Diversity, equality and inclusion are a driver of performance over the long term.

Calvert Research and Management, a global leader in responsible investing and part of Morgan Stanley Investment Management, has released new research which aims to explore recent trends in ethnic diversity at corporate boards as well as its relationship to equity performance.

Yijia Chen, ESG Quantitative Research Analyst at Calvert Research and Management notes: “Over the last 50 years, we have seen the key driver of the global economy shift from natural resources to human talent, ushering in the era of the “Talent Economy.” This megatrend now impacts all major economies as companies place greater focus on intellectual capital and a diverse workforce as material, competitive factors for business success.

“Focused on four developed-market countries in the MSCI All Country World Index – Australia, Canada, the United Kingdom (UK) and the United States – our research aims to explore recent trends in ethnic diversity at corporate boards as well as its relationship to equity performance.

Not surprisingly, the ethnic diversity of developed-market countries most affected by globalization has increased — most visibly in the United States (Exhibit 1). As the populations of traditionally marginalized and underrepresented groups have grown, the socioeconomic differences and cultural diversity among different ethnic groups have become more visible. Today, many companies are actively promoting more diverse and inclusive cultures to attract and retain talent and drive innovation. They recognise the importance of intellectual capital in creating long-term value in terms of profitability, brand and market competitiveness.

Does the fact that more diverse teams drive better results for companies extend to the teams that oversee companies — their corporate boards? Academics and private industry have recently focused great attention on the relationship between board diversity and company performance — establishing a firm link between the two.

However, most of the research focus has been on gender diversity. Studies on the relationship between the ethnic diversity of corporate boards and company performance are fairly limited.

One often cited study was conducted by McKinsey in 2015.^[1]

Here, McKinsey looked at the 2014 board composition data of 366 public Canadian, Latin American, UK and American companies and found that those in the top quartile for racial and ethnic diversity were 35% more likely to have returns above their national industry medians than less-diverse peers, based on earnings before interest and tax data from 2010-2013. While groundbreaking, the study’s sample size was small, and its test period was short. There have been calls to examine the relationship more deeply between financial performance and the ethnic diversity.

An expanded research framework

Focused on four developed-market countries in the MSCI All Country World Index – Australia, Canada, the United Kingdom (UK) and the United States – our research aims to explore recent trends in ethnic diversity at corporate boards as well as its relationship to equity performance. Building on existing research, we used a larger data set, looked back further and took a more nuanced approach to evaluating ethnic diversity. Our sample focused on the period from December 2012 to December 2020, and included 845 large-cap companies (as of 12/31/2020): 65 Australian, 83 Canadian, 87 UK and 610 American firms.

Notably, our research introduces a new, multicategorical framework for assessing ethnic diversity. Based on the latest data from each country’s national census, we set up a framework of seven ethnic groups to differentiate among underrepresented groups and compare across countries – a metric we refer to as “ethnic fractionalisation.”

Our key takeaways are:

• on average, large-cap Australian, Canadian, UK and American corporate boards have become more ethnically diverse, with American boards being the standouts
• we found a significant relationship between the degree of corporate board ethnic diversity relative to country demographics and monthly equity performance
• our research suggests that using ethnic diversity factors can improve U.S. large-cap equity stock selection. There may be additional benefit in tilting toward more ethnically diverse companies across all four developed markets
• we believe “ethnic fractionalisation,” which measures the likelihood that two randomly chosen people have different ethnicities, is more nuanced than a binary metric, such as “White versus non-White.”

Ethnic composition of a company’s board matters

We found no evidence of a significant relationship between the monthly equity returns and absolute levels of board ethnic diversity factors. However, we did find a significant link between monthly equity returns and the level of board ethnic diversity factors relative to the company’s home country demographics. In particular, two factors showed statistically significant positive correlation with monthly equity returns and meaningful differences in return between top and bottom quintiles:

1. Percentage of people of colour on corporate board relative to the country demographic.
2. Ethnic fractionalisation of the corporate board relative to the country demographic.

“ As investors, we recognise the value of diversity, equality and inclusion as a driver of performance over the long term. Through rigorous corporate engagement aimed at improving corporate behaviours on diversity, equity and inclusion, we can encourage a change in corporate behavior that can lead to a more sustainable and equitable world and stronger long term performance.”

———

[1] Hunt, V., Layton, D., & Prince, S. (2015). Diversity Matters. McKinsey & Company. February 2, 2015.

The post Does an ethnically diverse board mean better stock performance? appeared first on AdviserVoice.

But this conflation stems from insufficient research that has yielded inconclusive results note Yijia Chen, ESG Quantitative Research Analyst and Alexander Deleon, Quantitative Research Analyst at Calvert Research and Management, an affiliate of Eaton Vance

“Given the knowledge gap, we seek to evaluate over recent history the following questions:

1. What is the relationship between quality and ESG data over time?
2. What is the relationship between specific quality and ESG factors?
3. Is there an opportunity to improve portfolio performance through understanding the dynamics between ESG and Quality?”

In their joint new research titled ‘Financial quality metrics and ESG factor interactions in equity markets’ they aim to explore the relationship between quality factors and ESG factors, as well as the potential financial materiality of different multifactor combinations of quality and ESG factors across six-year backtests (June 28, 2013 to April 30, 2019) on the Russell 1000 Index, Russell 2000 Index4 and MSCI EAFE Index.

“Definitions of quality factors vary across the industry. For simplicity and clarity, we define quality in general terms of profitability. We use reported return on assets (ROA), return on equity (ROE) and return on invested capital (ROIC) as proxies for quality metrics.

“To represent the ESG factor, we use monthly MSCI Intangible Value Assessment (i.e., MSCI IVA6) weighted-average scores. We used Global Industry Classification Standard (GICS)7 sector classifications as the control variable for domestic universes, and used the combination of GICS sector and MSCI country classification as the control variables for international universes. Return data is calculated on a monthly basis.

“Our research shows that in large cap universes better ESG companies or higher quality companies have the potential to generate superior return performance over the sample period. This is largely consistent with other research findings.

“Interestingly, the data correlations between ESG and financial quality are uncorrelated while their factors returns are positively correlated suggesting that better ESG companies are not always higher quality companies but that both types of companies can outperform peer companies.

“When we create composite indictors using ESG and quality factors, we find that these factors can be combined to exhibit more positive return characteristics than do either factor alone. This suggests that ESG and quality factors have the potential to generate superior performance when combined, despite seeming to capture different kinds of companies when view through the singular lens of either ESG or quality,” they conclude.

The post Financial quality metrics and ESG factor interactions can impact equity markets appeared first on AdviserVoice.

Across all sectors, the average number of women in board leadership roles and women NEOs is less than one.

Do gender-diverse boards and executive teams really make a financially material difference to companies and capital markets?

“While numerous studies in recent years point to “yes,” we decided to put these theories to the test, using rigorous quantitative factors,” says Yijia Chen, ESG Quantitative Research Analyst, Calvert Research and Management, an affiliate of Eaton Vance.

Calvert’s new research titled ‘Evaluating the financial materiality of gender diversity factors’ examined the financial materiality of five distinct gender-diversity factors with relatively good data coverage.

The research looked at how these factors affected U.S. and non-U.S. equity markets and assessed diversity impacts, controlling company size (capitalisation), country and sector.

Ms Chen notes: “Some studies we examined showed that a more gender-diverse executive team has a stronger impact on company performance than the gender of the CEO.^[1] Other studies linked diverse boards and executive teams to better risk management and, in some cases, improved performance results.^[2],[3],[4]

To assess these claims, we conducted three-year back tests on the materiality of five factors:

• Number of female board members
• Percentage of female board members
• Number of women in board leadership roles
• Number of women named executive officers (NEOs)
• TruValue circumstantial score related to diversity and inclusion news/issues^[5]

We found that gender-diversity factors show strong efficacy in equity returns for both U.S. and international markets. More specifically, for U.S. large-cap companies, the TruValue circumstantial score related to gender and inclusiveness news/issues was the major driver of superior equity performance. For U.S. small-cap companies and non-U.S. markets, board-level gender diversity was the driving performance factor.

Across all sectors, the average number of women in board leadership roles and women NEOs is less than one, which implies that most companies do not put any women in the three-to-five most important company roles. While women’s voices are starting to be heard on corporate boards, their opinions are not as influential in leadership teams.”

Other highlights include:

• For U.S. large-cap companies, female representation in executive leadership roles (i.e., NEOs) is as important as representation on the board
• From a sector perspective, energy is the laggard, with the lowest female representation on corporate boards and in executive leadership roles
• On the other side, utilities is the leading sector, with the most women on corporate boards and in leadership roles

“On the whole, our comprehensive, back tested research confirms the findings of prior studies citing the impact of gender diversity on corporate financial performance. The research showed that gender diversity can have a significant impact on equity returns. The circumstantial score related to gender and inclusiveness news/issues is one of the major drivers of equity performance for U.S. large-cap companies, while board-level gender diversity helped drive results for U.S. small-cap companies and non-U.S. markets,” notes Ms Chen.

———

[1]”Female CEOs on a Glass Cliff? A Look at Gender Diversity and Company Performance,” ISS Analytics, 10/26/18: https://www.issgovernance.com/library/female-ceos-on-a-glass-cliff/
[2] “The Bottom Line: Connecting Corporate Performance and Gender Diversity,” Catalyst, 2004: https://www.catalyst.org/system/files/The_Bottom_Line_Connecting_Corporate_Performance_and_Gender_Diversity.pdf.
[3] “Why Diversity Matters,” McKinsey & Company, January 2015: https://www.mckinsey.com/~/media/mckinsey/business functions/organization/our insights/why diversity matters/diversity matters.ashx
[4] “Delivering through Diversity,” McKinsey & Company, January 2018: https://www.mckinsey.com/~/media/mckinsey/business functions/organization/our insights/delivering through diversity/delivering-through-diversity_full-report.ashx
[5] The TruValue Insight Score is a measure of a company’s longer-term ESG track record, similar to a ratings system, designed to reflect the enduring performance record of a company over time. Scores are derived using an exponentially-weighted moving average of the ESG performance, and the half-life of an event’s influence on the Insight score is 6 months. The Insight Score is an aggregated result of relatively positive and negative news about one company, with 50 as neutral, above 50 as overall positive, and below 50 as overall negative.

The post Examining board gender diversity and equity market performance appeared first on AdviserVoice.