Investments That Really Work

Commodity prices are important determinants of corporate profitability and hence of equity valuations. This relates to the fact that they are an input (i.e. raw material) to a wide range of production processes. Including commodities in an investment portfolio, in theory, should enable portfolio managers to hedge some of the risk that the profits of the companies they own are impacted unexpectedly by changes in the price of oil or wheat, for example. However, a recent paper from Marco Lombardi and Francesco Ravazzolo published by the BIS argues that “the popular view that commodities are to be included in one’s portfolio as a hedging device is not grounded”.

This led me to wonder whether any other inputs could reasonably be included in a portfolio instead. Most lack the desirable characteristics one might look for in an investment, such as the ability to offer a return. (You could argue that commodities do not fulfill this requirement – I have). I’m unlikely to convince you that you should invest in Post-it notes or red paint, but what about one of the most important inputs in almost all production processes: labour?

Unlike commodities, there is a dividend to labour in the form of wages. It is conceivable that wages could be securitised in much the same way as mortgages or car loans.  Imagine offering a large number of people a lump sum for, say, 30% of all their wages for next 5 or 10 years. Pooling a large number of workers together means that statistical and actuarial methods could be used to price the risk of “default”.

From the point of view of the worker this could be a very good deal. The lump sum could help finance the purchase of a house, an alternative to a mortgage where the risk is partly transferred to investors. Of course, armies of smart lawyers and behavioural economists (like Dan Ariely or Richard Thaler) would need to be recruited to minimize the increased incentive for you to quit your job (or laze around looking at cat videos on YouTube all day) once the lump sum is paid. From the portfolio manager’s point of view investing in a securitised product like this would be a nice hedge against inflation that actually offers a return.

Admittedly, there are some potential social issues and governments might not like private firms muscling in on their monopoly over taking a chunk of people wages at source. But from an investment stand-point I think this idea has some merit. Can anyone convince me otherwise? And, at the very least, based on this line of reasoning, is labour less eligible to be called an “asset class” than commodities?


4 thoughts on “Investments That Really Work

  1. Fascinating idea, which I’d never thought of. Not being an economist, I’m going to approach it from a very simplistic viewpoint, and hopefully won’t say anything that doesn’t contradict economic theory! In theory it may have merit. Like you say, it would be good to get paid up front and use that for buying a house, rather than get paid and pay for the mortgage out of it. However, there are a couple of significant issues in my view:

    – Even if we assume that employees will still meet their side of the deal and work, you’d have to target very specific professions. For example, take the situation where you commoditise the salaries of accountants, doctors, lawyers etc, whose salaries are liable to increase dramatically over time depending on their professional success. If their salaries exceed their expectations but they get no benefit from this, they will not bother trying to better themselves and will just stay at the same level, or the expected level. There’s a massive social impact to this and, ironically (given the fact that this is pure capitalism and people are trying to make money out of it), the impact could be similar to that of communism – your incentive as an employee to do better is taken away, so you don’t work harder than your neighbour. Free market economists would hate you!

    – The tax implications would be interesting, depending on the jurisdiction. Would the employees have to pay a significant tax up front, or would they pay income tax as normal and the return to investors would be the net pay? This is the more likely scenario and governments who are inclined to change payroll taxes etc would make the return a bit less reliable and thus less attractive. On my first point above, the jobs most likely to be attractive are those without significant long term variations in wages (ie low skilled government jobs). But these jobs are more prone to government pay cuts etc.

    – Governments would be very opposed to it, because a lot of people could blow the lump sum and then without a decent wage they may seek social welfare, and there’s a massive social and economic issue there.

    Finally, while we often say that in some industries, labour is commoditised, it is very different to a commodity. The big issue here is the human element, that no other commodity has. I googled this and Paul Krugman said: “A merchant may sell many things, but a worker usually only has one job, which supplies not only his livelihood but often much of his sense of identity. An unsold commodity is a nuisance, an unemployed worker a tragedy”.

    Despite the very interesting argument, and theoretically possible scenario, I could never see it working directly the way you suggest it.

    However, this exists in another form as it is – mortgages or other loans to people are paid back through wages, and these are paid over time to banks, many of which securitise these loans. The employee is legally obliged to pay the loans, they will benefit from upside in their wages, and banks can still securitise them no problem, as we saw with the sub prime crisis in the US!

    This is a bit rambling I know, but I was just writing as I was thinking!

  2. I agree that this may seem very similar to mortgages and other loans. However, these are debt contracts and what I am proposing is an equity-based idea.

    This means that the payments would not be fixed in dollar or euro terms. People who are owed money under a debt contract dislike inflation; this would be an alternative where inflation is actually welcomed. Plus, there would be rewards to picking the right group of individuals (i.e. those with the greatest prospects of wage growth).

    You rightly point out that it could distort people’s incentives to work hard and reap the benefits of innovation, but I disagree with your point on stable wages being most suitable. I suspect that people in very stable jobs will find debt financing more cost-effective and those with good prospects for growth or slightly riskier prospects may get a better deal going for the equity-based idea. The analogy with companies is that utilities tend to be funded largely with debt and small tech companies stick almost exclusively to equity.

    Maybe it’d be too risky and investors might therefore charge too high a cost of equity for the worker to feel it is worthwhile. Mortgages, after all, are a claim on property, not just on the income of the owner of that property so in the absence of any real “assets” that an investor can exert control over maybe the equity-based idea is a non-starter.

    • Fair point re stable jobs. What I meant was this won’t be attractive at all for people who have higher wage growth than they might have anticipated as they won’t reap the benefits. But I didn’t look at the other side which you kind of alluded to – if people have potential for high wage growth, they mightn’t reach the potential and the investor will lose out. That’s the risk I suppose – you’re not going to know how things will work out at the outset so there’s a risk of it going either way. I just think that very driven people are unlikely to go for it as there is limited upside, and as an investor I would want driven ambitious people involved in order to make a good return.

      Would fully agree with your last paragraph above re mortgages being a claim on the property. I can be quite the pessimist – even though I like a lot of “risky” investments, this one relies too much on people continuing to work after they get a big lump sum, and I think that the disincentive to succeed beyond expectations would be both financially troubling for investors and it would be socially undesirable.

  3. Total economic activity can be broken down into wages, interest, rents, and profits. Here are the flows and their capitalized forms.

    Interest –> Bonds
    Rents –> Real Estate, which may include mineral rights
    Profits –> Stocks, and Private Equity
    Wages –> Indentured Servitude

    The Puritans and others coming to the new world had indentured servitude. In exchange for your debts, serve for seven years, and after that time, I will give you enough resources to capitalize you. You will not only be a free man, but one with enough resources to establish himself.

    Unlike the slavery of the South, the Puritans saw the restrictions that the Bible put on servitude, and followed them. Most of the people willingly entering servitude did so because they saw they would be a lot better off seven years out, but they needed money to secure the voyage to the New World.

    But now to the point. It is very difficult to enforce long-term labor contracts. There are all manner of ways where “restraint of trade” could be alleged. US law does not look favorably upon long-term labor contracts.

    If it were structured in such a way that we were rescuing people from poverty, and capitalizing them at the end, this could work… following the way that the Bible works it. You don’t own the man, but you own his labor.

    This is a tricky area, and anyone trying to implement this would need skilled legal counsel before taking step one.


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