Morningstar Magazine - August/September 2017 - 58

Investors

Lane: It's important to remember that our moat
methodology is forward-looking, so a company
that has exhibited evidence of competitive
advantage may not have a sustainable moat going
forward. Historical performance is no indication
that whatever moat source the company enjoyed
over time will be there for the long run. That's
something that separates the moat methodology
from a quality-based factor analysis, which
tends to be backward-looking. The moat methodology requires us to investigate what competitive
dynamics will look like five, 10, and 20 years
down the road. We hope our approach will lead to
better investor outcomes than a methodology
that's purely backward-looking.

I'd also throw in that it doesn't necessarily mean
it's low-risk, either. Just because a fund has
a portfolio full of wide-moat companies doesn't
necessarily make it safer, As you guys said, it really
comes down to valuation; that's a huge part of this.
Collins: Kevin, do you see any managers who claim
to have a moat investing strategy but end up
having a lot of companies that don't agree with our
equity analysts' ratings in their portfolios?

McDevitt: Absolutely, and it becomes a great
discussion point, too. If you have someone
who talks about competitive advantages and then
you don't see that reflected in the portfolio, well,
then it starts a conversation. You have to reconcile
the difference between what someone says
they do versus what's actually showing up in the
portfolio. You also get managers who focus
on wide-moat companies who conflate the
concept with their own strategy. Just because

Hodel: Sometimes, we talk about moat width
versus moat depth. No one can cross a moat that's
deep, but maybe it's not very wide. It won't
take long for competitors to figure out how to get
across that moat. But in that short window of time,
when the moat is extremely formidable, this
company's going to earn high returns on capital.
You see this a lot in consumer-products companies
that are able to build a brand that resonates
with consumers for a short period but that doesn't
have staying power. Once that moat is breached,
it becomes just like any other company that
can't preserve those excess returns on capital. So,
that forward-looking idea is really important. There
are companies that can be posting really
impressive numbers for a short time, but if there
isn't something structurally sustainable behind
what the firm is doing, those returns can dissipate
very quickly.
McDevitt: I also find in talking with managers
that they'll look at the moat rating as a very broad,
comprehensive rating on quality, when really,
it's capturing just the business competitiveness
itself. Especially these days, with quality being
such a popular factor with exchange-traded funds
and other types of funds, you see that moats
are getting lumped in with it, and people miss the
nuances. Also, because portfolios that own
companies with high-quality moats have done well
in the past three bear markets, we're starting
to see this notion that portfolios with wide-moat
companies are safer. You guys alluded to this
already that just because a company has a wide
moat doesn't necessarily make it a good stock.

Morningstar August/September 2017

This idea that a moat is a static data
point is just not the case. These are
fluid, debatable things that make markets
at the end of the day. There's room
for disagreement and debate.
Mike Hodel

Table of Contents for the Digital Edition of Morningstar Magazine - August/September 2017