The German index provider shows how getting exposure to companies surrounded by an Economic Moat via a rule-based alternative index can deliver outperformance

Following the launch of the Solactive Systematic Moat Index last week, SRP spoke to Timo Pfeiffer (pictured), head of research at Solactive, about the latest addition to the index provider’s Intuitive Beta family, which uses an investing approach relying on ‘intuition and gut feeling’ as a starting point.

To support the new benchmark, the index provider has released a white paper, Economic Moat, which explores a rules-based approach to select companies with lasting competitive advantages as an alternative way of quality investing. “Any underlying strategy that can lead to high outperformance without leverage via options and has embedded protection is an interesting proposition to be delivered with structured products,” said Pfeiffer. “This particular strategy lends very well to tracker certificates, as the index provides exposure to stocks from companies that have an established and consistent business model. But it can also be deployed via partially-protected structures, as the non-protected part of the investment can be used to generate outperformance without having to resort to the use of leverage.”

The fundamental structure consists of three levels, including low cost production or differentiation power, scalability of the business model, as well as a company’s intellectual properties, like franchises, patents or licenses, according to the research paper.

The index was built as a quality strategy to generate outperformance and as an alternative to products using leverage, because the potential pick-up in case of a drawdown is naturally pretty high compared to other strategies as investors in bad days tend to resort to intrinsically safe investments, according to Pfeiffer.

The research paper argues that, in order to be surrounded by an Economic Moat, companies should maintain their unique selling proposition by means of products or services that lead to high switching costs for customers, and trigger strong network effects.

The research team looked at companies with the highest profitability per employee as a starting point, while the index captures commonalities among those profitable companies that the ratios that exist in long-term quality companies such as margins and valuation, according to Pfeiffer.

The index is designed to select companies that have a competitive advantage because of their business model and also have defensive blocks, as they benefit from a low substitution threat and strong network effect. “We then looked at how these companies reach that status and their characteristics,” said Pfeiffer. “We found that they all provide an innovative products or services that have established themselves rapidly in the market through a strong network effect. Once consumers start using these products and services, it is very unlikely they will switch to other providers. Needless to say, in the background, the respective companies are continuously investing, scaling, and innovating.”

The index provider believes its Systematic Moat US Index will resonate with retail investors because of the simplicity of the concept and the potential to deliver returns from companies surrounded by an Economic Moat, said Pfeiffer.

The first version of the index is based on a US universe where large brand names with market power intuitively ring a bell. “It is possible to provide a similar screening on different universes such as the European, global or emerging markets, but this will require a more intensive exercise in terms of cleaning up the data,” said Pfeiffer. The index provider’s ‘intuitive beta’ concept will continue to drive the investment belief “because there is always going to be companies that are difficult to value”, according to Pfeiffer.

To avoid having a bias towards size, Systematic Moat US Index constituents are equally weighted. The index universe consists of 40 stocks having the highest Economic Moat ranking, including Gilead Sciences, McDonald's Corp, Planet Fitness and Oracle Corp.

Solactive has 136 indices used as underlying across more than 1,000 products and 21 markets, and has over US$3 billion worth of structured products linked to its indices.