Investor's Business Daily, June 18th, 2007
Investors want to invest in the best companies. But how do you define best?
IndexIQ, a one-year-old newcomer, claims these qualitative characteristics can be quantified. It has created indexes that group the best companies based on qualities such as innovation, power, growth, productivity, work force leadership, corporate governance and customer loyalty. It has registered corresponding ETFs with the SEC.
If they sound like flashy lists found in magazines, that's because they are.
IndexIQ's co-founder and CEO Adam Patti was formerly associate publisher of the Time Inc. Business & Finance Network, which owns Fortune, Money, Business 2.0 and Fortune Small Business magazines, and CNNMoney.com. There, Patti led the development of ETF products based on Fortune magazine's ranking methods.
IBD: Your prospectus states, "The components of this index are derived using a purely quantitative, rules-based methodology." Could you elaborate on the formula that's used to find the top stocks?
Patti: In today's information-based economy, traditional accounting metrics fail to adequately capture the full essence of a company's market value. These accounting metrics are a look back in time, whereas the true drivers of company performance are based in large part on forward-looking intangible characteristics.
These characteristics -- such as innovation, productivity, customer loyalty and several others -- are not contained on a balance sheet, but they are among the principal determinants of a company's market value and also provide a multidimensional view of a company's prospects for future success.
The increasing gap between book value and market value in the S&P 500 is a good illustration of the power of intangible characteristics, as a proxy for the general market.
In 2005, almost 80% of the average company's capitalization was derived from intangible assets, such as those measured by the indexes that underlie our series of ETFs.
In 1975, less then 20% of the average company's capitalization was comprised of intangible assets.
IBD :How can you quantify qualitative characteristics such as innovation, work force leadership and corporate governance?
Patti : Intangible characteristics are quantifiable and manageable. To date, they have not been systematized in a comprehensive way for investors. This shortfall is particularly impactful when you consider that investments in R&D, brand development and employee training, for example, often exceed investments in traditional tangible assets.
As an example, let's consider the index we've developed for innovation, one of the principal drivers of future company performance.
Our objective is to identify companies that, through strong reinvestment and success in commercializing innovation, consistently improve their financial results.
This reinvestment may come in the form of new product development or infrastructure spending, which are key indicators of a company that is poised for future competitive strength and market appreciation.
The key thereafter is to determine which companies leverage that high level of investment into sustained sales growth.
IBD: Which company tops your list in each category?
Patti: The companies that top each one of our lists, and thereby command the highest index weighting, achieve that position based upon their relative performance within our rules-based screening process. The list below gives a cross-section of some of our No. 1-ranked companies.
Market power (large caps): Citigroup C.
Fastest growth (large caps): Apple AAPL, Google GOOG, Southern Copper PCU (tie).
Innovation (all caps): Plantronics PLT.
Productivity (all caps): Moody's MCO.
Work force effectiveness (large caps): Starbucks SBUX.
Corporate governance (all caps): NAVTEQ NVT.
Customer loyalty (all caps): Chi-potle Mexican Grill CMG.
Sustainability (large caps): Mattel MAT.
IBD : What leads you to believe that your methodology will lead to superior price performance?
Patti: Intangible assets are often more predictive of future performance than traditional accounting metrics. Yet, to date, there has not been a systematic way for an investor to accurately gauge the value or harness the power of these intangibles.
