Revealed: the hidden asset that gives companies a competitive advantage - and how to invest in it

30 April 2019

One of the reasons why Brits are obsessed with buy-to-let investing is because a house or a flat is tangible: we can see it, we can feel it.

An investment in stocks and shares, on the other hand, is intangible: we just get a piece of paper saying we own a certain amount of shares of a company. Even then, we don’t even really own some of the company itself – we can’t just walk in one day and take the printer or a computer because it’s ours. As MC Hammer once said: “U can’t touch this.”

The companies we invest in, however, often produce things we see and use everyday. Take Marks & Spencer – we see the shops and we buy the clothes or food.

But while we might take comfort in these more tangible aspects, more and more of the fund managers I talk to are looking for something extra – they are actively seeking out ‘intangible assets’ that give companies a long-term competitive advantage.

What are intangible assets?

Intangible assets have no physical existence. If I remember correctly, MC Hammer’s was something about being “dope on the floor” and “magic on the mike”. When it comes to companies, they include brand, reputation, intellectual property, know-how and ideas. And, unlike tangible (physical assets), they can’t be destroyed in a fire or rust in the yard.

The importance of these intangible assets should not be underestimated. They are often unique to that business and provide important barriers to entry. They can be used time and again with relatively little cost; they engender customer loyalty; and, importantly for us as investors, they can give that company an advantage, which will enable it to keep growing through the ups and downs of an economic cycle.

Some industries lend themselves better to intangibles than others: healthcare companies, for example, have patents and/or research and development resources, as well as pricing power – and reputation is key; IT companies have software or know-how; and consumer staples’ companies have distribution and branding power.

“As more people shop online, being a top brand is crucial”

Investing in intangibles

A couple of fund managers I rate very highly have intangibles at the heart of their investment processes, so I asked them to bring this subject to life for us.

Ben Peters, manager of Evenlode Global Income, is one such manager.

He cited PepsiCo. “We really like the branded nature of the business [its products include family favourites such as Doritos and Quaker Oats],” he says. “Twenty-two of its brands generate more than $1 billion of sales annually and the company’s portfolio boasts four of the top 10 retail brands across all categories.

“As more people go online to shop, being the number one or number two brand is very important. Think about your weekly online grocery shopping: we pick a number of products because we are familiar with them and then they are subsequently ‘suggested’ to us each week in our ‘instant shopping list’,” he adds.

Anthony Cross and Julian Fosh, managers of Liontrust Special Situations fund, won’t consider a company unless it has at least one of the three intangible assets: recurring income, intellectual property or strong distribution networks.

They gave me the example of Rightmove, which they say possesses all three.

“Perhaps the strongest of these is its distribution network, which puts it in an incredibly strong competitive position,” they explain.

Its market-leading position has proven resilient to competition from the likes of Zoopla and OnTheMarket and the company can actually benefit from tough property market conditions as online and traditional estate agents compete for business by spending more on advertising.

David Dudding and Mark Nichols, managers of Threadneedle European Select, are fans of Unilever.

“Strong management and good products are advantages for any business, but they are not enough to maintain a competitive edge,” says David Dudding. “Only exceptional companies possess sufficiently powerful competitive advantage to persistently protect their position and pricing power in a global market.”

Unilever has more than 400 brands, including Ben & Jerry’s, Dove, Lynx, Persil and Vaseline. The company has also spent many years building relationships with numerous small suppliers and distributors across the world – including emerging markets, where it generates more than half of its sales. This distribution network is a powerful barrier to entry: it can’t be easily replicated on the same global scale.

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius’s views are his own and do not constitute financial advice. The mention of specific securities is for illustration purposes only and not a recommendation to buy or sell.