I'm a big fan of the ASX-listed exchange-traded fund (ETF) VanEck Morningstar Wide Moat ETF (ASX: MOAT) because of its capability to potentially beat the S&P/ASX 300 Index (ASX: XKO).
No investment is guaranteed to outperform another one of course, and past performance is not a reliable indicator of future performance.
But if I had to pick to own either the MOAT ETF or the Vanguard Australian Shares Index ETF (ASX: VAS) (which tracks the ASX 300), I know which one I'd rather buy for a few different reasons.
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Historical performance
Ultimately, investing is all about making returns.
Let's look at how each of the investments has performed in recent history.
Over the past three years, the VAS ETF has returned an average of 8.1% per year, and the MOAT ETF has returned an average of 12.2%.
In the last five years, the VAS ETF has returned an average of 8.3% per year, and the MOAT ETF has returned an average of 14.6%.
Over the last 10 years, the VAS ETF has delivered an average return per year of 8.9%. The MOAT ETF is not 10 years old, so I'll mention the return over the past decade of the index it tracks, which has returned an average of 16.4%.
I believe there are three main reasons VanEck's offering has outperformed the ASX share market and why it may continue to.
Strong economic moats
Analysts from Morningstar have assigned economic moat ratings to approximately 1,500 US companies under their coverage.
What's a moat? Morningstar notes that an "economic moat is a sustainable competitive advantage that allows a company to generate positive economic profits for the benefit of its owners over an extended period."
Moats can include things like intellectual property, cost advantages, switching costs, network effects and efficient scale.
For a business to be rated as having a wide economic moat, it must, "with near certainty", be able to generate excess profits 10 years from now. In addition, excess profits "must, more likely than not, be positive 20 years from now."
The Morningstar analysts are looking for the duration of the moat rather than the current absolute size. The research outfit explains:
For example, if a high-flying tech company is a first-mover in offering a popular, innovative product or service, it might quickly achieve very high returns on invested capital. However, if there is no moat source (such as intellectual property) preventing competitors from replicating that product or service, we would assign a no-moat rating. In this case, the heady economic profits the company has been able to generate due to its first-mover advantage would likely deteriorate quickly as new competition enters the market.
Only businesses with excellent moats are allowed into the portfolio.
Good value stocks
There is a second layer of the investment strategy that helps the MOAT ETF perform so well, in my opinion.
VanEck says that target companies must be trading at attractive prices relative to Morningstar's estimate of fair value.
In other words, analysts believe these companies must be attractively priced compared to what they're actually worth (in theory).
With this tactic, the MOAT ETF should always have a portfolio of good-value, high-quality businesses that could outperform in the short term and long term.
ASX blue-chip shares earning low returns on retained profit
The ASX stock market is weighted to leading ASX bank shares and ASX mining shares. However, those businesses are not known for generating strong returns on equity (ROE).
That means that retained profits within the businesses are not unlocking major profit growth, which is a key driver of share price growth. The businesses are also paying out a substantial amount of their profit as a dividend each year, which is helpful for short-term passive income but leaves less within the business for reinvestment.
Overall, I think the MOAT ETF is set up to perform well over the long term and continue to beat the ASX 300.
