Diversity and investing

Nikki Matthews, CFA, CAIA

Senior Consultant

LCP clarity:

Different viewpoints help develop a more holistic picture, better risk assessment and can identify additional opportunities.

LCP insight:

Consider whether your investments are managed by teams with diverse thinking and background.

We see the world from our own perspective, and therefore naturally have blind spots and limited knowledge. We also tend to think in a unique way based on our experiences. Groups of people with very similar backgrounds are likely to have some commonality in their thinking. Cognitive diversity is widely accepted as beneficial to good decision-making. Having a demographically diverse team enhances cognitive diversity and allows different opinions to be expressed more.

There is also evidence to suggest that diverse teams of decision-makers allocate to assets owned by diverse groups (female or minority owned) significantly more.

Different viewpoints help develop a more holistic picture, better risk assessment and identify additional opportunities.

Ideally investment teams should be broadly representative of society as a whole, however a study by Morningstar found that women make up only 11.8% of fund manager positions.

There is evidence to show that women and men think about investing differently.

There is some evidence that funds run by females outperform male-run funds. However, it could be that the sample of women is of a higher calibre as the effort and determination historically required to reach a fund manager position is likely to have been higher for women.

Whilst studies on whether diversity improves investment returns may be relatively recent (largely due to a lack of data) and mixed, I believe that what we should really be looking at is risk versus returns.

Studies have found that women are less overconfident and maintain conviction in positions amidst market noise to a higher degree (less trading). A diverse team gives you access to different investing styles and therefore more diversification.

Investors generally diversify their portfolios by asset class, region, sector, and are beginning to focus on a perhaps overlooked risk within their portfolios – diversifying the investment teams that manage their assets by behaviour and decision-making.

Never invest in something unless you understand it sufficiently

Amidst increased geopolitical risk, valuations and fundamentals become less important, and the qualitative inputs matter more – having a broader understanding is helpful. For example, it is undoubtedly beneficial for an emerging markets manager to have people on the team from regions they allocate to who have an in depth understanding of the politics and culture of their country and can see the bigger picture.

Looking at evidence outside the investment industry

Evidence from other fields illustrating that diverse teams make better decisions has been around much longer. A Stanford study found that racially diverse juries were 10% less likely to presume a defendant’s guilt than all-white juries. Importantly, diverse juries spent more time evaluating information, made fewer factual errors and discussed more aspects of the case. Translating this to investing, greater due diligence and lower risk of unexpressed opinions, at no additional cost.

The inclusion aspect of D&I

Even if teams are cognitively and demographically diverse, people generally like to fit in so may not like to stand out or express their cognitive diversity. This is why the inclusion element of D&I is important, creating an open environment, with wide interaction across teams, where voicing ideas and concerns is encouraged. This is better than just focusing solely on increasing numbers across certain groups.

There is evidence to support that companies with higher employee satisfaction generate higher long-term returns. Employee satisfaction was not measured by D&I directly, (instead on credibility, fairness, respect, pride, and camaraderie), but most of these areas contain elements of D&I. If higher returns are available from these companies, it means the market is not fully including some intangible elements in stock valuations, therefore there could be an investment case to allocate to these companies which may be undervalued.

Manager selection

When selecting funds, key considerations are often a long performance track record and significant number of years of investment experience. For most institutional investors minimum fund size is also a consideration. Whilst these are all valid points to look at, it does inherently put funds or firms managed by or owned by females and minority groups at a disadvantage in attracting assets (as generally newer to the industry) and therefore creates a barrier to entry.

An option may be to look at other metrics in addition when selecting managers. For example, looking wider than performance numbers when assessing track record. Tracking the proportion of positions that outperform, the performance of the largest positions, whether stock selection is successful across a broad range of sectors the manager invests in (versus just one or two). The portfolio manager's overall track record could be accounted for instead by following their career across multiple firms and asking for references on their abilities. Adding extra data means that you could have a shorter performance track record as you have more information to assess the manager on.

Another option is to simply try to increase diversity across the industry when hiring people for investment teams. Though these may not be owned by diverse groups, it does increase representation more immediately.

Some asset owners are already taking action to diversify who their assets are managed by. Knight’s endowment increased its assets managed by firms owned by women and people of colour to 42% from 0.35% ten years ago. With increasing focus on D&I, I suspect other asset owners may move in the same direction.

Investment industry initiatives

The Diversity Project has published an Asset Owner Diversity Charter. LCP supported its creation and launch and has signed up to the charter. This means that diversity must be included as part of ongoing manager monitoring. Part of this monitoring is to send a questionnaire to managers identifying how managers look at D&I across five key areas: industry perception, recruitment, culture, promotion and leadership. We will be publishing a survey with our insights and results from the diversity questionnaire in April.

The Diversity Project has also set these two targets:

1. To halve gender pay gaps

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2. Reach 30% female fund managers by 2030