The VanEck Morningstar Wide Moat ETF (ASX: MOAT) recently paid a big dividend. Should you be buying this ETF for income?
Competitive advantage
The VanEck Morningstar Wide Moat ETF (ASX: MOAT) is an ASX-listed ETF with a focus on US companies with a strong competitive advantage – AKA a “wide moat”.
Moat is a term sometimes used by investors to describe a company’s competitive advantage. Much like a castle in medieval times with a wide moat (preferably filled with crocodiles), a company with a wide moat has some kind of barrier that protects it (and its earnings) from competitors.
This “moat” could be first-mover advantage in an emerging industry. It could be proprietary technology or protected IP. Or it could be that the industry the company is in has high barriers to entry (it might require expensive machinery or extensive infrastructure).
The theory is that a company with a wide moat should have greater control of its pricing than a company with a small, or no, moat.
Say you’re a commodity trader dealing in a common, high-volume item like wheat. It’s difficult to have any competitive advantage in that kind of industry. You’ll almost definitely be forced to take the prevailing market price for wheat and try to sell as much as you can on thin margins.
This isn’t a great way to run a business, but the reality is most businesses do exactly that – they take the market price.
A company with a wide moat on the other hand has some sort of advantage that allows them to offer a product or service that others can’t. Because they’re offering something unique, they have much more control over their pricing, and can therefore command higher margins.
A good example is Adobe Inc. (NASDAQ: ADBE), one of the companies held by the MOAT ETF. Adobe has several competitive advantages that allow them to control pricing.
They have huge market share and their software is considered the industry standard across creative professions. They also have a large suite of products that complement each other, giving users more optionality and creative choice.
The MOAT ETF
The MOAT ETF identifies these companies with competitive advantages using Morningstar’s Economic Moat rating system.
For Morningstar to identify a company as having a wide moat, it should have at least some of these key characteristics:
- High switching costs
- Network effects (value of a good or service increases as more people use it)
- Intangible assets (patents, IP, brand reputation etc.)
- Cost advantage (economies of scale)
- Operating in a market that only supports one or two companies
For a company to have a wide moat, Morningstar analysts have to believe the company can retain its advantage for at least 20 years, so they’re thinking long term.
The MOAT ETF currently holds 55 companies with an equal-weight approach, so you’re not heavily exposed to any one company.
The companies in the portfolio cover multiple sectors including industrials, health care, technology, consumer staples, and more.
Performance
Since inception in 2015 the MOAT ETF has returned just over 15% per year. Most of that has been capital growth (12%) but the MOAT ETF also pays a dividend once per year, with an average yield of 3% per year since inception.
However, MOAT recently paid a huge dividend and currently has a 12-month income return of 8.62%. So, should you buy it for the dividend?
The short answer is probably not.
Because the MOAT ETF is an equal-weight ETF, it needs to rebalance on a regular basis (at least a couple of times per year) to avoid becoming too heavily weighted towards a couple of companies.
When these rebalancing events occur, the MOAT ETF can end up accumulating excess cash. It then has the option to pay this out as a dividend to investors.
That’s why the recent dividend was so big – it’s not because the underlying companies were paying big dividends, it’s just that MOAT had to do a lot of rebalancing.
The historical dividend yield is much lower (around 3% per year) and dividends are only paid once per year, so MOAT is not an income-focused ETF.
If you’re looking for a growth ETF, MOAT could be a great option, but I wouldn’t be drawn in by the dividend.