Schroders has released a new framework to assess human capital value creation. This includes a simple set of quantitative accounting metrics which can be used alongside qualitative techniques to enable investors to refine their understanding of human capital management’s contribution to a firm’s returns and productivity.
Top-line findings from the research include:
- We can define and measure what the outcomes of good human capital management look like, and why we see structural and cyclical reasons to focus on this currently.
- Human capital returns are positively correlated with forward excess returns (those exceeding a relevant benchmark or index) over multiple time horizons and across a majority of sectors, even after controlling for Return on Capital Employed and adjusting for a variety of factors.
- There are multiple paths to human capital management affecting balance sheets and profit and loss.
- This being said, there is risk associated with focusing too much on an objective measure for human capital. Human capital analysis must combine qualitative and quantitative assessment. With KPIs to identify good human capital management, we can consider the drivers of change, and show how to optimize human capital productivity.
Created with academic support from the Oxford Rethinking Performance Initiative at Saïd Business School, University of Oxford and California Public Employees’ Retirement System (CalPERS), the analysis confirms that human capital is a clear driver of company productivity and profitability and that companies with durable management frameworks create stronger returns and value for investors.
Nicholette MacDonald Brown, Head of European Blend, Schroders, has been incorporating this analysis into her investment process. She said: “Unlike environmental factors which have transparent values, human capital has traditionally been difficult to quantify, especially when looking at the lower end of market cap where data is extremely opaque. 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.”
Angus Bauer, Head of Sustainable Research, Schroders, said: “This research tells us that investors cannot ignore human capital management in evaluating investee companies. As we approach continued economic volatility, our analysis shows that companies with strong human capital management are likely to be more capable of navigating the future effectively. Even as the integration of artificial intelligence across industries evolves, the relevance of people as the stewards of value creation will remain high.”
Key findings on the importance of human capital
Companies interact with a diverse set of capitals to create value – financial, physical and human. The latter is increasingly talked about but rarely analysed in detail. There are multiple structural and cyclical factors underpinning the materiality of human capital.
Below are the core views and findings on this topic so far:
- Human capital is a critical source of competitive advantage and fundamental resilience;
- Effective human capital management requires the stewardship of a variety of systems, including operating models, culture and inclusion, incentives, talent and learning, and innovation;
- Qualitative and quantitative analysis of human capital management allows us to ask different questions about the drivers and sustainability of value creation;
- Human capital return on investment (HCROI) is an accounting-based quantitative measure that can be used alongside employee economic value added (EEVA) and other metrics to assess the effectiveness of human capital management;
- HCROI is positively correlated with forward excess returns over multiple time horizons and across sectors, even after controlling for a variety of factors;
- Companies with stronger HCROI create 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 labour investment can achieve different fundamental outcomes;
- Corporate disclosure of human capital-related data remains poor; richer and more pervasive disclosure would benefit market participants and asset owners.
More information about the research and its findings can be found here. This framework is additive to Schroders’ Engagement Blueprint, which outlines priorities and approaches for engaging with companies.
Please see below for links to the research summary, and the five chapters covered in the research.