Nina Röhrbein examines a fund that sees a strong correlation between human capital management, productivity, financial results and stock performance

With the large majority of social responsible investment (SRI) funds focusing on environmental or governance issues, the social part of ESG often appears to be neglected.

However, the tide may be turning. It was this very element of ESG that encouraged AXA Investment Managers (IM) to launch its human capital management fund.

“Many aspects of human capital management are ideally suited to quantitative data and the gap around social is an investment opportunity,” says Jean-Marc Maringe, portfolio manager at AXA IM (pictured right). The idea behind the fund is our strong belief that there is a link between human capital management, productivity, financial results and stock price performance. It means that the company’s financial performance is the result of the people within it. Plenty of academic studies - by consultants such as Watson Wyatt, McKinsey and Hewitt Associates as well as by ourselves - have found evidence for that.”

AXA IM says it knows only of one other human capital management fund, that ofBassi Investments in the US, so this particular SRI investment space seems almost competitor free.

“Rather than being a cost, human capital is an asset,” says Maringe. “But this has been neglected so far. This is probably due to a lack of information from the companies and the difficulties in finding a provider that can supply the information. However, quite recently firms have started to communicate on this matter and provide data, although there is still less focus on human capital management data than on, for example, environmental data. But generally speaking, companies across all sectors are becoming increasingly aware of the importance of human capital management. They have started to realise that the need for greater innovation, the shortage of talent and the ageing of employees means it is now the critical component of competitive advantage for many companies.”

“Good fundamental investors should be considering social issues such as human capital in the course of their investment process,” agrees Danyelle Guyatt, principal at Mercer Consulting. But she adds: “There are questions as to whether this should be a branded human capital fund or whether it should be a factor better integrated into mainstream strategies. We believe there are wider benefits to integration as it will impact on a wider range of investee companies and not be restricted to those held in a branded human capital fund.”

AXA IM established three criteria to indicate productivity: career and development planning, which it weighted at 30% in the fund; working conditions including salaries, health and safety and staff turnover, weighted at 50%; and employment growth, weighted at 20%.

“According to our research, these three are the most relevant indicators for the time being,” says Maringe. “But we test the validity of these criteria on a regular basis as they could change in the future, for example as a result of a change in regulations.”

Using these criteria AXA IM rates companies in its investment universe - as an SRI fund the sectors of tobacco and defence are excluded - by applying a trading volumes and broker coverage filter followed by a best-in-class approach. This results in two portfolios consisting of the 50 best and the 50 worst companies respectively. The 70 to 80 companies with the highest human capital scores are included in the fund, while the lowest scorers are excluded.

Companies with a human capital score very close to the sector average may be eligible if they make progress, such as companies that have had accidents or integration problems with acquisitions or outsourcing, according to Maringe.

“One of the advantages of our size as a business is that we have good access to management,” he says. “Nevertheless, the attitude of company boards varies when it comes to engagement.”

Information about the companies is provided by ESG rating agencies Innovest and Vigeo, by sell-side brokers through the Enhanced Analytics Initiative (EAI) or is compiled through direct engagement with a company.

“Companies disclose an increasing amount of information,” says Maringe. “However we would still like to have more quantitative data. Therefore, the information provided is also based on company meetings we have either with the CEO, the management or human resources managers.”

Since its launch at the end of October, the fund has outperformed its benchmark - 50% of the Dow Jones Stoxx Small 200 and 50% of the Dow Jones Stoxx Mid 200 - by just over 600bps. According to a human capital management fund back-test, since January 2006, companies with the best human resources strategy have outperformed companies with the worst human resources strategy by more than 5% on a sector basis, says AXA IM (see graph).

Nevertheless, Maringe expects markets to be quite difficult in the current climate. “The timing of the fund’s launch - just before markets fell sharply - has not helped the performance so far because despite the outperformance of the benchmark we are down in actual terms and investors are generally still cautious on equities. However, the credit crunch has not questioned the philosophy of the fund and we believe improvements in the human capital management of companies put them in a good shape for the long run.”

Indeed Mercer has not experienced any direct impact of the credit crunch on SRI policies to date, says Guyatt.

“The fund performance has started well and is ahead of its mid term objective,” Maringe says. “But the idea behind the fund is investment over a long-term horizon where we are confident that a performance of more than 2% above the performance indicator on a three-year rolling basis will continue.

“Despite the market volatility, the turnover of stocks in this, like many SRI funds, will remain stable based on this long-term approach. We expect stocks to remain in the fund for a number of years, with studies showing that the effect can be felt after three years.

“And to achieve diversification through the human capital filter, we have no sector bias and a single stock can only make up a maximum of 4% of the fund.”

But Guyatt is a little more cautious. “It is too early to assess the performance of specialist funds such as these, but there is growing evidence in the management literature that good human capital management has a positive link with corporate performance,” she says.

The AXA World Fund Human Capital fund focuses on both alpha enhancement, in other words the search for outperformance through the lens of extra-financial criteria, as well as beta enhancement via better disclosure on non-financial criteria in order to strengthen long-term returns.

“Until the market better understands and prices human capital management-related risk and reward, we view it as an alpha opportunity,” says Maringe. “And so for us the goal is to increase productivity, which is a key indicator for company profitability and sustainable growth.”

Guyatt believes it is indeed possible to achieve alpha in such funds given that the fund manager has skill and developed a way of identifying long-term shareholder value that is not adequately reflected in valuations. “But human capital management is more likely to be a co-contributor to alpha generation where a range of extra financial factors are taken into account that impact on long-term shareholder value,” she adds.

The Luxembourg-domiciled fund consists of small and mid-cap companies ranging from €2bn to €6bn, leading to an investment universe of just over 1,250 stocks.

“For small and mid caps the challenges posed by human capital management are even more significant than for large caps,” says Maringe. “As growth companies, their risk at times of acquisition is higher than that of large caps if they do not change their poor structure.”

AXA IM aims to extend the fund’s listings - it has registrations in Austria, France and the UK so far - across Europe although Guyatt has yet to notice investor demand. But Maringe says: “More asset owners have started to recognise human capital as an asset. So far the countries where we have encountered most interest are France, Belgium, the UK, the US and the Nordic countries.”

“The fund is clearly dominated by its social focus,” says Maringe. “If companies look good on financials but not on human capital we will not invest in them. And as an SRI fund we will also not invest in companies that have a good social policy but present a risk in terms of environmental or governance policies.”