Human Capital: A New Investment Thesis That Is Delivering So Far

By measuring employee morale and other people-centered influences on share prices, fledgling ETFs have beaten benchmarks—and attracted a large SWIB position.

Human capital is not part of any balance sheet. A potpourri of employees’ skills, intelligence, motivation, morale and other such intangibles, this is a new theme in investing. Still, the basic concept has an obvious impact on how stocks perform, although not many people recognize that.

Judging by positive early returns from three newly hatched exchange-traded funds with a strategy based on human capital, the people-centric approach seems to have investment utility. The trio of ETFs, sponsored by Harbor Capital, uses a methodology that just marked its third anniversary.

Created by research firm Irrational Capital, in conjunction with the Canadian Imperial Bank of Commerce, this methodology attempts to quantify how the people element influences stock appreciation. While Irrational and CIBC keep the formula under a proprietary veil, they say it incorporates employee surveys from numerous providers.

“Human capital delivers alpha,” the excess equities return over market indexes, says David van Adelsberg, founder of Irrational Capital. As such, he argues, human capital should be included alongside other, better-known, investment factors, such as quality, momentum and risk.

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The old saying about a workplace is: A happy shop is a successful shop. An analysis by research firm VettiFi described how this adage is self-evident, yet seldom appreciated. The firm’s head of research, Todd Rosenbluth, wrote: “Human capital is overlooked by many investors, but is important. Happy, motivated employees are more productive, and this should impact share prices.”

Indeed, a 2021 J.P. Morgan Securities back test of 400 U.S. stocks, using Irrational Capital’s methodology—done before the ETFs appeared—found that the human capital factor produced “the highest returns among all style groups since 2010” by 5.4% on average over the period.

An unrelated iShares ETF has been tracking human capital in Japanese companies since 2016. The iShares JPX/S&P CAPEX & Human Capital ETF, which is designed to include Japanese companies taking proactive and efficient measures with their investments in capital spending and human capital, has reported one-, three- and five-year returns of 19.04%, 16.97% and 11.17%

Although the Harbor ETFs have yet to gain prominence (the threesome’s combined assets under management total only $412 million), one big-league backer is the State of Wisconsin Investment Board. The organization has invested in two of the Harbor vehicles, with a $362 million stake constituting 90% of the two ETFs’ market cap, as of SWIB’s most recent 13-F filing. SWIB declined to comment on its holdings.

Thus far, the three Harbor human capital ETFs have done very well during their short existence. (True, a track record of less than two years is usually too little an amount of time to make a definitive pronouncement on their staying power.) The three funds construct portfolios with well-known indexes’ constituents and use the indexes as benchmarks.

The oldest one is the smallest ($12 million AUM), the Harbor Human Capital Factor Unconstrained, whose benchmark is the large-cap Russell 1000. Opening in February 2022, it thus far this year is up 32%, as of Thursday’s close, beating the Russell index by nine percentage points. This is the one Harbor human capital ETF that SWIB does not own.

The second ETF to launch, in October 2022, is the Harbor Human Capital Factor US Large Cap, with stocks drawn from the S&P 500. This fund (AUM: $277 million) is ahead with 28.3%, versus 22.9% for the S&P index.

The third fund, which debuted in April 2023, is dedicated to small-cap stocks and is measured against the Russell 2000: The Harbor Human Capital Factor US Small Cap (AUM: $123 million) has climbed 14.6% in its eight-month tenure. The Russell 2000 gained slightly less, 12.3%, during that period.

To Irrational Capital’s van Adelsberg, using human capital as a lens to view investments is an undeniable improvement for investors seeking alpha—which he likens to the innovation of putting wheels on suitcases. “It’s a simple idea,” he says.