For many employers the wellbeing and contentment of their staff has become a far greater priority since the pandemic. One asset manager is betting those initiatives will produce financial gains.
US research firm Irrational Capital has created a novel approach to stock picking that largely abandons traditional financial metrics in favour of a system designed to select companies based on how happy their workers are.
It is tapping into a growing — but still unproven — belief that staff satisfaction is not just good for employee retention and morale but can also help boost a company’s share price.
Quantifying this phenomenon at scale has been a challenge. Irrational blends proprietary data based on employee surveys with publicly available job review websites such as Glassdoor to come up with thousands of ratings for publicly traded US companies, dubbed “human capital factor scores.”
These scores are intended to provide a tangible way of measuring staff satisfaction — a metric considered hard to gauge. They include data on how effective and innovative organisations are, the emotional connection employees have to their work and extrinsic rewards such as pay, benefits and work-life balance.
About two years ago, Irrational put its theory that happier employees lead to better performing companies to the test, making it investable through three exchange traded funds, run in tandem with Harbor Capital, a boutique asset manager.
The flagship ETF, HAPI, which picks large-cap stocks with the highest human capital scores, has beaten more than 90 per cent of peer funds since it launched in October 2022, according to Morningstar.
Irrational’s bet has been supported by research from JPMorgan, in which the bank’s head of European quantitative strategy, Khuram Chaudhry, and his colleagues have tied the ability to outperform the market to changes in the role work plays in our daily lives. They believe work has been supplanting traditional pillars of connection not just as a result of the Covid pandemic but due to structural shifts in how we spend our time and where we look for a sense of belonging.
“People used to go to work to offer a service to a corporation, and in exchange they would get a salary,” Chaudhry told the Financial Times. “But in the past there was also a community — you would have the church, or you’d have your neighbours.”
“Today what we are asking from the workforce or the company at large is to provide a lot of these services.”
Irrational’s approach illustrates “the importance of the human emotional response” for employers and employees when it comes to how engagement and culture are tied to business outcomes, said Keyia Burton, a senior principal with Gartner, a Connecticut research and consulting firm and one of the fund’s holdings. Feeling valued and invested in the success of a company can boost performance, Burton added. “We don’t put enough stock in how powerful that is as a catalyst to generate real change.”
Many employers have launched wellness programmes designed to retain employees and keep them motivated since the start of the pandemic. But evidence linking these to the performance of the business has been limited.
However, this is increasingly being examined. S&P Global, the rating agency, now includes job satisfaction, happiness, stress and purpose at work as part of its environmental, social and governance evaluation, for example.
Alex Edmans, a professor of finance at London Business School, has studied decades’ worth of US stock market data to assess the correlation between satisfied workers and company outperformance. His research found companies with high employee satisfaction did outperform their peers on the stock market by up to 3.8 per cent a year in some cases. But Edmans and his collaborators, in a study published in July in the Management Science journal, expressed caution about extrapolating those findings outside the US.
“A strategy of investing in firms with high employee satisfaction will only generate superior returns in countries with high labour market flexibility,” they wrote.
Bryan Armour, director of passive strategies research for North America at Morningstar, said: “Motivated employees produce at a higher rate than disengaged ones, I think we can all agree on that”. But he cautioned that the performance record of “human capital factors” is “short relative to established risk factors, and its proprietary data set is a bit of a black box”.
Irrational was set up by investment veteran David van Adelsberg and Dan Ariely, a behavioural economist and professor at Duke University. They are joined by a third partner, Bart Houlahan, co-founder of a non-profit that certifies B Corporations and former president of AND1, a basketball apparel company.
The HAPI ETF is up more than 20 per cent year-to-date, and though many of its top holdings are part of the booming “magnificent seven” big tech companies that have largely driven recent market gains, van Adelsberg said most of its outperformance was unrelated to those stocks. Other top holdings that have had strong returns over the past year include Eli Lilly and JPMorgan Chase.
“We have found something very different here,” he said, noting that Irrational intentionally avoids looking at traditional financial metrics: “This is purely the perception of employees reporting the nature of their relationship over a long period of time.”
However, a sibling ETF (HAPS), that focuses on employee sentiment within small-cap stocks, has not performed nearly as well. It has trailed almost all of its competitors since inception, and is also significantly more expensive than HAPI, according to Morningstar data.
Larger companies generally have more resources to conduct consistent comprehensive employee surveys over time, allowing them to produce more reliable data, Chaudhry and Burton said.
Irrational is now starting a new venture: selling human capital scores to publicly traded companies that want fresh workforce insights or private equity holdings whose owners want new data about their portfolios.
“As we’re showing outperformance in the [HAPI] ETF, it creates the argument for why companies should care and why firms should be interested in getting reports on their individual companies,” Houlahan said.
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