Diversity Leaders Open New Doors for Equity Investors

More companies are discovering that policies promoting diversity, equity and inclusion (DEI) are good for business. Equity investors who can find these “diversity leaders” will discover a promising source of return potential, especially in businesses that rely on human capital to drive innovation and business performance.

A company’s success increasingly hinges on its capacity to see and meet challenges from different perspectives, and a deep bench of diverse talent often provides an important competitive advantage. Promoting DEI does a lot of good, for employees, the business and investors alike, by creating a more inclusive, productive labor force.

The global workplace identity is steadily changing—across age, gender, sexual orientation and especially race. In the US, for example, 75% of working-age adults identified as white in 2010, according to the US Census Bureau. The number dropped to 64% in 2020 and is expected to fall to about 53% as the next generation reaches adulthood (Display).

 

Forward-looking companies are embracing these demographic changes. We think those that harness a more diverse population by reshaping their recruiting, culture and employee development will have a clear strategic advantage.

Employees Thrive Where Trust Is Strongest

Effective DEI policies rely on a distinct ecosystem of actions and attitudes (Display). Recruiting diverse talent is an obvious starting point. A culture of information sharing, productivity, trust and employee satisfaction is also an essential ingredient. Psychological safety is important, too, fostered through sincere empathy and commitments to reducing workplace bias so people feel they can be themselves. These all orbit alongside innovation, which exponentially builds on itself as trust grows and ideas flow openly within and across teams. At companies where innovation really matters, we believe that DEI can have enormous influence on business success.

 

Many companies fail to capture the benefits of DEI, despite its proven connection to bottom-line performance. Lack of accountability is a big reason. Even among companies with DEI initiatives, only 26% of senior leaders are tasked with specific DEI goals. Even fewer are focused on reaching DEI targets or applying them to leadership or employee performance evaluations (Display).

 

Greater Diversity Linked to Better Profits

Although the pace of adoption is glacial, businesses that have pursued DEI have outperformed their peers. For example, a recent McKinsey report, covering a study of 1,000 large companies in 15 countries, linked gender and ethnic diversity to enhanced financial performance. Companies in the top quartile of executive-level gender diversity were 25% more likely to post above-average profitability than peers in the fourth quartile. Moreover, companies with women in more than 30% of senior roles are significantly more likely to outperform those with fewer in charge.

Ethnic and cultural diversity are just as empowering, according to McKinsey. Companies in the top quartile for ethnic diversity were 36% more profitable than those in the fourth, slightly up from prior years.

The McKinsey and other studies have extensively documented the diversity-to-profitability connection. The direct link between DEI and stock performance is still coming into light, however. Our research suggests that among global companies that report gender diversity metrics, shares of the top 20% outperformed lower scorers by about 4% over three years, with similar results for slightly longer periods (Display).

 

Diversity Research Should Be Diverse Too

Finding diversity leaders with outperformance potential requires careful research. It’s rarely obvious if a company’s diversity initiatives are ingenuous, and DEI disclosure and data in general are nascent and somewhat fragmented. That’s why vetting diversity leaders requires a broad mosaic of inputs, from traditional financial reports and quant research to data science analysis of recruiting websites and employee blogs. Glassdoor, for example, aggregates employee sentiment, and companies with higher scores have performed better, our research shows. Used together, these nontraditional data sources combined with fundamental research are much more telling of a company’s commitment and progress around DEI.

We also search for companies aligned with relevant UN Sustainable Development Goals, namely gender equality (#5), decent work/economic growth (#8) and reduced workplace inequalities (#10). Leading home-goods retailer Williams-Sonoma, whose female representation is sector-leading at 63%, and balanced across seniority levels, stands apart in these areas. Another is India-based Infosys, a top IT consulting firm who is working with community colleges to expand access to STEM (science, technology, engineering and math) education.

In the post-COVID-19 business world, human capital is more valuable than ever. But it’s a fluid asset that many investors don’t fully appreciate or know how to measure. Most companies know why human capital is so important, but relatively few embrace the idea that DEI provides a critical foundation for success. As more catch on, the growing number of diversity champions will offer selective investors a dual path to improve their potential returns while enhancing workplaces for millions of employees worldwide.