Viewpoint: Can we use gender diversity to generate greater investment returns?

As systematic equity investors, we wanted to use extensive data sets to determine whether gender diversity at the management level – not just at board level – would enhance corporate decision-making. This would in effect test the ‘Upper Echelon’ theory that diversity in top management teams matters.

We also wanted to understand whether better decisions resulted in demonstrably stronger company performance and whether we could identify these more profitable companies. If we could, was this information not yet reflected in market valuations, and therefore exploitable? We could use these answers to better inform our investment decisions, so we carried out our own study to find definitive answers.

It was striking that past research had only looked at the effect of gender diversity within boardrooms – possibly a reflection of the lack of data availability for female representation in management teams.

We thought it likely that gender diversity in top management teams would have at least as great an impact on decision making as it does at board level, by encouraging a broader range of views and opinions, and discouraging ‘groupthink’. To test this theory, we developed a comprehensive data set that included both board and senior management appointments in multiple markets, and which tracked these factors over more than a decade.

How gender diversity has evolved regionally and over time

Joanna Nash and Ron Guido, senior quantitative portfolio managers who carried out the research, saw some clear trends in the board level data. In developed markets, with the exception of Japan, around 30% of company boards are women. In Japan, the equivalent figure has reached around 10%. Emerging market countries started at around 10%, but improvement has been slow, and hovers near 15%.

Faster progress has typically been made by implementing disclosure requirements or legislation. Quotas, especially those that are legally required, are the most effective, while disclosures or targets help, but much more slowly. Even though quotas, targets and disclosures exist in various countries, women still only make up less than a quarter of boards globally.

Since gender diversity beyond the boardroom also matters, Nash and Guido also explored whether similar trends were evident at a senior management level. They found quotas and mandated disclosures for C-suite roles (such as chief executive officer, chief financial officer and chief operating officer) have not been mandated in most countries, and it was borne out that the rate of change in gender diversity has also been extremely slow.

Globally, by the end of 2021, women comprised less than 20% of company management teams, although there were significant regional differences – the spread between the most and least diverse regions was almost 30%.

Does senior-level gender diversity improve company results?

While our analysis showed an improvement over time, we also wanted to gain insight as to whether leadership diversity would lead to better performance, and ultimately to higher profitability.

The team examined the correlation between senior female representation and the quantitative company characteristics we normally assess, such as return on assets, return on equity and profit margins.

They found that gender diversity was positively correlated with these factors, and that these higher-quality firms also tended to have higher price returns and lower market volatility over the previous 12 months.

Could we also use these metrics to identify those companies that should have higher profits in future? By analysing profitability metrics of a cross-section of more than 2,500 large companies in 30 countries over more than a decade, Nash and Guido investigated whether gender diversity and future profits were linked.

The data indicated that firms with high C-suite and board diversity had gross profit margins 20% higher in the following 12 months than those with low diversity. It also showed that cumulative future return on equity for companies with higher rankings for senior management diversity was 30% more, and 20% higher for more diverse boards.

According to Nash and Guido: “When it comes to the link between gender balance, company performance and investment returns, the data is compelling: more gender diverse leadership teams generate better results.”

Has the broader market noticed?

Further analysis determined that the market had generally not priced in expectations for higher valuations in firms with greater C-suite diversity, although it had recognised it in companies with high-diversity board rankings. It could be that greater visibility and regulation of board (as opposed to management) composition has fostered an expectation that good firms include women on their boards, which is then reflected in market prices.

This research has highlighted that a higher proportion of women, both on boards and in senior management teams, makes a tangible difference to company profitability.

While we would expect senior management diversity to matter more, the proportion of women in the C-suite remains relatively low, so their impact is harder to measure. We believe that being able to identify companies with more women on their senior management teams offers the greater potential to generate alpha in our portfolios.

As Nash and Guido have neatly summed up in the report on their findings: “The conclusion we draw from this is that investors who can identify and invest in companies with higher female representation in the C-suite may not just support social equity – they may boost their investment returns as well.”

_{Sources: All data and comments are sourced from the Realindex research Beyond lip service: tracking the impact of the gender diversity gap, by Joanna Nash and Ron Guido. Data in the report covers the period 1 January 2009 – 31 December 2021, unless otherwise stated.}

David Walsh is head of investment at Realindex, the systematic equities investment team at First Sentier Investors