Intangible Investments

From the Economist, an article entitled “Hyperactive, yet passive“,

Start with short-termism. The fear that capitalism is too myopic has a long history. John Maynard Keynes observed that most investors wanted “to beat the gun”. For over 50 years Warren Buffett has made money on the premise that other investors behave like headless chickens. But this drum has seldom been banged more loudly than today. If she wins the White House, Hillary Clinton wants to end the “tyranny” of short-termism. The Bank of England and McKinsey & Co, a consultancy trusted in boardrooms, worry investors cannot see past their noses. The French have legislated to give more voting rights to longer-lasting shareholders. Economists fret that firms’ reluctance to invest their profits hurts growth.

Since the 1990s the clock of business has whirred faster in some ways. Silicon Valley upstarts have unsettled some mature industries. Computers buy and dump shares in the stockmarket within milliseconds. Yet even in America Inc, the home of hyperactive capitalism, “short-termist” is the wrong label.

Since the crisis of 2008-09 firms’ horizons have in fact lengthened. New corporate bonds have an average maturity of 17 years, double the length they had in the 1990s. In 2014 departing chief executives of S&P 500 firms had served for an average of a decade—longer than at any point since 2002 (and longer than most presidents). The average holding period of an S&P 500 share is a pitiful 200 days, but that is double the level of 2009. Constant trading masks the rise of index funds whose holding period, like Mr Buffett’s, is “for ever”. Larry Fink, the boss of BlackRock, the world’s biggest asset manager, asks firms to draw up five-year plans.

Nor are firms investing less. The same system that is accused of myopia has just financed the $500 billion shale-energy revolution, a boom in experimental biotech companies and the electric-car ambitions of Elon Musk, a maverick entrepreneur. Relative to assets, sales and GDP, American firms’ investment has held steady. The mix has shifted from plant and machines to things like software and research and development (R&D), but that is to be expected as equipment costs fall.

The article did not provide the supporting charts for the transfer of focus from tangible to intangible investments, but the OECD has provided one that we can include here (last updated in June 2015):

intangible1

 

Investment in OECD countries has gradually moved away from traditional areas of physical investment to ICT and intangible/knowledge-based investments. This reflects a number of trends including technological progress, the rise of the digital economy, the shift from industry to services and the changing global specialisation in production as discussed above. This shift raises the importance of understanding the main factors behind the present subdued level of investment, since in addition to their direct impact on demand, intangible knowledge-based investments are central for the generation of new ideas and technologies and the successful diffusion of existing ones (OECD, 2015a).

New national accounts systems (SNA 2008 and ESA 2010)8 include many intangible investments – such as R&D, software and entertainment, literary and artistic originals and mineral exploration – in fixed capital investment, and this has translated into an increase in the share of investment in GDP. Measured intangibles, together with a broader range of investment-like activities that companies use to create value, are termed knowledge-based capital (KBC). Components of KBC that are not recorded in national accounts, include investment in design, new financial products, advertising, market research, training and organisational capital. Based on estimates of total KBC investment in 2010 (Corrado et al., 2012), intangible investment in the national accounts now covers 56% of total KBC on average across countries, ranging between 34% in Luxembourg to 80% in Greece.

The inclusion of intangible investments in the national accounts has led to marked changes in registered investment levels in some economies. The share of intangible capital in total investment varies considerably across OECD countries, but accounts for over one-fifth of total investment in several countries, including Ireland, Sweden, Denmark, the United States, Switzerland and France (Figure above).

Here is another noteworthy chart and commentary:

intangibles2

The relative resilience of intangible investment could indicate that intangible investment is less cyclically sensitive than physical investment or benefited more from government actions at an early stage of the crisis. It may also reflect longer-term shifts toward a higher share of intangibles in many goods and services. Ultimately there is likely to be strong complementarity between intangible and tangible capital.

For example, successful R&D investment may result in tangible investment with a lag, and business software complements capital spending on ICT capital goods. At a disaggregated level, important complementarities are found to exist between different types of investment. One example is the significant complementarity of organisational capital (not included in national accounts) and ICT capital investment (Andrews and Criscuolo, 2013).

The trend towards automation means that companies would rather develop programs than to hire another employee for the same task. Similarly, software can greatly improve asset utilisation leading to lower physical investment. Therefore, great companies would no longer be the ones with the best tangible infrastructure and impressive number of employees but rather the ones with the most profitable and enduring intangible assets.

To add, companies with large intangible investments and those exposed to intangible spending may deserve a higher valuation due to their lower cyclicality.

Marc Andreessen‘s edict that software is eating the world should lead us to re-evaluate the concept of investment as this trend would only accelerate in the future.

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