span>MXIM<\/a>)<\/span>, Amgen<\/b> (<\/span>AMGN<\/a>)<\/span> and Caterpillar<\/b> (<\/span>CAT<\/a>)<\/span>.<\/p>\n But there was one removed holding that really stood out: social media darling Facebook <\/b>(<\/span>FB<\/a>)<\/span>.<\/p>\n What exactly is going on here?\u00a0 Last I checked, Facebook still had an unassailable moat in its particular niche of the social media world, which consist of photo sharing and social networking.\u00a0 Its \u201ccompetitors\u201d have businesses that only overlap at the edges.\u00a0 Twitter <\/b>(<\/span>TWTR<\/a>)<\/span> has evolved into primarily a news aggregation and announcement service, and LinkedIn <\/b>(<\/span>LNKD<\/a>)<\/span> is a place to swap r\u00e9sum\u00e9s.\u00a0 And it has one of the strongest network effects in place of any company in existence. (Network Effect is one of Morningstar\u2019s five competitive advantages<\/a>.\u00a0 The other four are High Switching Cost, Cost Advantage, Intangible Assets\u2014i.e. powerful branding\u2014and Efficient Scale. )<\/p>\n Likewise, while I can make a strong case for the quality of the moats of any of the new entrants, I could just as easily make a strong (or stronger) case for most of those exiting.\u00a0 For example, Qualcomm technology goes into virtually every smartphone, and Amgen has size and scope that few of its competitors in biotech can match.<\/p>\n So what gives?\u00a0 Why the high turnover in a portfolio of wide-moat businesses?<\/p>\n It comes down to Morningstar\u2019s index methodology<\/a>.\u00a0 Having an unassailable moat isn\u2019t the only criteria; the stocks must also be attractively priced.\u00a0 And on this count, Morningstar uses a discounted cash flow model with a twist.\u00a0 Based on their assessment of the strength of the company\u2019s moat, the Morningstar analysts forecast its return on invested capital relative to its cost of capital (the wider the moat, the bigger the spread between the return on capital and the cost of capital).<\/p>\n If that last sentence made your eyes glaze over, don\u2019t feel bad.\u00a0 Academic finance has its own language, and Morningstar is being a little wonkish here.\u00a0 In plain English, Morningstar makes a list of the 20 cheapest stocks that it classifies as having a \u201cwide moat.\u201d<\/b><\/p>\n Facebook and the eight others were not booted off the list because their moats shrank. They were simply replaced with stocks that, in Morningstar\u2019s view, were more undervalued.<\/p>\n What are we to take away from all this?<\/p>\n The MOAT ETF doesn\u2019t have a long trading history (less than two years), but over its short life it has outperformed the S&P 500 by about 10%.\u00a0 Of course, this is before taxes, and with a turnover ratio of 45%, MOAT will generate its fair share of capital gains taxes in non-IRA portfolios.<\/p>\n With only 20 holdings, MOAT\u2019s portfolio<\/a> is also pretty undiversified by ETF standards.\u00a0 It\u2019s heavily weighted towards healthcare and technology (at least until its next reconstitution) and has very little exposure to consumer-focused sectors.<\/p>\n And if you\u2019re buying MOAT for its \u201cBuffett-like\u201d investing style, the high turnover and short holding periods are a little inconsistent.\u00a0 Yes, Warren Buffett actively trades, and not all of his holding periods are \u201cforever.\u201d\u00a0 But Buffett would never hold to a fixed reconstitution schedule, and it would be rare for him to unload nearly half of his portfolio every year.\u00a0 (Interestingly enough, Buffett\u2019s Berkshire Hathway<\/strong> (<\/span>BRK_B<\/a>)<\/span> is one of MOAT\u2019s holdings.<\/p>\n My advice?\u00a0 Use MOAT\u2019s holdings as a stock screener for quality stocks trading at a reasonable price.\u00a0 Morningstar\u2019s analysts have done excellent research here, and you can essentially piggyback on it for free by following the ETF\u2019s trading moves.<\/p>\n You don\u2019t have to buy every stock in its list\u2014and you certainly don\u2019t have to sell a good stock simply because MOAT sold it.\u00a0\u00a0 But I consider MOAT one of several good screeners to get you started in your research. Some others I like as well are the Shareholder Yield ETF<\/a>\u00a0(<\/span>SYLD<\/a>)<\/span>and Greenblatt\u2019s Magic Formula<\/a>.<\/p>\n Charles Lewis Sizemore, CFA, is the editor of the\u00a0Sizemore Investment Letter<\/a>\u00a0and the chief investment officer of investments firm Sizemore Capital Management. As of this writing, he was long KMI and SYLD.\u00a0Click here<\/a>\u00a0to learn about his top 5 global investing trends and get your copy of \u201cThe Top 5 Million Dollar Trends of 2013.\u201d \u00a0This article first appeared on InvestorPlace<\/a>.<\/em><\/p>\n This article first appeared on Sizemore Insights as The MOAT ETF: Not How Buffett Would Invest, But a GREAT Stock Screener<\/a><\/p>\n