What is human capital management and why does it matter to investors?

What is human capital management?

Angus Bauer: “By ‘human capital’ we mean the people working at a company and their capabilities and relationships within the business. Companies often say that their people are their greatest asset, but how are they managing that asset? Human capital management is about maximising the potential and value of those employees, their skills and networks.

“Aspects of human capital management include the company defining its purpose and sense of company culture, to talent & learning programmes, incentives and performance management, and more.

“And the key question is, can we see the value of that in investment returns? This is what I’ve investigated in a piece of research looking into the value of sustainable human capital management. The analysis shows that companies with strong human capital management are likely to be more capable of navigating the future effectively. Companies with durable management frameworks create stronger returns and value for investors.”

• Read more: Human capital management research: how people are our greatest asset

Why does human capital management matter to investors?

Nicholette MacDonald-Brown: “As Angus says, effective human capital management can be important for investment returns. From a sustainable investing point of view, a company’s environmental footprint has often been the main focus. But environmental factors are not necessarily the most important ones for every company. For some sectors, like technology for example, employees are the most significant stakeholder. It’s their knowledge and intellectual property that will be most critical to driving growth. We therefore want to understand how people are being attracted to a company and then trained and retained.”

Angus Bauer: “There’s a cyclical reason too for looking at the issue of human capital management now. We’ve come through the Covid-19 pandemic and the “Great Resignation”. That saw the balance of power swing slightly away from employers and towards labour. And while central banks have put up interest rates to combat inflation, labour markets have remained very robust. Labour has a degree of bargaining power now that it hasn’t had in the past.

“Whether or not we go into a recession, the relationship between a company and its employees is incredibly important for a company’s business model. It helps us understand its ability to withstand a changing economic backdrop and the sustainability of its returns profile.”  

What’s different about this research?

Angus Bauer: “What I’ve done in this research is bring a quantitative as well as qualitative approach to the topic. I’ve used novel data sets and metrics that have been honed in academic circles and in the HR industry to improve our understanding of the topic from an investment perspective.

“The research doesn’t argue that all aspects of human capital management can be adequately quantified today. Instead it offers a framework that mixes both quantitative and qualitative techniques.”

Nicholette MacDonald-Brown: “For me as an investor, this research has made an important contribution. Previously, we didn’t have a holistic framework that could help us capture the whole picture. We could look at a company’s employee turnover, or Glassdoor surveys. But that only gives a snapshot of what’s happening at that company right now. It doesn’t give much insight into why something is happening or how it could be changed.

How do you use this research when analysing companies?

Nicholette MacDonald-Brown: “As active investors in European equities, my team and I are trying to find companies where the market is mispricing their potential. This human capital management analysis forms part of the whole mosaic we look at when assessing a company. It adds to the more traditional financial analysis we do around things like valuations or forecasts.

“Importantly, the research helps us to ask the right questions of companies to find out where their approach to human capital management might give them an advantage, or not. Much of what we want to know is not typically disclosed by companies, or not in a format than enables comparison. That meant we decided to carry out a programme of engaging with companies, in the technology sector in this instance, to establish what good human capital management looks like there.”

Why did you focus on engaging with companies in the tech sector over HCM?

Vijay Anand: “Innovation is the heartbeat of technology companies, and that relies on people. We wanted a toolkit to understand the sustainability of that innovation.

“At the same time, the adoption of artificial intelligence (AI) will likely bring in some significant changes to the shape of the global workforce. It could be that the skillset for a successful company in ten years is quite different to what it is now. Companies who are leaders in human capital management may potentially be better placed to manage this transition. That would make them more sustainable investments from our perspective.”

What have been the key findings of the engagements?

Vijay Anand: “This engagement has been very insightful in helping us question some commonly held notions. One such notion is that companies with high staff turnover should be viewed as higher risk. But, actually, some such companies rank higher in terms of their overall human capital management than others with lower turnover. So we can see that the turnover data on its own is not helpful. In our engagements we have realised that companies have a much more sophisticated way of analysing staff turnover.

“Then there is understanding approaches to training and retention: is there formal training, is it all done via on-desk experience. Engaging with companies directly helps us better understand the nuances of each company's HCM strategy.”

How will it impact investment decisions?

Nicholette MacDonald-Brown: “This framework allows active managers like us to gain greater insights into companies within our investment universe. We can identify those which are leaders and laggards in human capital management to make informed allocation and engagement decisions. For example, it can help us ask the right questions to identify where a previously lower ranking company might be improving its human capital management. And where we identify best practice, we can share what that looks like with other companies looking to improve.

“Another dimension it helps with is comparing companies, especially those at the smaller end of the market capitalisation scale. As we’ve said, disclosure in this area can be opaque anyway but smaller companies have fewer resources to make disclosures about turnover, training, etc. This framework helps us ask the right questions and find out as much as we can about those companies where their human capital management is going to be material for their future investment returns.”

• Find out more: Podcast: Should investors view human capital as an asset or an expense?