We’re thrilled to announce that JP Morgan’s Quantitative Research Team has published additional in-depth research on Irrational Capital’s Human Capital Factor in a recent research note entitled “Creating an Innovation Culture Score Using Human Capital Factor Data”.
This is JP Morgan’s second report in less than a year on Irrational Capital’s work and serves as a natural expansion of its “Introducing the Human Capital Factor” report published in March 2021. This initial research concluded that the Human Capital Factor “strictly dominates all [other investment] styles across all metrics” and yielded the highest returns, lowest volatility, highest Sharpe ratio, highest hit rate and lowest maximum drawdowns when compared to Value, Growth, Momentum, Quality and Risk investment styles.
Consistent with our core thesis, this new report focuses on the value of analyzing deeper employee behaviors that go beyond run-of-the-mill disclosures and rudimentary, easy-to-count stats that permeate (and limit) much of the existing work on Human Capital. By studying harder-to-measure cultural themes such as Innovation, Emotional Connection and Organizational Alignment, the Human Capital Factor is the skeleton key that enables our partners to unlock (and commercialize) the value that companies derive from doing right by their employees.
Utilizing the Human Capital Factor, JP Morgan created ‘Innovation Culture Scores’ (ICS), a metric based on the Human Capital Factor with a tilt towards innovation, for a universe of public companies. These scores capture how well (or poorly) a particular company fosters a culture of Innovation within the organization. The results are both extremely impressive and highly consistent with the previous outperformance found across a wide-range of HCF-based portfolios.
Building on its previous research on our Human Capital Factor, the new report concludes that:
“The Human Capital Factor can enhance performances of the NASDAQ, Russell 1000 and the MSCI. For example the NASDAQ has performed exceptionally well over the past years; however,
applying the [Human Capital Factor] to select stocks from the NASDAQ universe has led to an annualized outperformance of +3.1%.”
A few of the many takeaways worthy of consideration are highlighted below:
A back-tested ICS Long portfolio (2014-2021) delivers annualized excess returns of +3.6%, with a t-stat of 1.7. The risk adjusted performance, given by the Sharpe Ratio, comes in at 0.6.
In contrast to many existing innovation-themed strategies, an ICS-based portfolio does not heavily default towards technology and appears to be particularly adept at identifying companies in more traditional sectors (i.e. Financials, Real Estate) that excel at Innovation. This analysis suggests that the ICS/HCF is better at distributing sector tilts across all sectors, yet has offered returns similar to many popular innovation stock indices. For example, the sector allocation of the latest portfolio (2020) reveals a surprising underweight in technology stocks, with Financials and Real Estate (surprisingly) exhibiting the largest overweights.
Companies with a high ICS/HCF have shown a similar profile of returns to traditional thematic based definitions of Innovation (but without the recent drawdowns).
We believe this research, once again, confirms the potential outperformance that can be unlocked from the deeper and more difficult-to-quantify aspects of Human Capital that are not captured by conventional balance sheets or disclosures. This is the cornerstone of our work at Irrational Capital and the crux of our greater mission.
To access the complete report, fill out the linked form and we'll promptly email you the full research paper from JP Morgan based on Irrational Capital's groundbreaking work with the Human Capital Factor.
As always, please be in touch as we would value your impressions and thoughts.
Thank you for your ongoing support as we continue to quantify the Human Capital Factor and enable our partners to unlock investable (and powerful) new strategies and innovative products.
Ever onward,
Dan, David and the IC Team