Why is the rise of intangibles important for active equity management? In my previous post, I looked at Stian Westlake’s arguments for the rise of intangibles.
Out of many, these two points strike me.
Intangibles are difficult to measure, sometimes impossible to quantify.
Intangibles now make up more of the value of a firm than ever before.
Hold those thoughts.
Now, it is a guide of active management that if consensus (the market or Mr Market) is correct about a company or an asset, then an active investor will not make any outperformance from investing.
An investor has to be correct in her view about a company/asset, and the market consensus has to be wrong.
This is difficult for active investors to achieve consistently. This is because the collective efforts of market participants reflect information into the market price of assets. (This flows from and is a central idea behind the efficient market hypothesis - more in another post).
We know 27% of investors ignore material ESG (the intangible Environment Social Governance factors) completely, only 35% of investors look at ESG systematically (this is examined in this post here).
ESG factors are part of the intangibles that are (1) difficult to measure, sometimes impossible to quantify and (2) now make up a significant value of a firm.
If an active investor can identify positive or negative value in these ESG / intangible / sustainability factors, that market consensus has missed (and it seems market consensus will continue to overlook these factors as many investor still ignore them and do not value them) then she can outperform. Indeed that is what Alex Edmans' paper on Employee Satisfaction (one of those ESG intangibles) suggests.
Does the stock market fully value intangibles? Employee satisfaction and equity prices by Alex Edmans. findings: (1) employee satisfaction is positively correlated with shareholder returns (2) the stock market does not fully value intangibles, even when independently verified by a highly public survey on large firms...
Now an investor does not necessarily have to quantify such intangibles with an $Xbn assessment. She only has to know that the intangibles are material, valuable and overlooked by the market. (Both positive and negative).
It is my belief that investors who assess such intangibles (like ESG) accurately should be able to outperform peers (and the majority of the market) who do not.
Along with this academic study on the benefits of Active Ownership and ESG engagement . If one puts this work together with the work on the outperformance of Global Equity managers described here, one can start to build a defense of Active Management for a global manager.
If you'd like to feel inspired by commencement addresses and life lessons try: Neil Gaiman on making wonderful, fabulous, brilliant mistakes; or Nassim Taleb's commencement address; or JK Rowling on the benefits of failure. Or Charlie Munger on always inverting; Sheryl Sandberg on grief, resilience and gratitude or investor Ray Dalio on on Principles.
Cross fertilise. Read about the autistic mind here.