Building a Six Factor Model Using Intangible Value with Kai Wu

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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.

00:00 - Intro
02:57 - The importance of intangible assets
06:07 - The pros and cons of capitalizing intangibles
09:50 - The four pillars on intangibles
11:04 - Turning intangibles into a value factor
13:56 - How far back can we test intangible-based strategies?
16:13 - The performance of the intangible value factor relative to the other major factors
18:43 - The correlation of intangible value with the other factors
20:23 - What is the goal of asset pricing models?
20:59 - The history of asset pricing models
23:04 - Analyzing whether intangible value adds value to existing factor models
26:52 - Does intangible value replace or complement traidtional value?
28:51 - Why is there not of academic work on intangible value?
31:38 - Using intangible value in a long-only framework
34:02 - Are there existing ETFs with high exposure to intangible value?
38:06 - The bad factor exposures that typically come with innovation
46:28 - Building a six factor model with intangible value

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[Bechs]

Collecting data sets and employing technology while creating labor force seems to me the most important thing as well as the result of caliculation of the model. Thank you for the industry designer.

[irhumbled]

How does an investor get exposure to these factors—single factor funds or multi factor funds that probably don’t have ihml? Wouldn’t single funds have a lot of transaction costs as funds trade the same securities on opposite sides?

[HepCatJack]

If we look at the examples from the past, the EV engines were always superior to the ICE engines. EV uses 95% of the power it's given from batteries whereas ICE only use about 25% of the power of the gasoline to make the car go forward. The limiting factor back then was the storage capacity of batteries. In the Beta / VHS competition, Beta was always claimed to have the superior quality and tech in image quality but ultimately VHS won in part because it could make 6 hours of low quality recordings of missed TV programs for people who couldn't be at home for a few days. The Commodore Amiga, had superior graphics, it could multitask nearly 12 years before pc's. The Amiga could also run IBM pc software via an emulator that covered about 80% of the programs that were out there, yet full IBM pc compatibility was considered more important by the market. Apple aficionados always said that Apple Products were superior to those of the pc world, and yet Apple was saved from bankruptcy by Microsoft. If Microsoft didn't have anti-trust concerns about having a dominant position in the browser world, they could have purchased Apple, and either incorporated their software tech in their products or kept producing the Apple products. For Microsoft their approach was to copy functionalities of their competitors by making their own version. They did this with Novell Netware, WordPerfect, Lotus 1-2-3 and Apple's OS. In a system where Lobbyist can rig the game against competitors can also tip the scales against a competitor which has the intangibles in its favor.

In WWII, often the tanks and planes of the Axis were often superior to those of the Allies, but the Allies won out by massively out producing tanks and planes that were good enough winning out with a greater number. Quality of the end product wasn't the only variable, the speed of production and cost of the products ended up mattering more.

I think that there many such examples where intangibles such as having a better quality product and other intangible isn't necessarily indicative of who will end up dominating the market place.