For many employers, staff wellbeing and satisfaction have become a much bigger priority since the pandemic. One asset manager is betting that such initiatives will yield financial benefits.
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’s about tapping into a growing — but still unproven — belief that staff satisfaction is not only good for employee retention and morale, but can also help boost a company’s share price.
Quantifying this phenomenon on a large scale has been a challenge. Irrational combines proprietary data based on employee surveys with publicly available employment review websites, such as Glassdoor, to come up with thousands of ratings of publicly traded U.S. companies, called “human capital factor scores.”
These scores aim to provide a tangible way to measure employee satisfaction, a metric that is considered difficult to measure. They include data on the effectiveness and innovation of organizations, the emotional connection employees have with their work, and extrinsic rewards such as salary, 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 conjunction with Harbor Capital, a boutique asset manager.
The flagship HAPI ETF, which selects large-cap stocks with the highest human capital scores, has outperformed more than 90 percent of peer funds since its launch in October 2022, according to Morningstar.
Irrational’s bet has been backed by research from JPMorgan, in which the bank’s head of European quantitative strategy, Khuram Chaudhry, and his colleagues have linked the ability to outperform the market to changes in the role that work plays in our daily lives. They believe that work has been supplanting traditional pillars of connection not just as a result of the Covid pandemic, but because of structural changes in how we spend our time and where we look for a sense of belonging.
“People used to go to work to provide a service to a company and get paid in return,” Chaudhry told the Financial Times. “But in the past there was also a community – there was the church or there were neighbours.”
“Nowadays, what we ask of workers or the company in general is that they provide many of these services.”
Irrational’s approach illustrates “the importance of human emotional response” to employers and employees when it comes to the relationship between engagement and culture and business outcomes, said Keyia Burton, a senior director at Gartner, a Connecticut-based research and consulting firm and one of the fund’s holdings. Feeling valued and involved in a company’s success can boost performance, Burton added. “We don’t give enough credit to how powerful it is as a catalyst for real change.”
Since the start of the pandemic, many employers have launched wellness programs designed to retain employees and keep them motivated, but evidence linking them to company performance has been limited.
However, this aspect is increasingly being examined. For example, the rating agency S&P Global includes job satisfaction, happiness, stress and purpose at work as part of its environmental, social and governance assessment.
Alex Edmans, professor of finance at the London Business School, has studied Decades of US stock market data To assess the correlation between satisfied workers and superior company performance, their research found that companies with high employee satisfaction outperformed their peers on the stock market by as much as 3.8 percent annually in some cases. But Edmans and his colleagues, in a study published in July in the journal Management Science, expressed caution about extrapolating those findings outside the U.S.
“An investment strategy in companies with high levels of employee satisfaction will only generate higher returns in countries with high labor market flexibility,” they wrote.
Bryan Armour, director of passive research for North America at Morningstar, said: “Engaged employees produce at a higher rate than disengaged ones, I think we can all agree on that.” But he cautioned that the performance track record of “human capital factors” is “short relative to established risk factors, and their proprietary data set is a bit of a black box.”
Irrational was founded by veteran investor David van Adelsberg and Dan Ariely, a behavioral economist and professor at Duke University. They are joined by a third partner, Bart Houlahan, co-founder of a nonprofit that certifies B Corporations and former president of AND1, a basketball apparel company.
The HAPI ETF is up more than 20 percent so far this year, and while many of its top holdings are part of the “magnificent seven” big tech companies that have largely driven the market’s recent gains, van Adelsberg said most of its outperformance wasn’t related to those stocks. Other top holdings that have had strong returns over the past year include Eli Lilly and JPMorgan Chase.
“We 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 sister ETF (HAPS), which focuses on employee sentiment in the small-cap equity space, has not performed as well. It has lagged nearly all of its competitors since its inception and is also significantly more expensive than HAPI, according to Morningstar data.
Larger companies generally have more resources to conduct comprehensive and consistent surveys of their employees over time, allowing them to produce more reliable data, Chaudhry and Burton said.
Irrational is now embarking on a new venture: selling human capital scores to publicly traded companies that want new insights into their workforces or to private equity holding companies whose owners want new data about their portfolios.
“As we are showing superior performance in the [HAPI] “The ETF makes the argument for why companies should care and why firms should be interested in getting reports on their individual companies,” Houlahan said.