December 21, 2018 / In-depth

Will diversity improve my client’s returns?

ESG Clarity

Can investors trust workforce diversity as an indicator of good outperformance?

Will diversity improve my client’s returns?

UK businesses are embracing the benefits of having an inclusive workplace, putting policies in place to help foster diversity and inclusion. But does this investment actually improve returns for both the businesses and those that invest in them?

Eoin Murray, head of Investment at Hermes Investment Management, is among the many to claim that research, both academic and commercial, suggests that gender-diverse companies specifically perform better overall.

Others say that the link between outperformance and companies with diverse workforces are purely because the workforce are able to recognise a broader spectrum of risks, than an employee base that all have the same shared experiences.

“It is thought to be linked to better risk screening and risk management – spotting problems on the horizon before they manifest,” says Mandy Kirby, co-founder and chief strategist of City Hive.

The evidence on the power of diversity has been building for some time. In 2003, the European Commission reported that companies with workplace diversity policies “identify important benefits that strengthen long-term competitiveness”. Since then, there has been increasing volumes of research in the area.

In 2016, Morgan Stanley established a link between gender diversity to measures of better performance, including return on invested capital, return on equity, and lower volatility. It added companies with a diverse workforce could expect to see improved productivity, decision-making and innovation.

Harvard Business Review has since followed this with a 2018 study looking specifically at venture capital in the US, finding that firms with similar investment partner profiles, had lower investment performances, due to a lack of diversity of thought.

SPOTTING THE WINNERS

Despite the growing body of work, it is still very early days for investors who wish to use this research to influence their portfolio holdings.

Adrian Lowcock, head of personal investing at Willis Owen, explains that diversity is only just starting to get assessed and reported, adding that many fund managers are still unsure as to the link to returns, despite the research in the past two decades.

“Fund managers are not as likely to talk about diversity outright, as they are to discuss the outlook for a business and the strength of the management team, using its diversity policy or gender pay gap report as an illustration of how progressive the management are,” he says.

“The link between diversity and success has not yet been made in the minds of investment companies and indeed many businesses, sadly we have a long way to go here.”

LIMITATIONS

The UN’s Sustainable Development Goals (SDGs) include specific targets on diversity, such as reducing inequalities (number 10) and gender equality (number five), but many financial experts are wary of using the SDGs themselves as a basis on which to shape an investment portfolio.

Simeon Willis, chief investment officer at XPS Pensions Group, suggests that conducting a portfolio assessment using the UN’s SDGs is a choice of an ethical stance, rather than a developed ESG approach. Willis’s views are echoed by some in the market, as the SDGs were originally developed for governments and not for investors.

“Ethical policy is a subjective matter and isn’t so much driven by pursuit of profit but rather desire to act in a way that is in keeping with personal or corporate values,” he said. “From research we have undertaken some managers specifically mentioned the UN SDGs but it is not a consistent stated goal of fund managers.”

Meggin Thwing Eastman, executive director at MSCI, agrees: “There is little doubt that measuring and augmenting a company or portfolio’s contribution to achieving SDGs is challenging. Companies and investors that are committed to doing so typically must deliver on their financial objectives while demonstrating that the way they achieve these financial returns can also create collateral benefits for society. This is a tall order.

“We believe that an important first step is having a systematic framework that considers both positive and negative impacts. This approach would allow public funds to offer greater transparency on not only the risk and return of their portfolio performance, but also the increasingly important third dimension of “impact.” With this information in hand, they can begin the work necessary to better align portfolios with the SDGs.”