Performance Drivers of the Moat Index

In 2024, one theme has influenced the market more than any other. That's generative AI, and no company has benefited more from that theme than Nvidia. In fact, through May, Nvidia has accounted for one third of the total return of the S&P 500 index in 2024. That leaves any strategy that excludes or underweights Nvidia with a ton of ground to make up.

The VanEck Morningstar Wide Moat ETF (Ticker: MOAT) is one of those strategies. The Morningstar Wide Moat Focus Index, its underlying index, has posted notable underperformance in 2024 through May. I hope to address that underperformance, the key drivers beyond Nvidia, but also put this period into a more historical context.

Performance Drivers of the Moat Index

Let's start with the drivers of year-to-date relative performance. And of course, let's start with Nvidia. The Moat Index is a systematic, rules-based strategy that targets undervalued high-quality companies, as identified by Morningstar. As Nvidia's share price has climbed higher, along with its fair value estimate, it simply has not been undervalued or undervalued enough to warrant inclusion in the Moat Index in 2024.

In fact, the last time Nvidia was in the portfolio was in late 2022 for about a two-quarter stretch into early 2023. This lack of exposure to Nvidia has accounted for approximately 36% of the Moat Index's relative performance.

A second driver of relative performance and a related one has been the Moat Index's equal weighting methodology. There's been an incredible lack of breadth in the market. In other words, only a few companies have driven the total returns of the overall market thus far in 2024. To expand upon the Nvidia example, the so-called Magnificent 7, Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla have accounted for over 50% of the total return of the S&P 500 returns in 2024. And if you exclude the laggards, Apple and Tesla, so far this year, the remaining magnificent five have accounted for approximately 60% of the total market's returns.

Another illustration of this lack of market breadth is the price ratio of the equal weighted version of the S&P 500 relative to the well-known market cap weighted version of the S&P 500. Those price ratios are at levels we have not seen since 2009 during the global financial crisis.

A third driver of relative performance for the Moat Index has been what typically impacts performance in most any period, stock selection, particularly those overweight positions that are held in the Moat Index.

And many of those positions thus far have not panned out for the moat index in 2024, as we wait for the market to realize the true value of many of these companies. These include MarketAxess, Etsy, Gilead sciences, Estee Lauder and Biogen. That's not to say that there haven't been excellent stock picks within the portfolio. Those have just been overshadowed by those other stock picks and the lack of Nvidia exposure.

And the fourth and final driver of relative performance in 2024 has been momentum or the lack thereof. As a strategy that targets undervalued stocks, the Moat Index has typically been negatively loaded toward the momentum factor. And as momentum has been the top performing factor of traditional factors in 2024, that has certainly been a headwind for the Moat Index thus far this year.

Putting the Current Performance into Historical Context

Let's put current relative performance into a historical context.

As a highly differentiated strategy, the Moat Index is prone to periods of underperformance. In fact, as recently as 2021, 2020, and 2017, the Moat Index had similar periods of underperformance. They were all, however, followed by periods of excess returns.

Zooming out and Looking at the full index history which went live in 2007, following periods of 6-month underperformance greater than 5%, the Moat Index has outperformed on average by 4.8 % in subsequent 1-year periods and it has outperformed on average by 4.3% annually in subsequent 3-year periods. So more often than not, following periods of significant underperformance, there has been excess returns or outperformance by the Moat Index.

The success of Morningstar's Moat Index can be attributed to finding attractive entry points amongst a group of high-quality U.S. companies. Sometimes it takes more time for the market to realize the true value of these stocks. But in its over 15-year history, the Moat Index has delivered as a core U.S. equity position.

To stay up to date with moat investing trends, visit VanEck.com/subscribe to sign up for our moat investing newsletter.