Championing Human Capital
A new ETF, Simplify NEXT Intangible Value Index ETF, (ticker NXTV) invests in companies that are cheaply valued versus their intangible assets, based on the NEXT Intangible Value Index.
In contrast, traditional value investing was based on fairly simple price to tangible book value measures, calculated by actually subtracting intangible assets, and liabilities, from total assets. The rationale was that a company trading below this level could be profitably liquidated, even if no value was ascribed to intangible assets. This was always flawed however, since patents can generate royalty streams, while brand names and trade marks can generate licensing fees, quite apart from their essential value to a business.
Over time, the traditional price to book value measure has become seen as increasingly naïve and incomplete in the data and knowledge-driven world where intangible assets such as patents, software, research and development, intellectual property and human capital, can be worth far more than tangible ones such as property, plant and equipment. This should not be at all surprising: the world’s largest software firm, Microsoft, is worth more than the entire equity market of manufacturing powerhouse Germany. And at the country level, some of the richest countries, such as Israel, Switzerland or Singapore, have little or no natural resources (analogous to tangible assets) but do have lots of highly educated people, and are many times richer than nearby countries endowed with huge commodity reserves.
For a semiconductor chip maker, the patents and IP underlying increasingly complex chip designs that cannot be copied by competitors, are worth far more than factories, which can also be located or relocated in many different places; Taiwan Semiconductor Chip Manufacturing is now building factories in Japan, and in Arizona in the US.
In fact, intangible assets are a much closer measure of “human capital” than tangible assets, since human capital is not only one part of the intangible equation but is also what created the other parts. As developed economies have moved from being manufacturing dominated to being overwhelmingly driven by services, it is natural to rethink which accounting measures are emphasized. For instance, service industries made up 81% of valued added in the UK economy between October and December 2023.
Therefore, value investors have moved on from pure price to book value to more sophisticated measures that include both tangible and intangible assets in a company’s valuation, and NEXT takes this one step further by ignoring the tangibles altogether in order to focus solely on intangibles.
The largest holdings unsurprisingly include chipmaker Micron Technology at 2.5%, and perhaps more surprisingly PepsiCo, but remember brands such as Quaker Oats, Sabra Houmous, Lays crisps (known as Walkers in the UK) or Mirinda orange drink are worth a lot – these products cost far more than unbranded versions, even for something like oats with no added ingredients or flavourings.
NEXT’s expense ratio of 0.25% is a little lower than on some thematic ETFs.
Simplify is a relatively new ETF provider, which launched in 2020 with a mission to bring alternatives to the mass market after the SEC rule 18f-4 gave ETFs more freedom. Though NEXT is a long only equity strategy, many of the other Simplify ETFs are based on hedge fund strategies that can take long and short positions in equities.