Why diversity should matter to investors

Why diversity should matter to investors

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A wave of diversity and inclusion (D&I) is rippling across corporate culture.

As someone that leads a lot of D&I activity in our office, I hear the praises but also the complaints. Too many of these comments miss why diversity is such an important focus for executives, boards of directors and investors.

Why do companies care? The common view is that bosses want to improve culture and community values in their offices, while giving employees a good feeling and positive reinforcement.

However, as important as it is for companies to have a good corporate culture and retain employees, another big reason is that diversity is being attributed to having a material impact on companies’ financial performance and their shareholder value.

The evidence

Consulting firm McKinsey & Company has been a leader in researching the subject. Its 2018 report, Delivering through Diversity, suggested greater diversity across genders and ethnicity was strongly correlated to higher profitability and value creation. A diverse company can help attract top talent, improve customer propositions and develop better decision-making methodology.

The Harvard Business Review provides a similar distinction in that diverse company management teams are also better performing. In a 2016 article, Why Diverse Teams are Smarter, studies were highlighted that show large cap companies with at least one woman on their board generated a higher return on equity (a measure of profitability) and net income growth (the rate of profit growth) compared to those companies that had no gender diversity.

The evidence also extends to the performance of investment management teams. Morningstar research[1] performed an in-depth analysis on whether investment performance explains if there is a decline in female portfolio managers or not. In one of its tests it found that when looking at funds based solely on the gender of the management team, performance of all-female fund teams had outperformed mixed-gender and men-only teams. Of course, just because that’s happened before doesn’t mean it will happen again.

[1] Female Fund Manager Performance: What Does Gender Have to Do With It? What we found when we looked at whether gender affects investment performance, by Madison Sargis, Morningstar, Inc., and Kathryn Wing, Morningstar Research Services LLC, March 8, 2018

Examples in action

Offhand, I can think of a few instances where I see how the diversity story could play out in a companies’ success, or how a lack of it could contribute to risky behavior and financial losses.  

Social media companies are currently facing challenges in monitoring their platforms from bots and hate speech. You can argue a lack of diversity of thought and experience within these companies impairs their ability to recognise and manage these conflicts. Not having the cultural awareness to be proactive and acute in handling these challenges could increase a company’s risk of fines, loss of customers, and, ultimately, its profits.

Another situation that comes to mind are when companies inadvertently create an insensitive ad campaign and then end up in headlines and face possible boycotts. Additionally there are the wasted funds on ads that have to be pulled.

Maybe having robust diversity and a platform for employees to share their experiences and insights could mitigate risk, while also providing opportunities for growth investing

As such, diversity is becoming a bigger focus in investment reports. Portfolio managers and analysts are using a company’s diversity statistics and programs to improve inclusiveness as a measure of their success to grow and contribute positive returns to their portfolio.

A strong D&I platform encourages diversity of thought and incorporates this experience in the decision-making process. Homogenous teams that lack diverse standpoints create a sanctuary for agreements to be reached without proper challenges and based on a singular view.   As much as you might want a group of people to unanimously agree upon a restaurant for a dinner party, you probably do not want important business and investment decisions being made in the same haste.

Diverse teams provide the platform necessary to challenge and counter hasty conclusions which can negatively impact financial performance.  Global companies serving diverse communities simply need to have the cultural insight that integrates different standpoints in order to provide relevant valued services and avoid profit losses.  This is one of the leading reasons we embrace diversity of thought and think more investors should consider diversity and inclusion as an important input in their research and analysis.

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