The value in valuing employees

Written by Yolanda Courtines and Mark Mandel on 31st May 2024

This article is from the latest Good Investment Review, which you can download free here. 

When companies value their employees as part of a “holistic approach to people, profit and the planet,” the odds of sustained success tilt in their favour, says Wellington Management. 

One of the questions we reflect on most often these days is this: how do labour relations impact a company’s ability to carry forward a strong competitive position into the future?

Our team’s approach is anchored in the belief that companies who take a holistic approach to people, profit and the planet are better placed to generate long-term value.

Employees are a critical constituency within this framework, but a combination of economic uncertainty, high inflation and more challenging labour dynamics make it potentially harder for companies to act as a good steward for their staff. Yet, we think a company’s ability to score highly on this metric in those circumstances is even more critical as a potential indicator of sustained success and lasting value creation.

The importance of stewardship in today’s environment

Our conviction in the power of this combination — high returns and good stewardship — rests on two complementary beliefs. First, companies in strong, competitive positions, consistently out-earn their cost of capital and produce attractive returns over time. Second, when these companies practice good stewardship — by taking a long-term and responsible approach to all their stakeholders — the odds of sustained success are tilted further in their favour.

Stewardship is often cited as a driver of long-term, sustainable returns. What makes it a particularly compelling differentiator right now is its power to help companies adapt to and succeed in a new macroeconomic regime. As our macro strategists have identified, we expect the future to be characterised by higher and more volatile inflation, higher interest rates and greater cyclicality.

Companies will need to grapple with this more challenging economic environment alongside a more fragmented world, with continued pressure on supply chains, potentially exacerbated by geopolitical uncertainty and the growing impact of climate change.

To paraphrase Warren Buffett, a less flattering macroeconomic environment will make it easier for well-run companies to stand out. Regardless of sector or region — and in a range of market environments — leaders of the future will distinguish themselves by their ability to adapt to challenges. Post-COVID, we saw strong stewards differentiate themselves by strengthening their supply chains to be more resilient and dependable. More recently, we have seen growing pressure for managers to adapt and respond to labour. We believe changes in labour market dynamics are the result of secular, rather than cyclical, forces, and that companies will experience upward pressure on wages for some time.

Why labour is so important now

We think labour will be an important, long-term investment theme, and a good example of how an ESG factor can have a material effect on long-term financial returns. Over the last three decades, the return to providers of capital has far outstripped the return to providers of labour.

This balance of power is starting to shift, in our view. A number of factors, including demographic change, immigration limitations, COVID, workforce mobility and deglobalisation, have contributed to shrinking the available pool of labour. This has pushed up costs and is giving workers greater power to demand higher compensation or changes in working conditions. We believe it’s going to take more than a traditional wage cycle to reach equilibrium between capital and labour; this is a long-term trend and labour will remain more expensive for employers.

How will good employers differentiate themselves? 

Good employers will differentiate themselves by taking a proactive and thoughtful approach to investing in their workforce. These companies are likely to reap rewards in terms of employee engagement and productivity as well as strengthening their reputation with customers, suppliers and other stakeholders.

Ensuring that compensation remains competitive is important but is only the first step. Optimising non-wage benefits, such as pension plans, health care provision, job flexibility or leave allowances, can also help a company stand out against its peers. As competition for talent intensifies, developing an innovative approach to identifying and attracting talented workers, especially at entry level, may create advantages.

Many of those trends are medium- to long-term in nature, but we think engaged investors are well placed to distinguish between a company that has a genuine commitment to investing in its workforce and one that increases wages as part of a short-term exercise in inflation adjustment. Meetings, onsite visits and board engagements can be valuable touchpoints, providing evidence that a company is in touch with and engaged with its staff and is actively innovating to address emerging labour trends

Turning short-term winners into future leaders

A commitment to valuing employees will most likely see a company score higher on soft but meaningful metrics such as engagement. It also translates into tangible benefits for a company’s bottom line. Labour is the first- or second-highest expense item for many companies. Any progress to increase retention and lower recruiting and training costs immediately improves profitability and helps lay the foundations for long-term success.

But success in this area will have to be weighed against the cost on other stakeholders and the ability to secure consistent long-term value for shareholders. We believe companies able to solve this multi-dimensional puzzle are well positioned to become the leaders of the future.

Risk warning: Past performance should not be seen as an indication of future performance. The value of investments may go down as well as up and you may not get back your original investment.

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