It's been a rough ride for investors in 2016, with weak energy prices, an uncertain economy, worries about when and how much the Fed will raise rates, anxiety over the U.S. dollar and even political concerns over the upcoming election playing havoc on the broader stock market. But investors, desperate to stop the bleeding in their portfolios, might take a page from Warren Buffett's playbook and turn to so-called "wide moat stocks" for refuge.
What are moat stocks? Generally, they're companies that dominate a sector, often have a big brand name, have a long track record of stable profits, and, most importantly, have "wide moats" - or barriers - that would make it tough for a competitor to disrupt or steal business. Put simply, a wide moat stock is like a medieval castle that's surrounded by a large moat, which keeps enemies - or competitors - at bay, said Dan Lefkovitz, a content strategist for Morningstar's indexes. Only about 10% of the 1,500 stocks that Morningstar tracks are considered wide moat stocks.
Year-to-date, wide moat stocks have been sitting pretty.
Case in point: Morgan Stanley Investment Management's flagship Global Franchise Fund (MSFBX) - Get Report , which heavily favors wide moat stocks, is up more than 4% so far in 2016 while the VanEck Vectors Morningside Wide Moat ETF (MOAT) - Get Report is up more 10% year-to-date. Both far outpace the S&P 500's 0.6% return, the Nasdaq's negative 5.4% return and the Russell 2000's negative 1.9% return.
The term "moat" was first coined by billionaire investor Warren Buffett in November 1999 when he was describing why he was sticking with mundane companies that dominated their markets rather than jumping into the red-hot technology sector. "The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors," he wrote in an editorial to Fortune at the time. Within a year after making this comment, many of the tech stars had crashed and burned while his moat stocks remained resilient.
Morningstar assigns moat ratings on every stock it tracks - whether it's wide, narrow or no moat at all. A wide moat company holds the biggest competitive advantage: Often the company holds a monopoly on a particular product or service because of its large size, patents, pricing or popularity. Also, demand for a wide moat company's product often remains stable in good economic times or bad, and there's little concern that some new player will topple it with a better mousetrap. "We think they'll be able to hold off the competition for 20 years or more," said Michael Holt, global head of equity research at Morningstar.
Names like Coca-Cola Co. (KO) - Get Report , which is up 5.5% year-to-date; Oracle Corp. (ORCL) - Get Report , which is up 7.9%; Facebook (FB) - Get Report , which is up 14%; and Wal-Mart Stores (WMT) - Get Report , which is up 11%, are examples of wide moat stocks.
Morgan Stanley Investment Management's Global Franchise fund has been making a case for wide moat stocks for some time as it targets the "steady Eddies" and "global franchise brands" that offer steady growth and margins. This strategy "could serve as a haven for investors in unstable times," said Bruno Paulson, the fund's co-manager, in a statement. His fund's holdings, as of the end of March, included Nestle, Reckitt Benckiser Group (RB.L), Microsoft Corp. (MSFT) - Get Report , Unilever PLC (UL) - Get Report , and Altria Group. (MO) - Get Report among others.
Still, wide moat stocks won't necessarily outperform the markets all the time. Much depends on valuation at the time. "At the end of the day, good companies can be overvalued and bad companies can be undervalued," said Holt.
That's where the VanEck Vectors Morningside Wide Moat ETF comes in. It tracks the 20 cheapest moat stocks, based on valuation, among the 144 companies that Morningstar lists in its Wide Moat Composite index, said Brandon Rakszawski, an ETF product manager at VanEck. Each quarter, the top-20 list is reviewed and shuffled.
Right now, healthcare moat stocks make up a big chunk - 39% - of the ETF.
"Through the first three months of the year, health care had struggled particularly in the pharma and biotech sectors," making them attractive to add to the ETF, he said. These companies include St. Jude Medical (STJ) , Express Scripts Holding (ESRX) , McKesson Corp. (MCK) - Get Report , Biogen Inc. (BIIB) - Get Report , Varian Medical Systems (VAR) - Get Report , Gilead Sciences Inc. (GILD) - Get Report , and Amgen (AMGN) - Get Report . Others in the VanEck ETF include CBRE Group (CBG) , LinkedIn (LNKD) , State Street Corp. (STT) - Get Report and Walt Disney Co. (DIS) - Get Report .
"These are high-quality companies that are trading at attractive valuations," said Holt. "And their competitive advantage should persist for at least 20 years."
This article is commentary by an independent contributor. At the time of publication, the author held TK positions in the stocks mentioned.