There is a strong argument to be made that modern accounting standards have failed to keep up with the shift from only including physical assets like property, plants, and equipment on the balance sheet to more nonphysical, intangible sources of company value such as data, intellectual property, research and development, brand equity, trademarks, goodwill, and more.
According to research from Ocean Tomo in its Intangible Asset Market Value Study, 2020, the intangible value of S&P 500 companies has grown from only 17% in the mid-1970s in a “manufacturing centered economy” to more than 90% in today’s “technology enabled economy.”
Many theorize that the underperformance of value style products over the last few years is attributable to failure of traditional value metrics such as price to earnings (P/E) and price to book (P/B) ratios to properly account for intangible sources of value. But calculating intangible value is not a simple task, as it is not conveniently provided on the balance sheet or other financial statements. This market inefficiency creates both a problem and an opportunity.
Some Intangible Value Pure-Plays
There are a few ETFs in the marketplace targeting the theme of intangible value. The first one is the Sparkline Intangible Value ETF (ITAN ). It is an active product that invests in companies based on Sparkline’s proprietary measure of “intangible augmented intrinsic value.” This ETF sits at $33 million in assets under management and is up 8% YTD. Its largest holdings are not value names based on traditional measures, but technology-rich companies such as Amazon, Meta Platforms, Oracle, and Salesforce.
Sparkline also just launched an international version of the product this month, the Sparkline International Intangible Value ETF (DTAN). The fund applies the intangible valuation selection philosophy to international companies including big pharma names like Roche and Novartis, and German software company SAP. It provides a vehicle that is less tech-focused than its U.S. counterpart.
ETF issuer Simplify also has two ETF products launched last April that also seek to provide a solution to the intangible asset conundrum. The+ Simplify Next Intangible Core ETF+ (NXTI ) is a passively managed ETF that overweights companies with high intangible-to-book asset ratios. Its top holdings are Walmart, Meta, and Berkshire Hathaway. Simplify has also launched the Simplify Next Intangible Value ETF (NXTV ), which seeks companies that look cheap on an intangible-adjusted book value basis. Its top holdings currently include telecom companies T-Mobile, AT&T, and Verizon.
Since the funds’ inception on 4/16/24, NXTI’s core-focused approach has considerably outperformed the valuation-based approach of NXTV, up 9.8% versus 5.5% YTD. Neither of these ETFs has yet to attract much in the way of assets yet, with both sitting at around $1.3 million in assets.
Moats Are Intangible
Other ETFs have tried to capture the intangible value effect in other ways. A prime example is the VanEck Morningstar Wide Moat ETF (MOAT ). The “economic moat effect,” popularized by Warren Buffett, refers to the sustainable competitive advantage companies have over one another that helps defend market share. The sources of economic moats cited by Morningstar include switching costs, network effects, cost advantages, efficiency of scale, and — you guessed it — intangible assets. The MOAT ETF has amassed over $15.6 billion in assets and spawned a suite of seven other moat-focused ETF offerings covering different market cap ranges and geographies, as well as an ESG-screened version. The MOAT ETF is up 10.7% YTD.
Intangible Generators of Free Cash Flow
Free cash flow (FCF) yield is another metric that ETF investors have used to capture intangible value. Historically, companies generating the highest levels of FCF have done so because of intangible asset items like intellectual property and royalties. Apple is a great example. Many companies can design a smartphone, but in the U.S., the iPhone brand has become an aspirational consumer product that continues to innovate and generate huge amounts of FCF on the company’s cash flow statement.
There are many ETFs in the marketplace that target high levels of FCF. The largest of the free cash flow ETFs is the Pacer US Cash Cows 100 ETF (COWZ ), with $24 billion in assets and a YTD performance of 6.9%. Up and coming in the category is the VictoryShares Free Cash Flow ETF (VFLO ) which has climbed to $894 million in a little over a year in the market, thanks to an additional growth filter than has boosted YTD performance to 13.6%. Both Pacer and VictoryShares also offer small-cap versions of these approaches: CALF and SFLO. Success in this ETF category has also encouraged new competitors with free cash flow ETFs, including First Trust, Invesco, Amplify, and Global X.
At some point, accounting standards will catch up to help investors quantify intangible sources value, but until then, there are ETFs out there to help fill the gap in GAAP accounting.
VettaFi LLC (“VettaFi”) is the index provider for VFLO and SFLO for which it receives an index licensing fee. However, VFLO and SFLO are not issued, sponsored, endorsed or sold by VettaFi, and VettaFi has no obligation or liability in connection with the issuance, administration, marketing, or trading of VFLO and SFLO.
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