How to Invest in Wide-Moat Companies and Oligopolies via ETFs

What do the bankruptcies of once-iconic American brands like Eastman Kodak, Sears, and Bed Bath & Beyond have in common? While it's tempting to point to financial missteps—ill-timed buybacks, burdensome debt, declining sales, and negative cash flow—these issues only scratch the surface.

Digging deeper, the root cause of these companies' decline began long before their stock prices plummeted, originating from the gradual erosion of their competitive advantages. This underlying weakness made them vulnerable to market changes that they ultimately couldn't withstand.

For long-term investors, this highlights the importance of focusing on companies that not only have strong competitive moats but are also likely to maintain these advantages over time due to inherent structural characteristics. While it's possible to identify and invest in such companies individually, leveraging ETFs can often simplify and automate this process.

Here are two notable ETFs that specialize in holding companies with sustainable competitive advantages, sometimes verging on oligopolistic dominance.

Wide-moat stocks

The concept of wide-moat investing has been thoroughly explored by Morningstar, which has developed a methodology identifying five key sources of a moat. These sources, as I've previously discussed in an article on Warren Buffett's investment style, include:

• Cost Advantage: Companies that can produce goods or services at a lower cost while maintaining profitability. For instance, Walmart dominates retail through its massive scale and efficiency, undercutting competitors.
• Intangible Assets: This encompasses brand strength, patents, and regulatory licenses that prevent competition. Coca-Cola, for example, benefits from unparalleled brand recognition and consumer loyalty that are difficult for competitors to replicate.
• Network Effect: The value of a service increases as more people uses it. Visa illustrates this point well, as each new user enhances the network's value without significantly increasing costs.
• Switching Costs: It becomes costly or troublesome for customers to switch providers. Axon, which supplies law enforcement with Tasers and body cameras, creates high switching costs due to significant training and regulatory challenges involved.
• Efficient Scale: Occurs in markets effectively served by one or a few companies, deterring others due to limited opportunity. Union Pacific operates in a market where the logistical and capital costs of entry are immense, securing its competitive edge.

In a practical application of this theory, Morningstar partnered with asset manager VanEck to launch the VanEck Morningstar Wide Moat ETF (MOAT).

This ETF tracks the Morningstar Wide Moat Focus Index, a benchmark that selects stocks from the broad Morningstar US Market Index based on two criteria: a "wide" economic moat rating and a "fair value" estimate by Morningstar analysts, adding a subjective element to the evaluation process.

The MOAT ETF filters out the smallest 3% of companies by float-adjusted market capitalization. The remaining stocks are ranked by their fair value ratios, with about 40 stocks selected and split into two sub-portfolios. These are equally weighted within each and reconstituted semi-annually on a staggered quarterly schedule—one sub-portfolio in December and the other in June.

Despite a relatively high expense ratio of 0.47%, MOAT has performed commendably. From its inception on April 25, 2012, to October 25, 2024, it has achieved a compound annual growth rate (CAGR) of 14.50%, slightly outperforming the SPDR S&P 500 ETF (SPY), which had a CAGR of 14.14%.

Monopolies and oligopolies

While a moat refers to sustainable competitive advantages that protect a company from its competitors, the concepts of monopolies, duopolies, and oligopolies represent arguably stronger and more entrenched competitive positions.

• Monopoly: A market structure characterized by a single company dominating an industry, often with exclusive control over a product or service. An example here could be Deere, which dominates the construction and agriculture machinery sectors, facing little competition in specific niches.
• Duopoly: A market predominantly controlled by two companies. A classic example is the Canadian railway industry, where CNR (Canadian National Railway) and CP (Canadian Pacific Kansas City) virtually split the market, creating a duopoly in rail transportation across Canada.
• Oligopoly: A market where a limited number of firms hold a large market share, making competition among them less fierce but more strategic. The exchange market, with players like ICE (Intercontinental Exchange) and CME (Chicago Mercantile Exchange), showcases an oligopoly where these entities operate major financial and commodity market exchanges.

For investors interested in capitalizing on such powerful market positions, the Tema Monopolies and Oligopolies ETF (TOLL) provides a high-conviction approach. This ETF is actively managed and charges a reasonable 0.55% expense ratio, only marginally higher than MOAT.

Unlike passive index funds, TOLL emphasizes a bottom-up fundamental analysis, capturing the subjective elements of investing in monopolies and oligopolies. As Warren Buffett famously commented:

"No formula in finance tells you that the moat is 28 feet wide and 16 feet deep. That’s what drives the academics crazy. They can compute standard deviations and betas, but they can’t understand moats.”

TOLL seeks to invest in what it identifies as "true monopolies" with tangible barriers to entry and defensive earnings streams. This includes companies with real assets and inflation-linked pricing, thus reducing reliance on the tech and consumer sectors that often bank more on intangible assets.