Morningstar describes wide moat businesses as those that can't be hurt even if you allegorically shoot, strangle, poison and drop them off a tall building. Wide moat firms are those that enjoy an almost monopoly in their field.
No moat firms, on the other hand, are those that have an almost impossible time getting an edge over their competition. That doesn't mean that they're not profitable or bad companies it's just that they are in a highly competitive sector with lots of other firms fighting for the same consumer.
For example if ten years ago you were looking to invest in a software company the name Microsoft would spring to mind as a wide moat firm. It still enjoys a strong monopoly today.
On the flip side is DuPont, a giant in the chemical and just about everything else or what I call the kitchen-sink business. It makes a bunch of stuff from radiator coolant, seeds, plastics and bulletproof vests. It has a no moat rating because all the businesses it is involved in are loaded with fierce competition.
Bringing this to an investment perspective is that in 2009 investors are ignoring the wide moat businesses and are favoring the no moat firms. This is also being reflected in mutual funds that own wide moat companies and seeing less than stellar returns so far in 2009.
No moat firms are being well rewarded in 2009, as are their investors and the mutual funds that own them.
Which brings me to my point, or better yet to the point Morningstar made when they wrote about firms with wide and no moats.
Many investors who study this bit of arcane information will ignore firms that have a no moat rating. But, as you can see from my example of two quality companies with great products they operate in different markets. One enjoys a wide moat and the other no moat. Owning either one could possibly enhance your portfolio and over time both have returned value to investors. But, from an asset allocation viewpoint they perform differently during certain economic periods because of their different moat status.
We've been taught that to have a pure asset allocation we should buy investments hugely different from each other, such as foreign and domestic or bonds versus common stocks. Now here is something much more subtle and we can create an allocation simply by buying either a wide moat or a no moat stock, or both or finding mutual funds that do.
The next time you review your mutual fund or stock portfolio you may want to double check some of those holdings to see what moat-category they fall into if their lagging the market, What you may find is that you do not own a bad stock or mutual fund but one with a moat rating that is currently out of favor. You can use this to your advantage with both domestic and foreign stocks and be assured of identical results.
You learn something new every day.
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