Investors and companies are focusing on this key factor. Here’s what you need to know.
We live in a new investing reality. More extensive data, corporate disclosure and regulatory reporting give investors new insights into how well companies are managed. Investors are paying increasing attention to how environmental and social information affect something specific: corporate performance. Done right, a focus on this type of information can potentially lower investment risk and generate higher returns.
But not all environmental and social information is material. Financially material factors are those that could have a significant impact – both positive and negative – on a company’s business model and value drivers, such as revenue growth, margins, required capital and risk. The material factors differ from one sector to another. For example, environmental factors are likely more material to the value of materials companies than to internet companies, where management of privacy and data security is critical to gaining and maintaining market share. In other words, not all information has a fundamental impact on a company’s financial well-being. Investors need to distinguish between what is and isn’t material. How a company performs on these factors can often signal whether it is likely to produce an attractive risk-adjusted return to investors.
In this article, we zero in on one critical factor, human capital management. Human capital encompasses the skills, knowledge and experience that employees bring to an organization and the value that they create. Investors and companies are increasingly focused on improving their human capital management practices, which can have a material impact on corporate performance depending on how well it is managed.
Human capital: People, skills and value delivered
How can investors think about human capital management, a broadly material factor? First, acknowledge reality: The world of work has changed. Following the workplace impacts of COVID-19, companies are more carefully considering human capital issues—how to recruit and retain the right people with the right skills to serve customers and stakeholders and deliver shareholder value.
Increasingly, a greater share of a company’s value is derived from its people—who generate intellectual property—rather than its physical property (such as machines, equipment and real estate).1
Today, as companies navigate a tight labor market, many are reorganizing to attract, retain and motivate their workforce. More and more, investors are looking to understand how companies assess and monitor human capital management and corporate culture.
A recent report from Gallup highlights key factors influencing retention, performance, and engagement, which contribute to a supportive and inclusive workplace environment:2
- A positive and engaging environment enhances performance and business outcomes
- High-engagement teams experience greater employee wellbeing, productivity, profitability and sales
- Effective managers foster engagement through meaningful feedback, goal setting, and understanding employees’ strengths
Gallup’s findings align broadly with J.P. Morgan research on the Human Capital Factor (HCF), a strategy that quantifies employee sentiment and behaviors based on surveys and public sources such as Glassdoor. J.P. Morgan’s Commercial & Investment Bank used HCF scores as a stock selection method, and the HCF portfolio delivered excess returns compared to the benchmark across a series of back tests.3
Turnover and engagement data can be revealing: some research shows higher turnover and lower engagement correlate with weaker performance.4 Still, not much of human capital management data is standardized or uniform. That means it requires some work to make it useful for investment decision-making. For those ready to do the research, identifying material information among this data could be a real opportunity.
Intangible assets on corporate balance sheets
As always, investor research includes a close look at corporate balance sheets. The balance sheet treats human capital, the value of a company’s employees and intellectual property, as among the company’s intangible assets. That’s always been true, but it matters much more now: In 1975, only 17% of the market value of the S&P 500 was intangible. Less than 50 years later, that share had grown to 90%.5 In other words, intangible assets including human capital are increasingly valued and need careful management to ensure profitability.
Think of a human capital-intensive tech company whose value is almost entirely derived from one powerful algorithm (a creation of human brains). Imagine that the team (the human capital) responsible for the creation and development of the algorithm suddenly left the company. Who can doubt that this would be material information?
How can I invest?
Finding and analyzing information about human capital management requires considerable research and due diligence. But you don’t have to do the digging yourself. Consider a well-managed fund or investment strategy whose research teams and managers are scouring all available data and— again, this is key—determining what of the information is and isn’t material.
Different paths can take you to the same destination: a smart focus on material factors, including human capital, potentially leading to stronger risk-adjusted returns.
We can help
For a thorough analysis of how these considerations might fit into your portfolio and best align with your financial goals, reach out to your J.P. Morgan team.
1 Wagner, Renate. “Why it’s time to rethink human capital in corporate valuation, ”World Economic Forum, 9 Jan. 2024, https://www.weforum.org/stories/2024/01/why-its-time-to-rethink-human-capital-in-corporate-valuation/.
2 “State of the Global Workplace,” Gallup, 2024 https://www.gallup.com/workplace/349484/state-of-the-global-workplace.aspx.
3 Chaudhry, Khuram. “Commentary: Linking human capital management to equity performance,” Pensions & Investments, 7 March, 2024, https://www.pionline.com/industry-voices/commentary-linking-human-capital-management-equity-performance
4 “State of the Global Workplace,” Gallup, 2024 https://www.gallup.com/workplace/349484/state-of-the-global-workplace.aspx.
5 Brown, Monika. “Boom of Intangible Assets Felt Across Industries and Economy,” UCLA Anderson Review, 19 April 2023, https://anderson-review.ucla.edu/boom-of-intangible-assets-felt-across-industries-and-economy/.
