How will demographic shifts & deglobalization impact human capital management and human rights?
Our sustainability team discuss how demographic shifts and deglobalization will impact human capital management and human rights and how will this translate to opportunities for active managers?
A new regime in financial policy and market behavior is unfolding and the patterns of the past decade are facing a period of adjustment. At Schroders, we call this The 3D Reset; a new regime shift that will be driven by three key factors: deglobalization, decarbonization and demographic change. In a recent webinar, Whitney Sweeney, Sustainability Investment Director, Angus Bauer, Head of Sustainable Research and Lazaro Tiant, Sustainable Investment Analyst, discussed human capital management, human rights and AI in the light of demographics and deglobalization. The below is a summary of their discussion.
Q: What are the sustainability considerations that are related to deglobalization and demographic shifts in the context of the 3D Reset?
I think it's important to be clear that in the sustainable research team in which Laz and I sit, we look at things from a thematic perspective. So we cover climate change, natural capital, human capital management, human rights and innovation and technology. And when we're looking at these topics, we're trying to think about them through the lens of materiality. Are there issues going on here that are material? Are there issues going on here that intertwine with other big global trends? For example, how will demographic shifts or deglobalization trends affect different stakeholders?
When we speak about demographic shifts what we mean is that in developed markets, we are facing labor shortages due to an aging working population. There are estimates out there that suggest that the world will be short as many as 85 million jobs by the year 2030 costing trillions of dollars of global GDP. So are the right workers even available for certain jobs in certain sectors or do we need to train them and at what cost?
Whilst you might read a lot of macro-related content that talks about the inflationary consequences of demographic shifts; from a sustainability perspective, what we're really looking at here is whether we can start to identify companies who, in the long-term, have good human capital management skills.
We believe, the harder it is to find workers, therefore the more important it is for companies to be good managers of human capital; to be good employers, to offer better work-life balance, pay better and to offer effective training.
So higher productivity as well as higher pay, better outcomes for workers, may lead to better outcomes for investors as well. That is really the essence of Human Capital Management. That is the importance of Human Capital Management when viewed through the sustainability lens and that is where it intersects with these fascinating global demographic changes that are taking place at present.
From a deglobalization perspective, what we have seen since 2020, global supply chains have been put on the spotlight and have been either broken down or impaired to some degree. On top of that, there has been a surge in the need for energy independence as the top agenda item for many countries. Consequently, countries are looking to bring manufacturing back home and limit the supply chain risks. Actual announcements of reshoring jobs are increasing due to federal or state incentives, ensuring supply chain resiliency and avoiding geopolitical risk. This movement of reshoring/nearshoring will cause inflationary pressures which not only affects equity markets and companies but also sovereign credit and what it means for sovereign bond investors.
Q: With this focus on the labor force, let’s turn to employees as a stakeholder.
Millennials have had a tough time since entering the job market due to events such as the global financial crisis, the euro crisis, and the COVID pandemic. However, they are currently a significant portion of the global workforce and will continue to be for the next decade and a half. In developed markets, they make up around 30-40% of the workforce today, and by 2030, this number is expected to increase to around 75%. Millennials generally have different values and motivating drivers compared to previous generations. They are purpose-driven, values-led, and seek organizations where their values are shared. To be clear, it's important to acknowledge this isn't just a Millennials issue. Bill O'Brien famously noted in an interview in 1991 that up until that point, companies had been great at providing for the first three levels of Maslow's hierarchy of needs - food, shelter and belonging - but not the love, nor self-actualization needs, sufficient for people to grow and feel truly fulfilled. While people management has been evolving to address these ever since, the COVID pandemic shifted the balance of power between capital and labor. It led to the 'Great Resignation where many individuals have been re-evaluating their job satisfaction and bargaining power. To put it simply, companies need to pivot in the way they manage their people to address and get the most out of their employees.
Q: Staying on that perspective of employee as a stakeholder, could you provide some insights on Human Capital Management in the context of the global themes that we've laid out?
An organizations’ human capital refers to its people’s capabilities, relationships, networks and their competencies. It is a critical source of competitive advantage and resilience for companies. There is an acute need to apply both quantitative and qualitative analysis to the way companies seek to manage their human capital. But what we've really done throughout our research so far is tried to boil it down to a sort of set of core systems that we can think about when we try to understand whether or not companies are managing their human capital effectively.
So when we consider the fundamental changes in demographics in a human capital management perspective, we look at how the composition of the workforce intersects with traditional sustainability analysis and financial analysis i.e. understanding how companies are managing an evolving group of employees to get the maximum possible value out of them.
We think there is a growing evidence base that Human Capital Management is material. We believe there is a real logic to assessing this, not just to understand the employee stakeholder outcomes, such as employee satisfaction, mental and financial wellbeing, employee turnover, which has a tangible physical cost on companies, but also to understand company return on capital. These different human capital systems can really affect the revenue and cost items in the PNL, or a company’s cash flow statement and its the balance sheet. We expect that companies with strong human capital management are likely to be more capable of navigating the future effectively.
Q: . So we have discussed Human Capital, but there are other stakeholders that we should be looking at as well. For instance, customers and communities, how are human rights included within these deglobalization and demographic changes?
Within human rights, it’s a spectrum of different stakeholders that need to be considered. There are workers and communities across the value chain as well as the customers of end products and services.
What does this mean for companies? Companies have to provide basic access to fundamental products and services such as educational, financial and health services. Digital inclusion and digital rights are becoming interestingly important subtheme within our human rights framework and will be particularly important in the changes in demographic trends going forward.
Digital access and the growth of communication technologies have made significant contributions to economic development. This has also raised the stakes for an individual or community’s ability to participate in and contribute to the economy. As technology evolves, the digital divide prevents equal participation for low income households, the disabled, rural areas, and older adults. As investors, we need to ask whether companies are responding to changing customer needs resulting from demographic and structural trends in the population e.g., ageing population? Are their networks reliable?
As we think about deglobalization, you see countries, such as the US, really focused on bringing manufacturing back or closer to home and this is very evident within the energy transition. However, when we think about what's needed in terms of key components for technologies like batteries and solar panels, this remains sourced from sensitive regions and therefore more enhanced due diligence will be needed when reviewing global supplier trade moving forward.
Q: How does AI come into play in the context of deglobalization? From a human capital perspective, what does AI mean?
As mentioned before, companies are facing labor shortages. This means they will need to invest in productivity-enabling technologies such as AI. While there are concerns about job displacement due to automation, historical evidence suggests that overall job numbers have not decreased and society has become more prosperous. The service sector and knowledge-based industries are considered by some as being particularly vulnerable to AI, but we believe the introduction of AI will be a case of augmentation rather than substitution.
What is exciting is that on a micro level, workers generally in the knowledge-based industries are keen to reskill. It's one of the really unique things about a human capital asset: it is malleable. People have the potential to evolve, to grow, to become more valuable over time. We are seeing that many employees are keen to learn how to use AI and how to integrate its use into their day jobs. That could be consistent with a change in human capital management, with HR practitioners focusing more on talent and learning mechanisms and reskilling existing employees.
At the same time, there are opportunities for companies to integrate AI into all areas of human capital management. Companies can differentiate themselves by developing the skills of their workforce in utilizing AI models and fostering strong relationships and customer service. The way we see it, human capital management is crucial in the AI-integrated future both for sourcing labor and generating value.
Q: How does AI come into play in the context of demographics and human rights?
When we consider AI from a human rights perspective, we consider where AI can be leveraged to improve access and connectivity, education, health and wellness. From the ethics and bias standpoint, we want to think about digital and health equity, health inclusion and health safety. Read more about this in my article: AI revolution: what’s the impact on connectivity, education and health?
Q: We have spoken a lot about the changes that deglobalization and demographics will bring. How do we take the information that we have, the trends that we are seeing and apply a quantitative lens; how does our analysis of human capital management or human rights translate to investment?
What does human capital return of investment mean? Human Capital Return on Investment (HCROI) is an accounting-based quantitative measure that can be used alongside Employee Economic Value Added (EEVA) and other employee outcomes metrics to assess the effectiveness of human capital management. It is positively correlated with forward excess returns over multiple time horizons and across sectors, and companies with stronger HCROI have historically created more value through the cycle. HCROI analysis can be used as part of a broader investment and engagement process, helping us interrogate why companies with similar levels of labor investment can achieve different fundamental outcomes.
But the key is that we try and build HCROI and other quantitative human capital analysis and metrics into a mosaic of data points that speak to the effectiveness of a company's Human Capital Management holistically. We have to combine the quantitative analysis with the sort of qualitative assessment that investors across the platform here at Schroders have been thinking about for a long time. But really it's the blend of a whole range of data on employee and financial outcomes that allows us to answer the questions such as: how does company Human Capital contribute to value creation and how sustainable is a company's Human Capital Management?
So on the macro lens, I mentioned that some of these issues such as education have sovereign or sub sovereign municipal consequences. So when we think about this from the perspective of fundamental research, we think about the social impacts that are driven by things like education, as well as things like brain drain via talent migration. How do these things affect GDP? How do these things have a forward-looking lens to help us understand the growth of potential GDP given the quality and access of things like education and employment?
From the quantitative perspective, you can see the number of populations that are educated across different levels. You can see what levels those are in terms of primary school vs. vocational school vs. university schools. But then the underlying information in terms of the quality of those curriculum and the quality of the education provides another lens to help us understand how these can affect a company's ability to procure this talent and have it lead to things like innovation.
From a qualitative sense, in a more of a micro sense, how can this affect companies in terms of talent leaving certain countries to go start jobs and companies elsewhere, thus those jobs not being at home? And so these are things that we can think about from that sovereign level, but then also apply that to company on the micro level. We have a tool called ThemExTM* that really helps us take a more product and services lens to demographic shifts as well as deglobalization. So understanding things like healthcare, sustainable food, sustainable infrastructure, water and wellbeing, we're able to point at where companies are generating revenue towards these different products and services and how that is adding towards sustainable objectives or sustainable development goals.
Then to contextualize all the quantitative and qualitative data through the demographic shifts and deglobalization such that we're able to understand if some of these trends are to persist. Who are the companies and which sectors that can be most advantageous from an investor standpoint?
*ThemExTM analyses the thematic alignment of individual companies and portfolios to the UN SDGs. The alignment Tscore is derived from proprietary qualitative analysis across themes, sectors, regions, and stocks. The mapping of business activities to SDG’s utilizes third party categorization of companies’ divisional revenues. ThemExTM alignment score for a given company is limited by the granularity of the underlying data and that company’s market capitalization, sector, or region. Like any model, ThemExTM will evolve and develop over time as Schroders receives feedback on the model and continues to seek ways to systematically enrich the insights captured through the tool.
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The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.