This ETF outperforms by stressing corporate culture — but not ESG

Irrational Capital serves as the subadviser for the Harbor Human Capital Factor U.S. Large Cap ETF
HAPI,
which tracks an index of 150 large-cap companies selected for having strong corporate cultures based on proprietary scoring of publicly available data from companies such as Glassdoor and third-party surveys of employees.

“The Human Capital Factor looks at the economic value people create by working toward the goals of their companies,” Colson said. He went on to describe six “intrinsic” dimensions and one “extrinsic” element in the analysis.

The intrinsic dimensions include:

• Direct management: how much respect employees feel from their managers.

• Emotional connection: how much employees feel appreciated; whether they see meaning in their work.

• Engagement and leadership: employees’ level of pride, loyalty and motivation and belief that senior management conveys a corporate vision.

• Innovation: how empowered employees believe they are to contribute ideas.

• Organizational alignment: whether or not employees feel their employer’s goals are aligned with their own goals.

• Organizational effectiveness: how employees perceive the quality of their company’s output; the level of respect they see for their brand their company’s effect on society.

The “extrinsic” factor might be the first one that comes to mind: compensation, along with working hours, training and a sense of career progress.

But Colson said that Irrational Capital’s backtesting of the data showed the intrinsic dimensions were correlated with good performance in the stock market “a lot more, and in a much more statistically significant way, than the things we consider the basics or typically measure when looking at employees, especially pay.”

Only the components of the “human capital factor” are used for the selection of stocks in the index. Colson said returns on equity tend to be stronger for higher-scoring companies.

Performance and holdings

The Harbor Human Capital Factor U.S. Large Cap ETF, or HAPI, tracks the CIBC Human Capital Index, which was created by the Canadian Imperial Bank of Commerce and typically includes 150 stocks identified by Irrational Capital when the index is reconstituted annually.

The 150 stocks are selected from the components of the Solactive GBS United States 500 Index, which itself includes stocks of the largest 500 U.S.-listed companies by market capitalization. It is similar to the S&P 500
SPX,
but lacks the additional qualitative factors that can exclude some companies from the S&P 500.

The CIBC Human Capital Index follows a modified cap-weighting strategy, with companies weighted by market capitalization when the index is reconstituted annually, but subject to caps for individual stocks of 5% or five times a stock’s weighting in the Solactive GBS United States 500 Index. When reconstituted, the CIBC Human Capital Index is weighted to match the sector weighting of the Solactive GBS United States 500 Index, making use of exchange-traded funds to hit those weights if necessary.

The Harbor Human Capital Factor U.S. Large Cap ETF was launched on Oct. 12, 2022. Its annual expenses come to 0.36% of assets under management. Its performance benchmark is the S&P 500. Here’s how the fund has performed since inception against the SPDR S&P 500 ETF Trust
SPY,
net of expenses:

The fund has grown quickly to $290 million in assets under management. While the fund has 151 holdings, it is fairly concentrated, with the largest 10 positions making up 42% of the portfolio, and the largest 15 more than 50%. Here are HAPI’s largest 15 holdings as of Friday:

Click on the tickers for more about each company or ETF.

From the archives (November 2021): These are the most important things to check on a stock’s quote page before deciding whether to buy or sell

ESG or not?

There has been some pushback against environmental, social and corporate-governance strategies. The idea of ESG is to enable investors to limit their portfolios to companies perceived as trying to make the world a better place. Some ESG monitoring focuses on the environmental aspects — many companies publish material to make the case that they are being environmentally responsible, and “sustainable” is a frequently used term to describe this type of policy. One way of addressing the social aspect of ESG has been for companies to stress their diversity, equity and inclusion policies. On the governance side, a fund manager might push to report on its participation in votes on shareholder proposals.

Since HAPI tracks an index that scores companies only on the “human capital factor,” or their employees’ indicated levels of satisfaction, it cannot really be considered an ESG fund. It doesn’t exclude companies based on other factors, such as their compliance with any environmental standards or the products they provide. It holds shares of tobacco companies, for example.

“Ultimately, ESG is in the eye of the investor,” Gleich said, while stressing that Harbor launched HAPI and two associated funds “because we believe they have the potential for better returns. Period.”

That said, Gleich added that within ESG investing, “typically there are offerings with environmental or governance pillars, but the ‘S’ is underrepresented in the marketplace.” HAPI addresses the social aspect of ESG.

The two other funds that Harbor offers that make use of Irrational Capital’s analysis of employee-survey and related data are the Harbor Human Capital Factor U.S. Small Cap ETF
HAPS
and the Harbor Human Capital Factor Unconstrained ETF
HAPY,
which takes an equal-weighted approach to hold between 70 and 100 stocks of large-cap and midcap companies with the highest Human Capital Factor scores.

Don’t miss: Here’s a new way to consider value for stocks in the S&P 500