Vol. 51, No. 6
HR can help pull in funds from two different kinds of investors. The question is: How best to do it?
Capital. It’s what makes the wheels of industry turn. Without it, start-ups can’t get started and established companies can’t weather the tough times or make the investments needed to gear up for the boom times.
Why should HR professionals care about generating capital? Because investors care about HR. Until recently, investors paid little heed to such “soft issues” as human capital management, choosing instead to focus exclusively on financial data. But times are changing as investors look more closely at HR issues when deciding whether to loosen their purse strings. ›
And those strings control sizable purses: In the United States alone, money managers and analysts determine the fate of more than $24 trillion in investments.
As a result, HR professionals can play an increasingly important role in helping their organizations attract the capital they need to live, thrive and survive. The challenge, however, is that investors tend to fall into one of two distinct groups—traditional and socially responsible (SR) investors—each with different goals and different informational demands. Understanding both camps is crucial if HR is to provide the human capital information necessary to attract investors—and their capital.
Traditionalists vs. SR Investors
Traditional investors focus single-mindedly on making money for their clients. They’re out to beat the market—in fact, their compensation is tied to their ability to do so. To them, nothing speaks louder than a company’s balance sheet, income statements and other financial metrics.
By contrast, SR investors also consider nonfinancial factors—including those relating to the environment, society and governance (ESG). Before sinking money into a company, they want to see full corporate disclosure in applicable areas—including certain HR practices—so they can be sure an employer is socially responsible.
“We do both the financial analysis and social research as one concurrent process,” says Ingrid Dyott, co-portfolio manager and managing director of the Neuberger Berman Socially Responsive Fund. “In the long run, we think it’s fundamental good business for a company to act responsibly in its various constituent relationships,” including its relationship with employees.
Traditionalists generally disagree with the SR approach, but evidence exists of SR funds either beating the S&P 500 or faring about as well as non-SR counterparts. As a result, some traditionalists are looking more closely at human capital practices—but only when HR professionals can make a solid business case for the bottom-line benefit such initiatives can bring.
Beyond their fundamental differences in approach, other factors differentiate SR and traditional investors. For example, traditional investors are a tempting target because they control 90 percent of the available capital. SR investors, by contrast, account for only 10 percent of total investments. Still, $2.3 trillion is nothing to sneeze at. And SR investing is growing 4 percent faster than the overall market. For global companies, attracting SR investment dollars may be particularly important because the SR trend is growing more rapidly overseas than in the United States.
What’s more, SR investors tend to buy for the long haul. Unlike mainstream investors—who have a reputation for churning portfolios based on quarterly performance—SR investors usually look to hold a stock for three to five years.
“They’re willing to ride out tough market conditions,” says Fran Teplitz, managing director of the Social Investment Forum in Washington, D.C.
“We buy and hold,” says Anita Green, vice president of social research for Pax World Funds, a Stockton, Mo., company that manages more than $2 billion in SR mutual funds. “You’d think that would be an attractive selling point for CEOs, but I’ve never heard one say so.”
A long-term investment view also is echoed by Vidette Bullock Mixon, director of corporate relations for United Methodist Church General Board of Pension and Health Benefits, which practices SR investing. “We realize there will be ups and downs in the market. Staying in allows us to encourage and motivate companies to take positive action.”
And there’s the rub: For some companies, SR investor loyalty comes at a price—advocacy.
Mixon, for example, says her organization may invest in a company with ESG shortcomings as a way of prompting the company to improve. “We’re likely to advocate, learn and work for change. For example, we’re in Wal-Mart working for workers’ rights.”
She’s not alone. SR investors frequently use their shareholder status to launch reform initiatives at companies whose ESG policies they disagree with. According to the Social Investment Forum, in 2005, 31 percent of SR investors were into advocacy.
In fact, from January 2003 to August 2005, SR advocates filed 997 shareholder resolutions—motions offered at shareholder meetings that encourage a company to take a specific action. The second largest number of shareholder resolutions filed, 95, dealt with equal employment opportunity (EEO), especially related to sexual orientation and nondiscrimination policies. Fourth on the list: global labor standards, with 82 resolutions. Resolutions addressing executive pay, board diversity and human rights were in the top 11. Overall, nine of the 25 resolutions receiving the most shareholder support dealt with EEO and diversity.
For some companies, the prospect that SR investment money will come with advocacy strings attached may be too much to bear. “You only need 100 shares to sponsor a resolution,” points out Lloyd Kurtz, senior portfolio manager at Nelson Capital Management in Palo Alto, Calif. “Is it worth it for the company to engage with SR” investors?
Yet some corporations, like British Petroleum (BP), welcome SR investors—agendas and all. They say constructive engagement is preferable to stonewalling.
“We’re actively pursuing them,” says Mary Jane Klocke, director of North American shareholder marketing investor relations at BP in New York. “The value for us in engaging with the SR investing community is to find out what the concerns are; it’s one way to ward off shareholder resolutions.”
SR Investment Concerns
The concerns that drive SR investors can be as varied as the participants who make up this group. (SR investors include individuals, businesses, universities, hospitals, foundations, pension funds, corporations, religious institutions, and other nonprofit organizations and institutional investors.) Still, there are patterns.
In 2005, the four factors most commonly used to screen companies out of SR investment mutual funds related to the products and services those companies offered: tobacco, alcohol, gambling and defense/weapons.
Human capital concerns followed closely behind: Equal employment and labor relations ranked fifth and seventh among the 13 screens applied by institutional investors (such as pension funds and religious organizations). In fact, equal employment—in the form of diversity—is the single biggest HR-related factor that SR investors focus on.
To understand how SR investors use HR-related investment screens, it helps to see how the Calvert Group, an SR investment firm based in Bethesda, Md., uses seven screens in its Calvert Social Index to weed out potential investment targets. If a company doesn’t pass all seven screens, it’s deemed ineligible.
One of the screens encompasses “workplace practices.” Calvert social research analyst Amy Augustine, who specializes in HR, starts by subdividing workplace issues into three general areas: diversity, employee relations, and employee health and safety.
For each area, she obtains information from a company’s web site and other publicly available documents. She follows with a preliminary analysis of the corporation’s policies, programs and performance. Eventually a team of analysts reviews her findings and issues a pass or fail grade.
For example, when screening for diversity, Augustine looks at the following areas:
- Policies. Is the EEO policy inclusive—not just governed by Title VII, but expanded to cover gender identity and sexual orientation? Is the policy disclosed on the company web site? Would the average consumer and investor be able to access it?
- Programs. Does the company offer diversity training? Is the training offered to employees and managers? How extensive is it? Are there supplier diversity programs, mentoring, glass-ceiling programs for recruitment and outreach, programs to increase diversity of the workforce?
- Performance. Is there full disclosure of the EEO-1 report?
How To Woo SR Investors
Given the criteria used by Calvert and others, it’s not surprising that SR investment analysts place corporate “transparency” at the top of their “must have” list. SR investors say that to attract and retain their dollars, companies must be open and cooperative. Make as much information available to them as possible, they say.
What’s the best information to provide to SR investors? It likely will vary from company to company, based on such factors as industry and workforce demographics.
To ensure that investors can access such data—which are sometimes known as corporate sustainability reports or social responsibility reports—post them in a conspicuous place on your web site. (Among Fortune 500 companies, 52 percent now produce such reports—up 7 percent since 2002—according to KPMG’s 2005 International Survey of Corporate Responsibility Reporting.)
Ultimately, SR investors want uniformity of reporting so they can more easily compare data. (Because SR investing is growing more rapidly overseas, especially in Europe, than in the United States, many global corporations have adopted a standard format—the Global Reporting Initiative’s Sustainability Reporting Guidelines.) In the here and now, however, SR investors are more frustrated by the dearth of access to corporate data—particularly diversity/EEO data.
According to the Social Investment Research Analyst Network’s 2005 study of companies in the S&P 100, only six provide full EEO-1 disclosure; 27 will disclose this information to analysts upon request.
“The most important step HR can take is to disclose your EEO-1 data,” says Pax World’s Green. “It paints a reliable, systematic picture of your workforce.”
Green also craves more diversity information about senior management and boards of directors. “We have to figure it out; generally it’s not disclosed,” she says. When companies refuse to disclose such information, some analysts examine photos of boards and executive teams to identify women and minority members.
But according to Ken Sloan—former senior vice president of HR for the Pharmaceutical Group at Bristol Myers and currently professor of management at Marist College in Poughkeepsie, N.Y.—SR investors place too much weight on EEO-1 data. “Because it’s aggregated, it doesn’t tell you enough,” he says. “What it does do, however, is raise more questions than most organizations want to answer.
“In a perfect world, disclosures wouldn’t hurt you,” he says. “But that’s not always the case. Disclosure always raises questions, and questions need to be answered by more disclosure. Eventually, you may reach a point where you’re providing so much that you’re disadvantaging yourself with your competitors.”
Traditionalists Catching On
There’s evidence that traditional investment managers, and the investors they work for, are becoming more attuned to SR investment factors, including human capital performance. No doubt, few want to limit their options the way SR investors do. But a growing minority sees the value of well-run HR programs and policies and increasingly takes them into account when making investment decisions.
“They’re not addressing ESG issues on ethical grounds, but because they believe these factors can affect the performance of underlying investments and therefore must be managed,” says Jane Ambachtsheer, global head of Mercer Investment Consulting’s Responsible Investment Business in Toronto.
In Mercer IC’s 2006 survey of 183 U.S. institutional investors, 61 percent included SR investing in their thinking as a way of reducing risk or improving returns. In the same survey, most mainstream investors said SR investment factors will affect stock performance in the next five years. Specifically, 91 percent said corporate governance will affect stock performance; 83 percent said the same for employee relations.
Overall, 75 percent of respondents said effective management of ESG can affect the company’s bottom line, but fewer than half evaluate or plan to evaluate their investment manager’s ability to analyze and track ESG capabilities.
The numbers reveal the onset of a trend, says Ambachtsheer. “As clients continue to ask investment managers if they are assessing ESG risks, if they’re not already doing it, they’ll have to get on board.” Already, well-known firms such as Smith Barney and Neuberger Berman offer SR research and funds to investors.
How To Woo Traditionalists
While traditional investors may eventually take on some of the qualities of SR investors, in the meantime, HR professionals hoping to lure traditionalist capital will need to make a strong business argument. Don’t worry: General impressions to the contrary, traditionalists will listen to the business case for longer-term initiatives, such as those HR is likely to advance.
“Don’t be fooled into believing all mainstream analysts are shortsighted; they’re not blind to the fact that some investments take time to cultivate,” Sloan says. “But whenever you say, ‘Trust me, you’ll see results down the road,’ and the other guy says, ‘You don’t have to trust me, the benefit is here right now,’ you’d better have a powerful case.”
To make a strong business case with traditional investors, include metrics and rationales that fall within their comfort zone. Couch your human capital information into a case built on profit potential, risk management or reputation enhancement.
Issues relating to corporate reputation may be particularly persuasive to business leaders: A survey of 2,000 private- and public-sector organizations by Aon Human Capital Consulting found that reputation was the biggest business risk respondents faced.
Likewise, such arguments may hold sway with investors as well. True, there is no Holy Grail definitively showing that reputation has a positive impact on stock prices, admits Robert Fronk, senior vice president, brand and reputation strategy, for Harris Interactive in Rochester, N.Y. But a recent Harris Interactive study revealed that when there’s a crisis, companies with positive reputations experience less of a drop in share price than their counterparts.
Fronk says investments in reputation can and should be measured to demonstrate positive impacts on performance. He cites one company that decided to decentralize its philanthropic donations so that hometown branches would benefit more. When the change was implemented, the company was able to demonstrate that it increased sales, employee retention and publicity.
That type of argument should be applied to HR areas as well. For example, to attract traditional investors you will need to demonstrate that promoting diversity, better wages or generous benefits translates into more profitable performance.
Be wary, however, that some HR arguments can be read two different ways, says Sloan. “On one hand, a diverse workforce is more creative and offers wider perspectives. On the other, it also means more time reaching agreements, and more conflict because of different value perspectives and different management styles,” he points out.
“It narrows down to a trade-off,” says Sloan. “For some [companies], creativity and innovation is essential; for others, it’s not life or death. All have to face the minimums required under the law. After that, your business case should dictate what’s best for the bottom line.”
Present your argument, not only from the cost side but from the revenue side as well. For example, assume your company lacks health care benefits and is experiencing turnover, difficulty in recruitment and lost workdays because of illness. “If you propose a health plan that costs $5,000 per employee, analysts looking at your current projections know they’ll probably triple over time. They’ll wonder how you’ll maintain your margin so that it remains net neutral in the future. How do you make the case? Show them you’ll be able to attract better people, keep them longer and that it will translate into increased sales and profitability,” Sloan says.
David Sirota, chief author of The Enthusiastic Employee: How Companies Profit by Giving Workers What They Want (Wharton School Publishing, 2005), studied 24 publicly traded companies with a total of more than 750,000 employees over the last five years looking for a correlation between employee satisfaction and stock prices. He found that stock prices of 14 high-morale companies increased an average of 16 percent, while prices for the other companies in the study increased by only 6 percent.
Sirota gauges high morale through an employee survey instrument that asks about fair treatment, a sense of achievement in their work, pride in their employer and whether they have good relationships with co-workers. Data from surveys like his, he suggests, “is grist for an HR value-added case.”
Rick Guzzo, worldwide partner at Mercer Human Resource Consulting, says corporations have been painfully slow to see the value of incorporating the human capital management case into their financial reporting, a potentially costly oversight. “Mainstream analysts are less likely to read sustainability or social responsibility reports,” he says. “They look at annual reports. HR metrics and anecdotal reporting should be in them.”
Better to hedge your bets, says Julie Tanner, corporate advocacy coordinator for Christian Brothers Investment Services Inc. in New York. Tanner says there are two philosophies about reporting. “One is to keep your ESG reporting separate. These issues deserve 10 pages instead of the one page they’ll get in the annual report. Others think a company should incorporate ESG reporting into the annual report.”
But Tanner offers a third option: “To broaden your appeal, why not do both?”
In the end, both SR and traditional investors will hold a growing appreciation of the role that enlightened human capital management plays in corporate performance. Savvy HR professionals will understand the importance of effectively promoting and customizing their case for either—or both—audiences.
Robert J. Grossman, a contributing editor of HR Magazine , is a lawyer and a professor of management studies at Marist College in Poughkeepsie, N Y.