Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
Benefits from diversity not only about gender
Early research on ethnicity as well as gender by Willis Towers Watson should significantly broaden the discussion about potential economic benefits from improved diversity among boards and management at super funds, corporates and other organisations.
In the first public airing of its latest thoughts on what it terms ‘cognitive diversity’, Willis Towers Watson (WTW) says: “Investment teams with diversity, in particular ethnic diversity, tend to generate better excess returns.” The researchers put plenty of caveats around this and admit there is a lot more work to be done to provide the sort of quality data which is likely to influence positive change.
Gender and ethnicity represent four out of 25 questions the WTW asset consultants are already asking of fund manager investment teams on the characteristics of their people. Separate research this year among pension funds in The Netherlands, for instance, highlights the impact of age on decisions made at trustee level.
Speaking to the results of the WTW report, ‘Diversity in the Asset Management Industry’ published in October, Chris Redmond, the London-based head of manager research, says that the general sense, beliefs and principles about diversity, as held by WTW, are well understood, but without the data to back them up it’s difficult to affect change.
Original studies on gender were focused on ownership, whereby between 9-11 per cent of ownership in funds management was by “minorities”, including women. In the US there are various programs to promote diversity, including a tax break in California for fund managers with a majority of ownership by minorities. But the numbers for women and other minorities (let’s call them that for simplicity’s sake), are so low that it is very difficult to get a statistically significant sample for study.
“So, we have focused on the investment team,” Redmond says, “Which enables us to ask questions without impinging on various regulations such as privacy.” WTW developed its own diversity score across the characteristics. The case for gender diversity is “awash” with the impact on returns looking “roughly the same” between the sexes. “But with ethnicity it is a dimension where we saw a more statistically relevant impact.”
For its research purposes, WTW regards the diversity score as a starting point. In the broader discussion on ESG, diversity will fit across the G and the S. WTW prefers to use the term ‘sustainable’ because “the failure to act on it will threaten the legitimacy of investment management”, Redmond says. “It means we are not representing society or our customer base and at some point there will be intervention.
The other 21 questions WTW’s asset consultants ask of mangers are to do with experience, both work and life in general, including background. “But one of our people has done some work which suggests experience doesn’t have much positive power,” Redmond says. “You have to be careful how you both ask those questions and how you analyse the answers.”
To illustrate that it means business, WTW has told managers, and mentions in its published report, that cognitive diversity will be considered when it makes its manager selections for mandates. But the firm favours engagement first and is looking for progress from managers without having to wield such a stick. Redmond points out that the US experience of giving incentives to managers with better diversity records tends to ignore all the others.
Philosophically, WTW is not keen on the introduction, presumably by governments or regulators, of quotas to enforce better diversity. “We are continuing to explore that and I don’t know where it will get to,” Richmond says. “It’s almost a last resort, I think.”
In a sense, some targets under discussion represent a form of quota, such as women’s groups aiming for a 30 per cent minimum representation on boards. And the Federal Government failed to pass, because of lack of time and a due to some political haggling prior to the last election, a bill which would have forced big super funds to have a 3x3x3 board make-up of representatives for unions, employers and independents. Seeing that this may be inevitable, several funds have already introduced the proposal, which could indirectly introduce diverse “experience” characteristics.
But there is still hope for the apparently fading fortunes of the “old white guys” in all this discussion. That research in The Netherlands, published as a white paper called ‘Your Trustees’ Age Matters’ where there is already a loose quota relating to age (boards need to have at least one member younger than 40 in The Netherlands), shows that older males tend to skew their asset allocations towards fixed income rather than equities, as younger males tend to do. This makes a case for at least some older members of boards.
