35 years of investment performance with DEI
Diversity is known to drive innovation, productivity and market success, and thus increasing corporate performance, and yet has recently come under anti-woke fire. What do financial analyses say about this?
This article was written for 4investors in German and first published there.
It is worth looking initially at a study conducted at the very beginning of the diversity era: Stock markets reacted positively to the announcement of US affirmative action legislation in the studied timeframe from 1986 to 1992. In that period, it seemed obvious that the conscious consideration of all talents would make sense from all business and economic points of view. Stock indices were promptly established that used diversity criteria as an additional lens to filter the investment universe: The Domini400Social Index (1990) was followed by Calvert Social and Dow Jones Sustainability or FTSE4good.
From initial hype to long-term success
Scientific analyses later showed that the first three indices outperform their respective benchmark, the S&P 500, e.g., from 1990 to 2004, albeit not in every period, and that this performance is not merely an illusory correlation. Since 2006, the now MSCI KLD400 Social index has outperformed its benchmark portfolio by a wide margin (e.g. +100 vs. 93% in 5 years, +270 vs. 197% in 10 years).
A more basic analysis of the German stock market showed significantly higher returns on capital, returns on equity and higher P/E ratios between 2002 and 2010 for B2C companies with a higher percentages of women both on supervisory boards and among employees.
Critical questions on complex interrelations
In order to understand how reliable such results are, legitimate critical and therefore essential deeper questions need to be explored:
- What factors or criteria are related to higher performance (certain diversity characteristics, binding guidelines or particular HR practices)?
- Is the selection of certain shares not at the same time detrimental to performance (due to the exclusion of certain other shares)?
- Are causal relationships verifiable or are these spurious correlations or reverse effects (successful companies ‘afford’ diversity)?
- How robust are the findings across different time frames, regions or industries/sectors?
In fact, a large number of mostly scientific studies have clarified these questions over a period of 35 years. Of all of them, a few individual studies found negative correlations between DEI and economic success, while the vast majority showed positive or neutral effects. Furthermore, the results were very similar across regions/countries, industries and company sizes!
Over 1,000 individual studies and several meta-analyses
A report by Rockefeller Asset Management and NYU Stern provides a particularly clear, comprehensive and insightful description of the research landscape: it aggregates over 1,000 studies (!) conducted between 2015 and 2020, broken down into analyses of company and investment success.
- 58% of the company studies found a positive correlation between ESG and ROA, ROE or share price (13% neutral, 21% mixed, 8% negative)
- 59% of investment studies showed similar or better (alpha or Sharpe ratio) performance of ESG versus traditional portfolios, 14% performed worse
The report cites 13 other similar meta-studies, all of which (!) found a positive correlation between ESG and share price performance and 2 investment meta-studies that showed a neutral correlation (i.e. similar performance).
What BlackRock (i.e. Larry Fink or Friedrich Merz) knows about DEI
A detailed report by BlackRock (co-founded and still led by investment magnate Larry Fink, German subsidiary was chaired by Friedrich Merz from 2016 to 2020) uses the example of ‘gender’ to show that deliberately managed diversity is consistently positive for economic success. The financial experts at the world’s largest asset management firm analysed and explained that the following points are decisive for superior business results:
- Balanced approach to [gender] diversity (‘closest to parity’),
- Consistent talent management (‘representation between middle management and the overall workforce’ and ‘promote more women into senior roles’),
- Recognition of the existence of a glass ceiling
- Policies and practices to balance work and private life (‘higher average maternity leave’) and
- Transparent DEI measurement and metrics (‘human capital and diversity metrics … established as drivers of financial performance’).
With its report, BlackRock was a latecomer on the one hand and also pursued a, at the time, unusually focused approach: all six authors are women and write about ‘investing in women’ (not gender or diversity); they justify this with the higher availability of representation data for women… Even if these managers (from the Global Client Business, Global Product Group, Investment Institute and iShares Investment Strategy) were not aware of certain studies, their specific results are still strikingly clear. It therefore seems questionable when current or former BlackRock top managers make negative comments about diversity or sustainability. For they must be aware of the robust, long-term success factor this presents, and that their current position actually implies negative effects/impacts for companies and the economy.
Bandwidth and variation explained
Further scientific studies investigated why the results of comparative analyses differ both before and after the establishment of the 17 SDGs (2015, United Nations). One analysis calculated that 56% of the deviations are due to different measurement approaches (categories, criteria and metrics), 38% to the scope of the survey (number of criteria) and 6% to different weightings. From an investment perspective, this variety offers the opportunity to create different products for different types of investment customers and some recent funds presented below illustrate just this.
Organisational maturity as a variable lever
Another key finding of several studies is the correlation between diversity or ESG and improved performance: increased innovative capacity, performance optimisation and risk management (especially in crisis situations) are frequently documented mediating factors. Analyses also show that the strength of the effect varies with an organisation’s level of maturity: ESG Leaders and Laggers both achieve lower benefits than the (lower) midfield, which can more easily realise improvements that produce rapid and/or significant effects.
Various investment products
With the findings of superior performance and rapidly growing demand, a range of actively managed funds (each with their own criteria) and passive products based on one of the social or ESG indices (e.g. FTSE4Good, FTSE Diversity & Inclusion, FTSE Europe Equal Opportunities Select, Solactive Equileap Global Gender Equality) have emerged. Four newer products illustrate the bandwidth:
- The Nordea Global Diversity Engagement Fund has been focussing on the predictable effects of early-stage D&I management since February 2019 (current volume USD 698 million, performance above MSCI ACW benchmark)
- Since April 2019, the Mirova Women Leaders and Diversity Equity has focused primarily on the United Nations Women’s Initiative and pays particular attention to gender representation in management. (Current volume EUR 279 million, performance like MSCI ACW benchmark)
- Since November 2021, the M&G Diversity and Inclusion Fund has combined criteria on diversity in management and activities to promote equal opportunities. (Current volume EUR 20 million, performance below MSCI ACW benchmark)
- Since January 2023, the Calvert Sustainable Diversity, Equity & Inclusion Fund has focussed on large US companies that are leaders or active in DEI and have at least one woman on their board. (volume USD 31 million, performance like Russell 1000 benchmark)
The experience of these new approaches reinforces two previous research findings:
- Benefits of ESG-based investment strategies are increasingly evident over longer periods of time
- Narrow (or strict) focus on representation numbers (aka quotas or targets) is not a viable approach in itself – broadly orchestrated approaches are required.
The cause-effect relationship that has been researched for decades
A number of authors criticise the presumed fact that ‘too little’ is known about the links between DE&I, innovation, efficiency and corporate success. This criticism does not withstand scrutiny. Between 2006 and 2018, a series of meta-analyses (IBCR) presented the respective state of research – with carefully selected global studies based on quality criteria. The latest report contains 255 studies from three decades that have reliably analysed the creation of different economic added values of proactive, strategic diversity management in various business contexts (sales, motivation, or team work).
The findings from 35 years of diversity research show managers, investors and politicians that the deliberate and comprehensive consideration of the diversity of employees, customers and other stakeholders has positive financial and economic effects. The leverage that arises in a specific situation must be carefully and professionally explored and subsequently implemented in a tailored way.
