Happier staff more effective for fund operators

New US study shows that fund operators that care more holistically for culture and people management see better returns. What could this mean for HR practices?

Andrew Putwain POSTED ON 9/20/2024 8:00:00 AM

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A new study by US financial research firm Irrational Capital has created indices to show the happiness and productivity link between employees at fund operators and how this effects the company’s overall performances.

The index was designed to look at stock picking in a way that largely abandoned traditional financial metrics in favour of a system designed to select companies based on how happy their workers are.

In October 2022, Irrational Capital company created their thematic ETF based on the proposition that “happier employees lead to stronger stock returns”.

The science behind the hypotheses isn’t new – since the pandemic, many employers have increasingly prioritised employee well-being and satisfaction including work/life balance and mental health of staff in order to boost productivity. One of the key ways this can effect it is in a lower rate of burnout among staff, which leads to absences, and well as turnover of staff.

Other studies have showcased this too - the importance of a good working culture at investment companies has been outlined with emphasis on how it should be a key concern for organisations when trying to understand, define, and demonstrate their corporate culture. 

The trend has been highlighted in a report from JPES Partners earlier this year, which was based on a Masterclass on the ‘Role of Culture in Asset Management,’ hosted by consultants Debbie Clarke and Angela Docherty

That summary was based on the annual Asset Owner Study, which surveyed the evolving priorities and requirements of asset owners that represent more than £2 trillion of assets across pension schemes, charities, insurers, wealth managers, and platforms.  

Study details

In the study, Irrational Capital used stock picking by refocusing from traditional financial metrics and instead toward employee happiness.

According to the coverage in The Financial Times, the firm created "human capital factor scores," which assess employee satisfaction using data from surveys other sources, which include publicly available assessments – i.e. reviews on recruitment sites, such as Glassdoor and reported on the way the data is collected. The idea, said Irrational, was that happier employees lead to better business performance, driving stock market success.

The media releases on the project specified that some sources were relatively nascent.

This approach was tested through the HAPI ETF, launched alongside investment manager Harbor Capital, which invests in large-cap companies with high human capital scores.

The ETF says it is based on the Human Capital Factor (HCF) and “seeks to identify and scores companies on their management of human capital based on a proprietary methodology, selecting them for inclusion in the index in an objective and systematic way.”

The HAPI ETF offers exposure to larger capitalisation companies with strong HCF scores while constraining sectors in an effort to enhance overall diversification.

To analyse the HCF, JP Morgan used the MSCI USA Index, which comprises more than 600 stocks. It formed and tested two share portfolios for the years between 2009 and 2020.

As of 31 December in each year, it placed a concentrated portfolio of 30 stocks with the highest HCF scores in the long-HCF portfolio. The 30 stocks with the lowest HCF scores were assigned to the short-HCF portfolio. The portfolios were weighted and regularly rebalanced, to ensure a fair comparison.

The high-HCF portfolio achieved an annualised return of 20.9%, compared to 13.3% for the MSCI overall, it said.

When the high-HCF portfolio was rebalanced to make it ‘sector-neutral’ – reflecting the sectoral composition of the MSCI benchmark – the difference remained profound. The sector-neutral high-HCF portfolio showed an annualised return of +19.2%, substantially higher than the Index benchmark 

Since its debut in October 2022, HAPI has outperformed over 90% of its peers, according to Morningstar. Supporting this strategy, research from London Business School professor Alex Edmans found that companies with high employee satisfaction often outperform their peers by up to 3.8% annually.

However, Edmans cautioned that this success might be most effective in countries with flexible labour markets. Despite HAPI’s success, a similar small-cap fund, HAPS, has underperformed, highlighting challenges in applying this strategy to smaller companies, which may lack the resources to gather reliable employee data. Irrational Capital is now expanding its offerings by selling human capital scores to companies seeking deeper workforce insights, emphasising the growing recognition of employee well-being as a driver of business success.

The results of the JP Morgan study were clear, said Irrational Capital. “Long term the Human Capital Factor delivers 4% annual returns in excess of the benchmark and 3.8% in excess of the low Human Capital Factor stock portfolio,” it said. “The implication is that since human capital is not accounted for on balance sheets, there [exists] the opportunity to gain enhanced returns by correctly identifying those companies which have superior human capital.”

It concluded that “Simply put, employees respond to more than pay, rewards and compensation to be highly motivated and productive in the workplace”.

“Being able to capture and measure both intrinsic and extrinsic motivational criteria does not only help employers but may also lead to better stock price returns.”

 

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