The steady upward climb of U.S. markets over the past year has brought welcome relief to investors punished by what will arguably go down as the worst U.S. economic downturn since the Great Depression. Although there are many reasons to be optimistic about the long-run health of the U.S. economy and future corporate profits, the extended rally has plucked most of the low hanging fruit, leaving the U.S. equity market, as a whole, slightly overvalued by our estimates. It seems that market participants have put the 2008 crisis firmly in the rearview mirror, even though current market valuations would be hard-pressed to maintain their lofty levels should the economy retreat again during the near term.

Despite this uninspiring investment backdrop, we continue to believe that patient investors, who give thoughtful consideration to business quality and valuation, will do well over time. The Morningstar Wide Moat Focus Index captures this belief in an investable strategy. This index is composed of the cheapest wide-moat firms in our 1,700-stock coverage universe. Index constituents possess their industries' strongest competitive advantages, which we believe will persist many years into the future.

Only 160 companies that we cover (fewer than 10%) carry our wide economic moat rating. For inclusion in this index, we pick the 20 cheapest (based on price/fair value ratio) wide-moat firms every three months, and we readjust the holdings to equal-weight them at 5% of the portfolio apiece. The result is a fresh collection of high-quality firms with undervalued stocks. The latest reconstitution occurred on March 19.

The previous portfolio of 20 stocks underperformed the S&P 500 on a total return basis, gaining 2.7% between December 21 and March 19, its most recent reconstitution, versus 4.1% for the S&P 500. However, through March 30, the Wide Moat Focus Index's trailing one-year total return of 74.9% handily outpaced the S&P 500's 52.2% gain during the same period. Over the past five years, the Wide Moat Focus Index's annualized performance of 9.2%, versus 2.0% for the S&P 500, reinforces our view that quality matters, valuation matters, and patience matters.

Constituent Performance

Twelve constituents posted positive returns during their three-month run. Genzyme (GENZ) led the index with a 23.9% return between Dec. 21 and March 19.