The Challenges of Diversity Investing
- Both academic research and our own experience indicate that the business case for corporate diversity is compelling as a result of higher collective intelligence.
- Testing the investment case for greater diversity faces two major challenges: insufficient historical data and difficulty in measuring whether the culture is one that embraces dissenting views among the team.
- Accordingly, we conclude that investors who seek to promote diversity and its business benefits would be well served to combine diversity with known drivers of excess returns.
The broad business case for diversity is compelling. Research shows that cognitively diverse groups have higher levels of collective intelligence than nondiverse groups, resulting in greater creativity and innovation as well as in more-effective corporate leadership. The investment case for diversity is less clear-cut because researchers simply lack the necessary data to determine whether a link exists between diversity and portfolio performance. Given what we know (and do not know) now, we encourage investors who seek to promote diversity and its business benefits to use investment strategies that combine diversity with known sources of excess returns in the pursuit of investment performance.
Diversity is a word with many meanings. Given its primary definition relates to “a range of different things,” it should not be surprising that a conversation about the benefits of diversity is multi-faceted. The broad business case for diversity is compelling. Research shows that cognitively diverse groups, which interact in a culture that embraces dissent, candor, and respect for other viewpoints (an inclusive culture), will tend to make better decisions. In general, cognitively diverse groups have higher levels of collective intelligence than nondiverse groups, resulting in greater creativity and innovation, as well as in more-effective corporate leadership.1
The narrower investment case for diversity is less clear-cut, because researchers simply lack the necessary data to determine whether a link exists between diversity and portfolio performance. Indeed, we can test the relationship between observable measures of diversity and cross-sectional firm characteristics, but it is much more challenging to test the robustness of whether more-diverse firms are better investments in a portfolio context. An additional challenge is that the corporate advantages associated with greater diversity are dependent on an inclusive culture. (In the extreme, homogeneity of thought is no different than one individual making all the decisions; curiosity regarding divergent views is essential to unlocking the benefits of diversity.) Corporate culture, however, is exceedingly hard to measure—particularly on a large scale across thousands of firms around the globe.2 Therefore, the ability to ascertain with any degree of definitiveness if diversity attributes are priced in, or if they should lead to otherwise unanticipated excess returns, is limited at this time.
The good news for investors is that the growing attention paid to gender diversity and the issue of gender disparity over the recent past has led to increased transparency, more research, and ever-broader reporting of gender statistics. With time, the data and the research will extend past gender into other areas of diversity, such as race, ethnicity, age, and cognitive differences, providing more insight and direction for investment strategies. In the meantime, investors who seek to promote diversity as a social choice as well as for its broad business benefits may prefer to rely on investment strategies that pair diversity with known return-driving metrics in the pursuit of investment performance.