Intangible Assets Provide Tangible Defenses for Equities

04 November 2020

6 min read

Kent Hargis, PhD| Chief Investment Officer—Strategic Core Equities; Portfolio Manager—Global Low Carbon Strategy

Sammy Suzuki, CFA| Head—Emerging Markets Equities

Christopher W. Marx| Global Head—Equity Business Development

Defensive equities are usually found in sectors that have withstood market shocks, such as utilities and real estate. But as COVID-19 shakes up investment conventions, companies with intangible assets are being more appreciated for their volatility cushion.

The nature of defensive stocks can be surprising. We saw evidence of this during the COVID-19-fueled sell-off in the first quarter, when equities from traditionally defensive industries like utilities and real estate didn’t protect portfolios as in prior downturns. Meanwhile, historically less-defensive sectors, such as software services and digital media and entertainment, were surprisingly less impacted.

Broadening Conventional Defensive Wisdom

While defensive stocks didn’t meet expectations during the recent sell-off, we don’t believe that their protective potential is lost forever. Still, investors should broaden their sources of volatility mitigation. And in an economy increasingly influenced by service- and technology-heavy industries, we think intangible assets should be top of mind.

By capturing the contributing value of things like brand, platforms and data, intangible assets are more concrete than many investors think. Along with other fundamentals, intangibles can augment quantifiable intelligence on a company’s competitive advantages, sustainability and resiliency—all very tangible predictive signals of long-term defensiveness.

Touching on Intangibles: The Different Paths to Defensiveness

Factoring intangible assets into fundamental analysis isn’t new. Brands and patents, for instance, have always mattered to a company’s bottom line (just ask Coca-Cola and Merck). But the distinct ways intangibles are assessed are rapidly evolving—and turning even obscurities like culture and network effect into measurable, predictive data.

Separating and capitalizing intangible assets can better reveal how businesses are run. Whether it’s a company’s research and development, culture, brand or patents (Display), intangibles like these often can provide surprising insight on a company’s defensive positioning.

Intangible Assets Can Provide Stability in Different Ways

A large hexagon is surrounded by six loosely connected smaller hexagons, each labelled for a type of intangible asset.

Source: AllianceBernstein (AB)

Intangible assets can add value in different ways. So, a closer look can unlock how variations uniquely contribute to a company’s competitiveness, growth and stability.

Platforms with Network Effect–Platforms are matchmakers. And by growing the number of participant connections, a platform business can reduce friction—which helps grow its total accessible market—and effectively lower transaction costs, which can stabilize revenues.

More effective platform models, like PayPal and Salesforce.com, also benefit from network effects when a product or service gains value as it adds users.

Successful high-density platforms cleave to a protective supply-demand model that often assures consistently high return on invested capital and stable sales growth. Leaders tend to stay there, as would-be disruptors struggle to cross an ever-widening network-effect moat. For example, Zillow, the US online real estate database, has most of the country’s house-listing supply and most of the viewer demand—a high barrier that new entrants can’t seem to clear. And great platform businesses tend to yield strong-performing stocks—not just among the few concentrated at the top but across a broad swath of global companies (Display).

Platform Stock Performance Has Been Exceptional

A line chart compares the dollar growth rate of platform-specific companies to the overall MSCI World Index below it.

Past performance and current analysis do not guarantee future results.
As of June 30, 2020
Platform stocks are companies that have both an inverted firm structure (participants, rather than the business, own the means of production) and network effect (growing participant connections that exponentially add value). Based on this, there was an average of 99 platform companies for the period shown, some of which are not included in the MSCI World Index.
Source: MSCI and AllianceBernstein (AB)

Data–Turning data into money is both art and science, whether packaged for sale or gleaned through online retail, advertising and browsing. Much like crude oil, without refinement, data is just raw material customers can’t use. So, companies that master the collection, cleaning and delivery along the “data monetization” value chain are in strong demand and increasingly attractive defensive plays.

Companies such as S&P Data and RELX Group sell differentiated high-velocity data and analytics that customers want in perpetuity, which creates scale, lowers marginal costs and helps sustain profits. For example, over the last six years, companies with rising data sales have enjoyed stable and consistent growth and were less influenced by economic and other factors (Display). Our research suggests these trends should lead to potentially less erratic share-price swings.

Data Monetization Underpins Stability and Growth Potential

Past performance and current analysis do not guarantee future results.
As of October 29, 2020
Data monetization stocks are companies that derive more than 50% of revenues from data-related sales and services. Based on this, there was an average of 47 data monetization companies in the MSCI World Index for the period shown.
Source: MSCI and AllianceBernstein (AB)

Human Capital/Culture–These intangible assets are the secret sauce for sustainable growth, especially for new-economy businesses, many ranked among the “Best Companies to Work For.” Both categories of intangibles contain factors with measurable cause-effect; higher employee satisfaction leads to better motivation and retention, which independent studies show directly translate to higher productivity, lower turnover and stronger customer loyalty.

Gauging human capital and culture is also where third-party sources, such as Glassdoor and LinkedIn, are highly effective when objectively interpreted. For instance, we have discovered that the sharpest Glassdoor predictor for stock performance is tied to its “outlook” rating, followed by factors like CEO approval (way up after Microsoft’s Satya Nadella replaced Steve Ballmer), work-life balance and the overall rating. In our view, these natural language measures of how those on the inside think and feel can be harnessed into objective indicators of profitability and return consistency.

Research & Development (R&D)–The generally accepted definition of R&D likens it to expenses to search for or discover “new knowledge.” But we believe investments in R&D can offer much stronger signals, and their added value can be quantified beyond just the pursuit of ideas or concepts. We have found that businesses that spend more on R&D end up more profitable—and for longer periods. And such firms tend to have persistent and predictable fundamentals, such as lower debt, higher growth potential, better profitability and positive market sentiment.

Patents–Beyond legal protections, a patent’s value is often the most underappreciated of all intangible assets. Patents are usually overlooked because they’re generally owned by the firm, and not recorded in financial statements. Yet, hundreds of patents are issued every year to companies ranging from information technology to industrials, according to PatSnap. Half of the stocks in the Russell 1000 Index have at least one patent, and some have dozens—each one reinforcing the barriers to entry from competitors, improving internal efficiencies and defending long-term profitability.

Brand–A company’s brand is valuable beyond just golden arches, red circles and other iconic monikers. But as an asset, brand is often mispriced by the market—especially in the short term—which creates opportunities for defensive investors who take a longer view.

Brand assets can be evaluated by looking at advertising costs, typically over the last five years. That might sound counterintuitive, because brand expenses hit a company’s annual financial statement. However, the benefits of advertising and promotion have lasting power—especially if they’re well-spent dollars. That’s why fundamental research of brand spending can be a leading indicator of top-line growth in consumer loyalty, which fuels revenues and helps stability.

COVID-19 didn’t change the nature of intangible assets—we’ve long appreciated their importance to active fundamental stock analysis. And we’re not suggesting they’re recession proof; very few stocks are. But in an unpredictable market, paying as much attention to intangible assets as to traditional defensive stocks can help investors broadly source stocks capable of reducing volatility in equity portfolios.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to revision over time.

About the Authors

Kent Hargis, PhD

Kent Hargis is the Chief Investment Officer of Strategic Core Equities. He created the Strategic Core platform and has been managing the Global, International and US Strategic Core portfolios since their inception in 2011. Hargis has also been Portfolio Manager for the Global Low Carbon Strategy Portfolio since 2022. Previously, he managed the Emerging Portfolio from 2015 through 2023. Hargis was global head of quantitative research for Equities from 2009 through 2014, with responsibility for directing research and the application of risk and return models across the firm’s equity portfolios. He joined AB in 2003 as a senior quantitative strategist. Prior to that, Hargis was chief portfolio strategist for global emerging markets at Goldman Sachs. From 1995 through 1998, he was assistant professor of international finance in the graduate program at the University of South Carolina, where he published extensively on various international investment topics. Hargis holds a PhD in economics from the University of Illinois, where his research focused on international finance, econometrics and emerging financial markets. Location: New York

Sammy Suzuki, CFA

Sammy Suzuki is Head of Emerging Markets Equities, responsible for overseeing AB’s emerging-markets equity business and instrumental in the formation and shaping of AB’s Emerging Markets Equity platform. He was also a key architect of the Strategic Core platform and has managed the Emerging Markets Portfolio since its inception in 2012, and the Global, International and US portfolios from 2015 to 2023. Suzuki has managed portfolios since 2004. From 2010 to 2012, he also held the role of director of Fundamental Value Research, where he managed 50 fundamental analysts globally. Prior to managing portfolios, Suzuki spent a decade as a research analyst. He joined AB in 1994 as a research associate, first covering the capital equipment industry, followed by the technology and global automotive industries. Before joining the firm, Suzuki was a consultant at Bain & Company. He holds both a BSE (magna cum laude) in materials engineering from the School of Engineering and Applied Science, and a BS (magna cum laude) in finance from the Wharton School at the University of Pennsylvania. Suzuki is a CFA charterholder and was previously a member of the Board of the CFA Society New York. He currently serves on the Board of the Association of Asian American Investment Managers. Location: New York

Christopher W. Marx

Christopher W. Marx is Senior Vice President and Global Head of Equity Business Development. He is responsible for overseeing the firm's team of equity investment strategists and product managers, setting strategic priorities and goals for the global Equities business, developing new products, and engaging with clients to represent market views and investment strategies of the firm. Previously, Marx was a senior investment strategist and a portfolio manager of Equities, and in 2011 he cofounded the Global, International and US Strategic Core Equity portfolios with Kent Hargis. He joined the firm in 1997 as a research analyst covering a variety of industries both domestically and internationally, including chemicals, metals, retail and consumer staples. Marx became part of the portfolio-management team in 2004. Prior to joining the firm, he spent six years as a consultant for Deloitte & Touche and Boston Consulting Group. Marx holds a BA in economics from Harvard University and an MBA from the Stanford Graduate School of Business. Location: New York

Intangible Assets Provide Tangible Defenses for Equities

Broadening Conventional Defensive Wisdom

Touching on Intangibles: The Different Paths to Defensiveness

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