Capture the Knowledge Effect in your portfolio

After our recent quarterly “Has Innovation Bottomed?” ​​​​CEO and CIO Steven Vannelli was invited to be a guest on ARK Invest’s For Your Innovation Podcast.  In this episode, Steve discusses the long history of intangible capital and its importance in valuing innovative companies (45 min).

Link to podcast ep. 159 | Video for podcast ep. 159 on YouTube

As of 9.30.22 the following securities mentioned in this podcast were held in the Knowledge Leaders Strategy and the rest were not: Qualcomm, LAM Research and Synopsis. This material is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any securities or investment strategies.

The Knowledge Effect is the tendency of stocks of highly innovative companies to experience excess returns. It results from investors’ systematic errors in evaluating companies that invest large sums of money in producing knowledge.

The origins of the Knowledge Effect can be traced to two factors:

1. A surge in the pace of knowledge production catalyzed by the release of the first commercially available semiconductor in 1971. Due to the cumulative nature of knowledge, this acceleration has resulted in an exponential increase in humankind’s total knowledge.

2. A mandate by the US Financial Accounting Standards Board in 1974 which ruled that companies must expense knowledge investments in the period incurred. This deprived investors of relevant financial information on corporate knowledge spending at the dawn of this massive surge in the pace of knowledge production.

The Knowledge Effect is grounded in academic literature. It was first discovered in a series of studies in the 1990s where NYU’s Baruch Lev analyzed 20 years of financial data and discovered an association between a firm’s level of knowledge capital and its subsequent stock performance. Further research advanced the findings, and in 2005, Lev proved the existence of a market inefficiency attributable to missing information about corporate knowledge investments. This phenomenon leads highly innovative companies to deliver persistent abnormal returns.

The Knowledge Leaders Strategy seeks to transform the Knowledge Effect into portfolio alpha. We identify Knowledge Leaders, or highly innovative companies, by measuring a company’s investment in its future growth. Knowledge Leaders possess deep reservoirs of intangible capital as a result of their history of investing in knowledge-intensive activities like R&D, brand development and employee education. Developed by founder Steven Vannelli and based on decades of academic research, our proprietary model adjusts a company’s financial history to capitalize these investments and reveal the companies with the greatest knowledge intensity. The companies that pass our quantitative screen are identified as Knowledge Leaders. We look for the best opportunities among Knowledge Leaders for investment by our actively managed funds. 

All portfolios are constructed from our proprietary universe of Knowledge Leader companies.