Building a Six Factor Model Using Intangible Value with Kai Wu
Jun 29, 2023
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Kai Wu, Founder of Sparkline Capital, discusses his research on intangible assets, measuring and turning them into a value factor, benefits of intangible value to a multi-factor portfolio, constructing a 6-factor model, diversifying a portfolio using six factors, finding companies building protective moats around intangible assets, and the potential acceptance of the six factor model in empirical finance.
Intangible assets are key drivers of value in the modern information age and should be considered in measuring value and investing in innovative companies.
The integration of the Intangible Value Factor into a traditional five-factor model provides significant alpha and can enhance the performance of a long-only investment portfolio.
Growth-focused ETFs capture the positive influence of intangible assets, while value-focused ETFs have limited exposure, suggesting a disconnect between traditional value investing strategies and the value derived from intangible assets.
Deep dives
The Rise of Intangibles and Value Investing
The podcast episode discusses the rise of intangibles and its impact on value investing. The speaker highlights that traditional value investing strategies have not been working in recent years and explores how the economy's transformation has affected the ability of traditional value factors to outperform. Intangible assets such as intellectual property, brand equity, human capital, and network effects are identified as key drivers of value in the modern information age. The discussion emphasizes the need to consider intangible assets in measuring value and investing in innovative companies.
Intangible Value Factor and Its Integration
The episode delves into Kai Wu's research on the Intangible Value Factor and its integration into the existing five-factor model. The host explains how Kai quantifies intangible assets, such as intellectual property and brand equity, to create a value strategy focused on companies with strong intangible value. The research highlights that the Intangible Value Factor provides significant alpha and can be used in a long-only investment portfolio alongside traditional market exposure. The potential of blending the Intangible Value Factor with other factors is also explored for diversified and enhanced performance.
Examining ETFs' Exposure to Intangible Value
The episode further examines the exposure of various ETFs to the Intangible Value Factor. It is revealed that growth-focused ETFs tend to have positive exposure to this factor, while value-focused ETFs exhibit less significant correlation. The discussion emphasizes how the growth ETFs, with their focus on innovation and technology, capture the positive influence of intangible assets and intellectual property. In contrast, value ETFs are found to have limited exposure, potentially indicating a disconnect between traditional value investing strategies and the value derived from intangible assets.
Evolution of Asset Pricing Models
The podcast discusses the evolution of asset pricing models, starting from the original Capital Asset Pricing Model (CAPM) to the Fama-French five-factor model, and eventually to the inclusion of two additional factors: investment and quality. The models aim to explain as much variance as possible and have increasingly incorporated factors that better capture market behavior. The speaker emphasizes the importance of finding the fewest number of factors that can explain a significant portion of the market, highlighting the need for intuitive factors with a fundamental rationale. By understanding the history and evolution of these models, investors can diversify their portfolios with a well-rounded set of explanatory variables.
Intangible Value and Innovation
The podcast explores the concept of intangible value as a distinct factor in asset pricing models. Intangible value focuses on the intangible side of the balance sheet, which differentiates companies held by traditional value factors from tech companies, consumer brands, and service businesses. The speaker highlights the importance of intangible assets in driving profitability and innovation. By investing in companies that are building intangible assets through research and development or marketing efforts, investors can capture future profitability. Intangible value is seen as a complement to traditional value factors and a hedge against changing economic trends. The podcast suggests that incorporating intangible value in asset pricing models can provide a steady driver of returns and help investors capture the sweet spot of companies transitioning to having a protective moat around their intangible assets.
In this episode, we speak with Sparkline Capital founder Kai Wu about his excellent recent paper "Intangible Value: A Sixth Factor". We discuss his research on the importance of intangible assets, how to measure them and turn them into a value factor, the benefits of intangible value to a multi-factor portfolio, and how he used it to construct a 6-factor model.
We hope you enjoy the discussion.
