There is much debate about diversity, but how do investment professionals define it?
“For us, it is about cognitive diversity,” says Clare Payn, Legal & General Investment Management’s (LGIM) senior global ESG and diversity manager. “Diversity has become synonymous with gender, which is where it started, certainly within the investment and financial space. But we are looking beyond just gender. We are looking at ethnicity, socio-economic background and LGBT+ and sexual orientation. All those different streams, if you want to call it that.
“So, for us, diversity is holistic,” she adds. “It comes down to lived experiences, as we all have different lived experiences depending on who we are. And those lived experiences are going to be different,” she says. “And that is what we are talking about when we talk about diversity: it is the cognitive piece. It is about diversity of thought, rather than anything else. We are using gender, etc, as proxies to try to quantify that diversity of thought.”
Aon’s head of ESG, Meredith Jones, focuses on the mechanisms of investment. “Because I am focused on the cognitive and behavioural alpha component, I tend to look at who’s managing the portfolio. Are women and minorities integrated and/or leading the investment charge?
“However,” she adds, “that can be messy to determine at some firms. And as a result, there are a number of investors who instead focus on firm ownership, which tends to be cleaner. In a perfect world, you would see both of those aspects maximised. You would see portfolio management undertaken by diverse individuals as well as substantial firm ownership by those same individuals.”
Ben Gunnee, head of UK and European business development at Cambridge Associates, offers his insight. “We are focused on types of diversity that create disparities,” he says. “Currently, we are focused on women and under-represented people of colour within a regionally specific context. Over time, as research develops, we anticipate that the definition will evolve.”
What initiatives have you undertaken to address this issue?
“We started with gender,” LGIM’s Payn says. “From the various reviews – 10 years ago now – we put out our first thought piece on the importance of gender diversity. Back then, we presented a business case because there were lots of questions about why was this important. And we have been engaging with companies over that 10-year period.”
This, in turn, led to action. “In 2015, we started to vote against the boards and chairs of FTSE100 companies that did not have any females on their board. We started with the largest companies,” Payn adds. “That came from the fact that you cannot boil the ocean, you have to start somewhere sensible. The largest companies should essentially be showing leadership here.
“This has escalated over the years that we now expect the FTSE350 to have at least 30% of its directors to be women. We would like to have more – we would like gender parity.”
The voting has also been focused for Payn. “Voting against annual reports and accounts is not going to have the same impact – I know that is how some investors may vote – but that is not the way we have voted because it is direct accountability to the chair that truly has an impact,” she says.
And there are slightly different approaches in different countries. “We have policies for the US, which on the gender side of things has been slightly slower on the uptake than the UK market, and France, which has quotas. We align with those quotas in our voting.
“But across the board, we expect 30% minimum representation,” she says. “We know for some countries, such as Japan, this is challenging.”
Payn notes there has been a similar approach on a racial basis. “On ethnicity, we launched our engagement campaign 18 months ago and are clear on what our expectations are, which, again, focus on large companies in the FTSE100 and S&P500. We took ISS data and wrote to all the companies that did not meet the one person of ethnicity on their board by the end of 2021, which is needed to align with the Parker Review in the UK.”
Asset owners and diversity
What should asset owners do to address diversity in their portfolios?
“What the Asset Owner Diversity Working Group is doing is exciting,” Payn says, “because what we are doing as asset man- agers, is on behalf of the asset owners. We are all on this journey together.”
Meredith Jones at Aon highlights a four-step approach asset owners should take. “We believe that investors should take a holistic view of diversity when trying to make changes to the levels of diversity in their portfolios.
“We believe that a four-step process focusing on: purpose, pipeline, pedigree and process makes the most sense,” she adds. “That way you are focusing on all four of the major inflection points that are required to truly boost diversity in a portfolio specifically and in the industry in general.”
But Gunnee says that diversity is more than just being seen to be doing something about it. “While we are excited to see an uptick in diversity, equality and inclusion from asset owners, simply taking meetings with diverse fund managers is not sufficient,” he adds. “Asset owners must address systemic biases in their diligence process as well to be successful.”
Diversity asset managers
Are enough groups represented within asset management firms to translate diversity into investment strategies?
“Representation in the industry certainly has a way to go but we do not see the pipeline as the problem,” Gunnee says. “At Cambridge Associates, we have built portfolios that are not only exceeding their return targets, but also have more than 30% of their portfolios invested with diversely-owned funds.”
Jones gives some insight into the situation. “In some strategies, there are plenty of women and diversely-run funds. The bigger question is how large are those funds and can they absorb an institutional allocation? This is less of a numbers issue and is more of a how many women and minority-run funds are out there of sufficient size to be able to absorb an institutional allocation without it becoming a majority of the portfolio. So, I suppose the short answer is, yes and no.”
What are the main barriers for investors to include diversity in their investment approach?
“Despite the research available to the contrary, investors still believe you need to sacrifice returns to invest with women or people of colour,” Gunnee says. “The investment industry has long subscribed to the value of diversification within portfolios. To move forward, investors must understand that until we use an inclusive and equitable investment process to consider all fund managers, we are leaving money on the table.
“Our firm believes that strong investment performance depends in part on the diversity of ideas, backgrounds and experiences of the managers with whom we invest on behalf of our clients.”
For Jones, size matters. “I believe it’s hard to over-estimate the issue of fund size. So many institutional investors cannot be more than 10% or 15% of a fund’s total assets under management. As a result, for smaller funds, getting allocations from institutions may just not be practical.
“If you have a $75m (£56.8m) fund, for example, an allocator may only be able to give you $7.5m (£5.6m),” she adds. “For a multi-billion dollar plan that number does not move the needle. So, we need to focus not just on the number of diverse managers but also the scalability of those managers.”
An Aon report has revealed that one of the most popular diverse manager interventions is targeted allocation. This is where investors carve out a specific portion of their portfolio for allocation to diverse managers. Is this an effective approach?
“While focusing on a targeted allocation to diverse managers has been by far the most common way for institutional inves- tors to attack diversity within their portfolio, it has not proven truly effective,” Jones says.
“Of course, small gains have been made in the number of women and minority-run funds over the years, but, unfortunately, we have yet to see seismic movement. As a result, we feel that institutional investors need to focus on all stages of the diverse asset manager lifecycle.”
Here Jones expands on her four-step approach – purpose, pipeline, pedigree and process – in the form of portfolio allocation. Starting with purpose, Jones says: “That institutional investors want to increase diversity in their portfolio will put all managers on notice that it is a critical issue for that particular investor.”
Then there is the pipeline. “The institutional investor should think about what they can do from an internship, educational or charitable support perspective to expand the pipeline of women and minorities in investing,” Jones says.
“At the same time, they should encourage the managers with whom they invest to do the same.”
And then there’s pedigree. “It’s incredibly important for women and minority fund managers to establish a track record at a firm to be able to effectively market a new women or minority-run fund,” Jones says. “As a result, it is important to track the amount of diversity within many non-women or minority-owned firms in the portfolio management space,” she adds.
“This is where the next generation of women and minority fund managers will, in large part, come from.” And finally, portfolio allocation. “It is important for institutional investors to either allocate a set amount of their portfolio to diverse managers or to otherwise ensure that diverse managers are included in every search.
“They should also measure the progress of diversity in their portfolio against an established baseline,” Jones says.
Reasons for diversity
Should diversity be addressed solely for better returns that can come from such an approach or for an end in itself?
“It is the financial case,” Payn says. “You only need to look at the numerous research papers that show this. But it is also knowing we are getting to a better economy and society.
“The social piece: companies need to be socially cognizant,” she adds. “We see companies performing better, with lower risk and better decision making. And when we are looking at gender diversity, 50% of the population is being leveraged, which is only good for society. It is a secondary outcome, but important.”
Cambridge Associates’ Gunnee says diversity in the decision-making process is crucial. “Our mission is to build portfolios for our clients that outperform the market and we believe that diversity is a tool for our success.”
“Given that our clients may also be mission-serving institutions, building diverse portfolios can also have the added bonus of mission alignment, but we are returns-focused,” he adds.
Jones points to the importance of manager diversity. “I believe that diverse managers create value in a portfolio through potentially higher returns and an additional layer of diversification.
“However, I know that social justice can be a component of a diverse asset management program as well,” she adds. “As a fiduciary, I tend to focus on the issues of enhanced returns and diversification first, but there’s no ignoring the side benefit of social justice improvements.”
Doing your homework
And the importance of data…
“Data and transparency are crucial,” Payn says. “We need, as investors doing a stewardship job, accurate data. This is so we can build an engagement programme. To build voting policies and investment strategies, we need data – and vitally important: accurate data,” she adds.
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