Looking For a Good Investment? Find a Company That Understands Its Employees.

The “Human Capital Factor,” a methodology that measures worker behavior and motivations, may provide better portfolio returns than traditional metrics.

Illustration by II

Illustration by II

A new entrant has emerged in the landscape of factor investing.

According to J.P. Morgan, the Human Capital Factor (HCF), a strategy that analyzes certain employee perceptions such as pride, purpose, and psychological safety, has demonstrated that it may be more relevant to a company’s stock performance than other investment factors.

Developed by a Pennsylvania-based investment research firm called Irrational Capital, HCF quantifies corporate culture by studying employee behaviors and motivations, rather than by simply looking at more easily quantifiable stats, such as compensation packages or the number of diverse members on the board. Irrational Capital argues that these “run-of-the-mill disclosures” don’t provide an accurate appraisal of human capital, and that a better measurement should include employee perceptions of corporate culture, a factor that touches on the field of behavior science.

“[Investors] often focus more on ‘what is easy to count’ instead of ‘what is important to count,’” said Dan Ariely, a behavioral economist at Duke University and a co-founder of Irrational Capital. HCF, on the other hand, evaluates employee perceptions – a factor that Ariely believes is crucial – from a variety of angles, such as their opinion of the management team and their level of emotional connection with colleagues. Through proprietary data sets gathered from corporate employee surveys and public sources such as Glassdoor, Irrational Capital has collected two million responses and more than 13 million unique data points from over 2,000 companies in the U.S. The public and private data sets are eventually combined into an aggregate HCF score that reflects how motivated the employees are to create value for the company.

“Covid really emphasized the importance of intrinsic motivation,” Ariely told Institutional Investor. Companies have grown to be more dependent on self-driven employees than ever, and those with high HCF scores could have an edge on their competitors, he added.


J.P. Morgan analyzed HCF’s performance across a wide range of indices, including the Nasdaq, Russell 1000, and MSCI USA. By back-testing stock performance data from 2015, JPM found that the Nasdaq HCF Long portfolio delivered an excess return of 3.1 percent, while the Nasdaq HCF Long-Short portfolio generated a significantly higher annual return of 13.3 percent. The report concluded that “within the tech-heavy Nasdaq, the HCF is highly proficient at identifying underperformers.” For the Russell 1000 and MSCI USA indices, the HCF Long portfolios delivered excess returns of 3.7 percent and 6.2 percent, respectively.

David van Adelsberg, a co-founder of Irrational Capital, said that the HCF score can be used for a variety of portfolio-construction objectives. For example, JPM’s environmental, social, and governance investing team adjusted the HCF for the innovation element to create a metric called “Innovation Culture Score.” It found that on average, companies where employees feel the most encouraged to pursue innovative ideas deliver an excess return of 3.6 percent.

In an earlier research report, JPM also used HCF to study how gender equality affects stock performance. Instead of looking at how many women are at the company or in senior leadership roles, the HCF comes up with a Gender Alignment score that measures the “absolute differences between the responses between female and male employees,” the report said. “The key here is that this data allows for a far more meaningful analysis of gender inequality than simply counting metrics.” JPM found that the Gender Alignment strategy developed from HCF outperformed the S&P 500 and many mainstream gender-diversity ETFs.