- Human capital is generally 30% stocklike, although signiﬁcant differences exist across industries and occupations. For example, government industry has a market beta of 0.00, while mining has a market beta of 0.53. In addition, different industries/occupations have different exposures to the size and value factors.
- Volatility associated with a job is much greater than volatility associated with a given industry or occupation.
- Industry and occupation factors in isolation are about equally important, while job-speciﬁc factors (deﬁned as the unique combination of an occupation within a given industry) account for the majority of human capital variance.
- Human capital beta—or the extent that human capital risk is correlated to the equity market—is the primary determinant of difference in the optimal equity weights at the aggregate level.
- Market and nonmarket factors play important roles at the individual job level.
- Investors in jobs with high wage volatility that is unrelated to market factors face a lower capacity to take on risk.
As an example of the impact of human capital on portfolio design in an optimization, Blanchett and Straehl found that the spread between the industries with the highest and lowest equity allocation was 35.5 percentage points.
Not surprisingly, the government sector has the highest equity allocation—76%—given its market beta of zero and a low overall variance of human capital. Conversely, mining has the lowest equity allocation—40%—given its high market beta of 0.53.
Blanchett and Straehl concluded: “We ﬁnd signiﬁcant evidence that job-speciﬁc human capital differences have a material impact on the optimal portfolio and should therefore be considered during the portfolio optimization/construction process.”
This is important because human capital is a dominant asset for many investors, and unlike the risks of individual stocks, it is a risk that cannot be diversiﬁed away and is difficult to insure/hedge. This highlights the importance of including human capital risk in portfolio design.
Do Investors Consider Human Capital: The Evidence
Sebastien Betermier, Thomas Jansson, Christine Parlour and Johan Walden, authors of the study “Hedging Labor Income Risk,” which appears in the September 2012 issue of the Journal of Financial Economics, attempted to determine if investors were actually incorporating sound portfolio theory into practice.
They used a detailed panel data set of Swedish households to investigate the relationship between labor income risk and investment decisions. In particular, they examined whether changes in the wage volatility of households (as workers switched industries) led to changes in portfolio holdings. Following is a summary of their findings: