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The curious case of diversity dividends – How diversity links to performance

In June 2017, the Women in Governance Roundtable, the only all-female annual governance meeting that brings together female board directors of listed companies and investors will for the first time take place in the UK. The tradition of this annual gathering was established in the US as an acknowledgement of the importance of support and mentoring of female executives and investment professionals.

I had the opportunity to participate in the event in New York in 2016 and I am looking forward to a different but equally distinguished crowd in London this year.

The financial impact
But why should we care about diversity? Nine times out of 10 the first question of an investment analyst is whether it makes a difference to performance. Many researchers have attempted to investigate the correlation between diversity and performance. The widely referenced 24-page McKinsey study Diversity Matters (2015) covers 366 public companies in the US, Canada, the UK, Brazil, Mexico and Chile. It concludes that companies in the top quartile for racial and ethnic diversity are 35% more likely and those in the top quartile for gender diversity 15% more likely to have financial returns above their respective national industry median, based on measuring earnings before interest and tax (EBIT). In the UK, for every 10% increase in gender diversity, EBIT rose by 3.5%, according to the study. However, this is by no means the only research. Using data from 4.4 million firms across 34 European countries, the Gender Diversity in Senior Positions and Firm Performance: Evidence from Europe (2016) report by the International Monetary Fund reveals that companies with a large share of women in senior positions have a significantly higher return on assets (ROA). This means that replacing one man with a woman in senior management or on the board is associated with 8 to 13 basis points higher ROA.

Furthermore, half way across the world in Singapore, using data from local listed companies, the Monetary Authority of Singapore’s 270-page paper Is Board Diversity Important for Firm Performance and Board Independence (2012) finds that gender and ethnicity is positively associated with higher company value as defined by Tobin’s Q1.

Impact on fraud
The study of diversity is becoming more interesting due to new available data and more importantly, analysis from various perspectives, such as the assessment of correlations between different aspects of financial performance and definitions of diversity. So what should we try to focus on? Would it be ethnic diversity in relation to turnaround performance? How about diversity of background and expertise in relation to revenue growth of new businesses? In our engagement with companies, our focus on board diversity has addressed perspectives of gender, connections, groupthink, experience, skills and expertise. In many markets, we criticise that boards choose their directors from a small group of insiders with similar social backgrounds. We also examine the number of times that directors cross paths with each other in different companies, and, if the figure is high, look for any identifiable impact, and decide what we need to do to encourage positive change.

It is a brave new world and it is up to each of us to decide how to embrace diversity.

 

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