Happy staff, higher returns

Google offices
Google: topped last year’s Fortune list of the best companies to work for

A cheery workforce is more likely to bring corporate success. Can investors profit from this insight?

Want to find out if a company might be a good investment? New research suggests that you should check out how happy its employees are. Glassdoor is a reviews website on which employees rate their employers – TripAdvisor for jobs, in effect. In a paper entitled Employee Satisfaction and Corporate Performance in the UK, researchers at the University of East Anglia used data from the website to examine whether there is any correlation between high employee satisfaction and corporate profitability.

In short, they found “a significant positive relationship between employee satisfaction and firm profitability”. Not only that, but investors who invest in such companies do better than those who do not – suggesting that this is a source of “edge” that investors have not yet fully exploited, even though the information is freely available.

This isn’t the first study to conclude that employee happiness is good for returns. Previous research in the US has also found that investing in companies included in the annual Fortune list of “100 best places to work for in America” also generated “significant positive abnormal returns” over the long run (25 years in the case of one study). Intuitively, this makes sense.

If you consider what makes a “high-quality” company, then – while it might not be the first thing on your list – then you’d typically favour a committed, skilled workforce operating within a coherent, thriving corporate culture, over a demoralised staff putting in the bare minimum effort against a backdrop of mass incompetence or permanent revolution. Hedge funds and private-equity funds are already using Glassdoor reviews to help in their due diligence process, reported Madison Marriage in the Financial Times last year.

Those who object to the idea, or find it a little too “touchy-feely” as an investment variable, note that staff with personal grudges or scores to settle might be more inclined to leave reviews than satisfied employees are. Clearly, it goes without saying that you’d need to take these reviews with a pinch of salt – just as when you’re using any other form of reviews website.

But then again, you wouldn’t build an investment strategy based purely on the quality of reviews from staff. Overall, this is another aspect of a tactic most closely associated with American investor Philip Fisher, who talked about the power of “scuttlebutt” – getting first-hand observations and gossip about a company from those who know it best, such as its suppliers, rivals, customers and staff. If nothing else, it can be an invaluable means of spotting potential problems or turnaround opportunities before the wider market catches up. It’s certainly worth adding to your investment checklist.

I wish I knew what an ETF was, but I’m too embarrassed to ask

Exchange-traded funds (ETF) are investment funds that are bought and sold on a stock exchange in the same way as you would trade normal shares. Unlike investment trusts, which are also traded on exchanges, ETFs are mostly passive investments. This means their aim is to track the performance of a particular market, rather than to try to beat it, as an active fund does.

ETFs are available on a wide range of indices, sectors, investment themes and commodities (and because of their huge and rapidly growing popularity, index providers are constantly launching new indices for them to track). Given their largely passive structure, ETFs tend to have lower fees than most traditional active funds, and rampant competition is driving the price ever lower.

ETFs come in two types: “physical” and “synthetic”. A physical ETF invests in the same assets that it’s supposed to track. For example, a FTSE 100 ETF will invest in FTSE 100 stocks in proportion to their weighting in the index itself.

A synthetic ETF instead agrees a “swap” with a third party – typically an investment bank – which agrees to pay the ETF a return based on the performance of the index. Many investors prefer physical ETFs because they view them as less vulnerable to unexpected risks, such as the possibility that the counterparty to the swap won’t pay out. However, synthetic ETFs based in the UK and Europe must hold collateral to back these swaps, which means the risks should be limited.

Physical ETFs are arguably simpler and more transparent, but there are situations in which synthetic ETFs may be superior. For example, when investing in certain emerging markets, some of which restrict foreign investment and share ownership, a swap-based structure may be more cost-effective than investing directly in the underlying shares.