Companies should be evaluated on how well they treat employees before any investment in them is considered, said David van Adelsberg, co-founder and partner at Irrational Capital, an investment research firm based in Conshohocken, Pa.

Using data that quantifies the "human capital factor" of a company can lead to wiser investments and better returns for the investor, van Adelsberg said in an interview. The unusual name of the company was derived from a book written by Irrational Capital co-founder Dan Ariely, a behavioral economist and the author of “Predictably Irrational.”

The data developed by Irrational Capital was used by Chicago-based Harbor Capital to create two ETFs, the Harbor Corporate Culture ETF (HAPI) and the Harbor Corporate Culture Leaders ETF (HAPY), which were launched in October and February respectively. A third ETF based on small-cap investments will be launched in the near future, Kristof Gleich, president and chief investment officer at Harbor Capital, said in an interview.

Van Adelsberg and Ariely maintain that companies that have happy, motivated employees are more likely to succeed and provide investors with the best returns.

“We studied human motivation in the workplace because we wanted to see if we could demonstrate that the attitude of employees toward the company is the one of the most important factors in determining the profitability of a company,” van Adelsberg said. Companies frequently say their employees are the most important element in their operations but they seldom calculate it as an asset, he added.

“Of all the investments companies make, creating a strong corporate culture is one of the best ways to create value. This is why employee behavior and motivation can be such an important element of stock market performance," Ariely said in a report compiled by J.P. Morgan. The omission of human capital from assets in the balance sheets is a critical mistake, Ariely said.

The human capital factor as defined by the founders of Irrational Capital is measured using two types of data sets, one publicly sourced from employment related websites, such as Glassdoor, and the other private and proprietary data that is based on employee surveys, van Adelsberg said. The surveys are conducted by a third party that establishes relationships with companies and uses a set of questions to determine employee satisfaction in a variety of areas including such things as workplace fairness and the absence of unneeded bureaucracy.

Companies do well when employees have a sense of appreciation, when they trust the companies and when there is transparency for operations, the co-founders said. In addition, employees value having good management, clearly defined career paths, and autonomy in their jobs, among other factors, he said.

HAPI includes 150 stocks and is up 11% since launch. HAPY includes 70 stocks and is currently down by 13% but that is a function of where the market was when the stock launched and of its short history, Gleich said. J.P.Morgan reported that companies with the highest human capital factor scores provided an annualized return that was 6.9% above the MSCI USA index between 2009 and 2020.

In addition to being beneficial to investors, the information used in determining the human capital factor is useful for the owners of companies because they can see where their companies are falling short of employee satisfaction issues, van Adelsberg said.

“We’re delighted to expand our partnership with the team at Harbor Capital to deliver further evidence that doing the right thing pays and is strongly linked to future investment performance. Our work has clearly proven that corporate culture and employee motivation are deeply connected with financial performance,” Ariely said in the J.P. Morgan report.

The data provided by Irrational Capital helps investors evaluate risk, Gleich said.

“They are proving our faith in their data and showing that the human capital factor should be considered by investors,” he said. “This is an investment factor that is fundamental to the analysis of a company. It is difficult to measure, but it is important. Returns may be harder to come by in the future.”

Van Adelsberg added, “Our objective was to demonstrate that those companies that do the right thing by treating their employees well get rewarded.”