In an extremely tight labour market, screening for strong social credentials will be crucial to identifying companies who can build strong talent pipelines without higher wage bills squeezing margins.
The battle for talent has never been more intense. With labour markets staging an impressive recovery as pandemic restrictions have eased, businesses now have a major task on their hands to source the workers that they need. The balance of power between employer and employee is shifting as a result. In the US, the number of people choosing to quit their jobs hit a record high in November 2020 last year, and remains at extremely elevated levels today*. Clearly there are many explanations for why a worker may decide to move on, but it is notable that typically lower-paid industries are seeing the strongest pace of “quits”.
Wages are surging as a result, with companies fighting to both retain existing employees and to poach talent from their competitors. Pay growth is rising strongly in both the UK and the US, and while headline numbers have been complicated by a shift in sector composition, measures that adjust for pandemic distortions still paint a very robust picture. The prospect of higher wages has not only caught the eye of employees looking for more power in their pockets. Bank of England Governor Andrew Bailey won few friends in February 2022 when he called for “quite clear restraint” in annual pay setting processes given fears that an upward wage spiral may be taking hold.
Higher wage bills are a double-edged sword for businesses, and therefore for investors. While rising costs are rarely positive for corporate earnings, if higher pay boosts the consumer spending outlook then this can often come back to businesses in the form of stronger top line sales. Margins have held up strongly over the past year in the face of rising input prices, with businesses able to pass higher costs directly onto their customers. Yet with the current energy shock exacerbating supply chain pressures that are both increasing business costs and dampening consumer confidence, margin pressures are set to intensify.
Attracting talent without breaking the bank
Against this backdrop, investors would be wise to pay particular attention to company scoring across social factors. It’s long been evident that a company who fails to treat their employees properly, or pays little regard for the communities in which they operate, is unlikely to prosper in the long run. Yet in this highly unusual environment, social credentials that strengthen a company’s ability to build strong talent pipelines without having to break the bank on wages warrant a particularly high premium.
This type of analysis is rarely straightforward. High quality data is arguably much harder to find for S factors than “E” or “G” metrics, with index level data often patchy or lacking the appropriate nuance. In part these limitations are linked to the nature of many companies’ disclosures. Gender diversity is a good example. A company might report a significant improvement in their gender mix, but if women are still underrepresented at a senior management level then strategic decisions are unlikely to benefit from appropriate diversity of thought.
The good news is that this data is now becoming increasingly available, if you know where to look. The big data revolution has been transformational for investing with a social lens, with alternative data sources providing another window into companies. At the same time, data science techniques are enabling investors to interpret this data efficiently, using metrics that can identify stocks with both the potential to benefit from social factors, as well as companies that face significant risks.
Analysis of data taken from Glassdoor – a website where employees anonymously review companies – provides a good example of the potential power of these alternative data sources. For example, my colleagues in J.P. Morgan Asset Management’s International Equity Group developed a model that digested more than 5 million reviews for over 5,000 publicly traded companies. Over a 10 year period since 2011, backtests showed that the share prices of top quintile companies based on Glassdoor scores outperformed those in the bottom quintile by approximately 6% on an annualized basis as of March 2022.
In sum, today’s interplay between wages, inflation and margins is a key issue for both investors and policymakers alike. And just like most major macro topics, ESG factors are inextricably intertwined. Few companies are going to be able to avoid higher wage bills amid the Great Resignation, but higher pay is not the only option in the toolkit. With workers exiting the pandemic recession with greater bargaining power, businesses will need to pay much greater attention to social factors going forward if margin pressures are to be avoided.