Diversity as a profitability moat
New research from Rosenberg Equities suggests that diversity can act like a protective moat, enabling some highly-profitable firms to withstand competitive forces. Kathryn McDonald, Head of Sustainable Investing, Rosenberg Equities speaks to Herschel Pant, Senior Consultant Relationship Manager about this compelling research.
HERSCHEL PANT: Following on from our ESG roundtable, where we discussed with our clients our research on diversity as a profitability moat, we met with Kathryn McDonald, Head of Sustainable Investing at Rosenberg Equities, to talk about this research. Kathryn, why did you do this research?
KATHRYN MCDONALD: We’re always interested in trying to make improvements in the way we invest. Rosenberg Equities is a quantitative equity management company. And so when we can find information that helps us at the margin improve the risk and return profile of our portfolios, importantly having that linked to company fundamentals and what we think are the drivers of risk and return in equity markets, we’re compelled to pursue that. And in the biggest picture terms possible ESG, we believe, helps make us better investors in that way. It helps us better capture fundamental characteristics that we want to capture in companies.
A key investment principle for us is earnings quality. Describing earnings quality or finding companies that are high quality today is one thing, but then actually being able to predict which companies are going to remain high quality tomorrow is a real challenge for us. And part of that is linked to the fact that it can be difficult to predict year ahead or forward profitability. So when we approached this research and when we were thinking about the relationship between diversity and governance that really is our motivation is how can we do a better job thinking about forward-looking quality and profitability concepts.
HERSCHEL PANT: And so what were the key conclusions from this research?
KATHRYN MCDONALD: The conclusions are very interesting. And what we found was that diversity, and in this case we’re using board diversity related to gender, diversity seems to provide a moat for companies. And specifically amongst the most profitable companies, we see those with the greater diversity being better able to hold on to their profitability going forward. This is very important for this part of the universe, because it’s the most profitable companies that are the most subject to competitive forces in the market. So this idea of diversity as a moat means to us that there’s something about diverse companies that allow them to be more resilient in the face of competition.
We really believe in this idea that diverse groups of problem solvers or people who are coming from different frameworks for problem solving are better in terms of decision making. There’s higher collective intelligence among diverse groups. And frankly we see that playing out in terms of these companies being able to keep more of that profitability that they’ve earned.
HERSCHEL PANT: And were there any challenges in this research?
KATHRYN MCDONALD: The challenges really are always data related for sure. So when we think about our description of diversity, I’ll be the first to say that gender diversity at the board level is a very incomplete picture of diversity. When we think of diversity as the remedy to group think, we really want to go above and beyond gender as the litmus test that we use for thinking about whether companies are diverse or not. But having said that the dataset that we found that was robust enough for us to work with, starting at about 2005, looked at board diversity amongst the largest US companies.
HERSCHEL PANT: So what’s next on the research agenda?
KATHRYN MCDONALD: Yeah, so next steps, I think we’ve touched on it a little bit here, is really to try and round out a more complete picture of diversity. How can we really capture what is best practices for decision making, both at the board level, or even amongst company management when it comes to giving access to different voices around the table that can really lead to the best creative and innovative thought. We think we need to go beyond diversity. We need to go beyond a board level view. How can we start to incorporate age or educational background, or even ethnicity where possible? But some of that’s difficult to get at.
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