Diversity investing has become a global megatrend as investors increasingly look to realize the benefits of racial and gender equality in their portfolios.
Many investors are moving towards diversity investing because it aims to improve fairness and quality of life for women and minorities. Various studies have found that both are still underrepresented, undervalued and unevenly treated in society.
However, evidence of the financial benefits of diversity is also growing. A 2020 study by the European Investment Bank highlighted a potential increase of 26% in global annual GDP; and $160 trillion of human capital – the value of workers’ skills and experience - from improving gender equality in business and financial communities.
A 2020 McKinsey report shows that companies with high levels of ethnic diversity are 36% more profitable than less diverse peers.
In investment terms, a recent World Bank report shows gender-balanced leadership teams generate a 20% higher internal rate of return (IRR). And MSCI found companies in its World index with strong female leadership generated an equity return of 10.1% a year versus 7.4% for those without it.
Evidence about profits is not unanimous. One meta-analysis of over 100 studies by Wharton University found companies with women on their boards do not perform better nor worse. However, the study did identify a small positive link between female representation and long-term financial value creation.
Zahid Torres-Rahman, founder and CEO of Business Fights Poverty, says gender equality helps increase competitiveness; build supply resilience; improve human capital and talent management; and drive product innovation to reach new market segments. This enables investors to unlock opportunities for increased growth and creativity.
Ute Stephan, professor of entrepreneurship at King’s College London, says: “Evidence is converging that diversity makes companies more resilient and sustainable in the long-term. For example, similar people with shared outlooks don’t consider some risks because they are not aware of them. Diverse management teams make better decisions and become more resilient, so tend to have more steady growth trajectories and less risk.”
Investors are responding to this trend by choosing funds that target diversity specifically, or do so as part of a wider environmental, social and governance (ESG) remit. So-called gender lens investing (GLI) - which addresses issues such as gender diversity in boards and workforces - is also popular in private equity markets. The World Bank report showed $4.8 billion (3.9 billion euros) were raised in 2019 with a gender lens across private finance vehicles.
The 2X Challenge has been an important contributor - it launched at the 2018 G7 Summit as a joint commitment by the seven largest Western economies to boosting GLI. The initiative exceeded its two-year target of raising $3 billion, mobilizing $4.5 billion in private sector investments that benefit women.
Jessica Espinoza, chair of the 2X Challenge, says: “GLI has become a priority for investors who want a social impact, but mainstream investors are also increasingly recognizing that inequality is a systemic risk and there are important upside opportunities. GLI resonates with investors across the risk-return-spectrum because there is a strong impact case and a strong business case.”
For individual investors interested in gender diversity, a few European funds target this area specifically and there are more in the US. A stumbling block for some is that these funds are relatively new, untested and have a narrower universe of stocks to choose from. Another criticism for some is that these funds could simply be jumping on the bandwagon of social media trends such as “Me Too” and “Black Lives Matter”.
An alternative is to invest in a fund manager that uses a wider range of ESG criteria that include gender and minority diversity. For example, many ESG and sustainable investing funds seek to align with the United Nations sustainable development goals (SDGs), which include improving gender equality and reducing inequality more generally, but also cover issues such as climate action, quality education and zero poverty. One advantage of using a broader ESG fund is that many have existed for much longer so have more experience in engaging with companies on ethical issues and tracking impacts.
Investors should consider their goals and priorities carefully before investing. “Being gender-smart comes with its complexities,” says Torres-Rahman. “Gender inequity reflects deep societal drivers, requiring ambitious cross-sector partnerships to drive change - bringing together government, civil society and business. Also data is patchy and it is not always easy to get gender-disaggregated information. Baiyun Chen, sustainable investing specialist at LGT Private Bank, concurs: "One major challenge of diversity investing is lack of data on social factors such as gender pay gap or community relations. To find a diversity investment that makes a difference, one needs to look beyond boardroom diversity, also at details like how a company offers flexible work options and promotes diversity along the supply chain.
For fund managers, gender-smart investing is a journey. Managers at the beginning can consider encouraging portfolio companies to take gender into account, and think about the gender composition of their own teams. Others may be more ambitious, prioritizing gender-smart deals or applying a gender lens across all investment decisions.
Espinoza says an important consideration is that gender equality is a “prerequisite” for achieving all the other UN sustainable development goals.
“A gender lens reveals the patterns that keep systemic inequities in place,” she says. “So, looking at gender comprehensively means also looking at other issues such as racial equity and how power dynamics shape the way we structure deals, and assign value; and where biases and privilege inform decisions and mask risks and opportunities.
“Gender-based investments create value for women and their families and communities, and are associated with important ripple effects at micro and macro level. In other words, returns on gender equality boost ESG performance as well as the bottom line.”
Most importantly to many, diversity investing harnesses the power of capital markets to address the root causes of inequality and help make economies fairer, stronger and more resilient. Its momentum looks set to keep rolling.
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