Pierre Stiennon, investment analyst at Axa Investment Managers: Why human capital management matters to investment analysts

Most companies, listed or unlisted, will say that employees are its most important asset. However, those investing in these companies should not take this statement at face value, and should look at what these companies effectively do.

Meeting companies face-to-face allows investors inside the day-to-day life of management and to link up strategy, culture, and performance. Companies with a solid human capital (HC) track record benefit have a competitive advantage. A comparative analysis of HC achievements is therefore a tool for investors.

When making investment decisions, an investor committed to HC analysis will consult brokers’ advice, company contacts, rating organisations and in-house research. However, brokers in their reports, and companies in their publications, generally pay limited attention to HC issues and the related key performance indicators (KPIs).

Brokers are generally too short-term oriented and resource-constrained to focus on longer-term issues. Companies generally feed brokers with purely financial indicators and associated targets.

Environment, social and governance (ESG) issues provide a complementary and useful insight into the positioning of a company and is a key indicator of overall management quality. Whereas the ‘environment’ (including climate change) is becoming mainstreamed and part of the company’s overall business environment, the ‘social’ aspects (including HC) remain under researched.

Generally excellent companies have an excellent HC policy. However one can come across companies where a suboptimal HC policy in some critical area is a leading indicator of weakness. When poor management persists, inadequate governance is often the explanation. Good governance is critically important for any organisation.

The overall rate of absenteeism; voluntary churn rate (resignations) among selected key executives; training commitment to achieve certain critical skill levels; engagement commitment as conveyed by employee surveys; management compensation structure; and various related KPIs, are all key indicators that illustrate the HC performance of a company.

An investor looking at HC issues will favour companies that are ’employers of choice’ for new recruits; where employees are shareholders and hence have an additional motivational factor; where the inequality of compensation between senior executives is lower; and where there is a strong board that controls management rather than the other way round.

On the other hand investors will be wary of companies where incentives are not based on clear cash targets and whose CEOs may be distracted due to spending too much time managing their profile in the media. Analysing how off-shoring or outsourcing is managed, and the relationships the company has with subcontractors is also insightful. The smooth integration of acquisitions is also key, as there are higher HC risks associated with an acquisitive company compared with an organic grower committed to internal promotion.

Obviously the position, role, and KPIs of the HC director are considerations in investment analysis, but which should be put into context. For example, the current shortage of skilled labour in the resources sector poses a specific challenge.

It is tempting for investors to assign a greater importance to HC in service industries (banking, media, IT) compared to those that are capital intensive (industrials, resources, utilities). This is illogical because optimal HC management is important across all sectors.

Companies relying mainly on skilled staff, such as investment banks, need to focus on managing HC and its associated risks. The current financial crisis shows clear disparities in HC management among banks.

Companies relying on significant invested capital are faced with health and safety issues in addition to the HC ones. For example, British Petroleum paid a high price for insufficient attention to safety rules at its Texas refineries.

Although there are differences among sectors in the implementation of HC best practice, with media being low on the list for example, it is the peer group comparison that sets the rationale for stock selection. However best-in-class companies within a sector find inspiration in other sectors; for example Reckitt Benckiser in its ongoing efforts to optimise performance.

Some HC indicators reflect company costs or benefits and hence have a financial value. In addition, and perhaps more importantly, the HC record reflects clearly on the quality of management. As the financial community broadens its traditional analysis and gives more prominence to HC issues, corporate executives will add value to the financial community and help themselves if they also communicate more on all KPIs that drive cash generation, including critical HC indicators.

Pierre Stiennon is an investment analyst at Axa Investment Managers.


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