The Impact of Intangible Capital on Factor Performance Efficacy

Abstract

Prevalent accounting standards require the cost of internally created intangibles to be expensed, disproportionately affecting the book values of high and low intangible intensity (II) companies. We expect this to impact the performance efficacy of various factors contextually, depending on the extent to which intangible capital affects their computation. We compare return spreads for Book to Market, a measure of Value, and Momentum for companies belonging to low and high II industries and find that for Book to Market, they have declined significantly for companies in high II industries compared to spreads for companies in low II industries. We show that this decline is linked to the increasing intangible intensity of companies in high II industries. In contrast, Momentum spreads have increased for companies in high II industries. For investors who use multifactor strategies, the implication is that weighting Book to Market and Momentum according to the II of the company’s industry may be a useful technique for incorporating the effects of intangibles.