Anyone browsing the popular investment press recently would be forgiven for thinking that diversity has become the latest buzzword in the investment industry and that by demonstrating diversity, organisations may increase the probability of generating superior investment returns.
Copious volumes of research are regularly published supporting the assertion that financial benefits accrue to companies that value diversity in its many forms. McKinsey & Company has published analysis suggesting that ethnically diverse companies in the top quartile for diversity are 35 per cent more likely to outperform, and gender diverse companies are 15 per cent more likely to outperform.
Interest in understanding and measuring the benefits of diversity in a tangible way is growing quickly. According to a study published by the UK-based Criterion Institute, in 2015 only a quarter of investors placed importance on gender diversity, whereas in 2016, a total of 51 per cent of investors agreed.
The speed of change in this attitude is both surprising and welcome. Diversity has long been an important part of our manager research process, based on a belief that more diverse teams with shared values make better decisions.
Mercer’s approach to researching and rating investment managers and their strategies is underpinned by our assessment of four key factors, the most important of which is idea generation. In assessing this, we consider how effective a manager is in generating value-adding investment ideas, which is central to the ability to generate superior returns for investors.
This is an intentionally broad perspective which ranges across the entire spectrum of opportunities, including those in particular asset classes, countries, sectors or specific strategies.
In all cases though, a common thread we observe in assessing the quality of a firm’s investment outcomes is the need to assess the quality of the organisation and team that is implementing the investment process.
Of course a group of people who look different from one another are diverse in terms of identity. However, of greater importance for an investment process is cognitive diversity. Our research process is focused on identifying and avoiding the phenomenon of “groupthink”, which we regard as the natural enemy of good decision-making.
Groupthink is a phenomenon that occurs when the desire for group consensus overrides an individual’s underlying preference to present alternatives, critique a position, or express an unpopular opinion. In this situation, the desire for group cohesion effectively overrides good decision-making and creative problem solving.
Diversity as a characteristic of a team is only beneficial to the extent that it helps drive imaginative and creative solutions and reduces the likelihood of groupthink.
There are circumstances other than a perceived lack of diversity of a team that can foster a culture of groupthink. For this reason we are wary when we observe a team with a dominant group leader or a low level of challenge within the group, regardless of any surface-level diversity.
The operating environment for a team can also discourage positive decision-making.
For example, a team that is subjected to pressure from poor performance or from funds outflow or other business pressures may be more vulnerable to groupthink.
Mercer’s onsite meetings with management teams are central to our investigation of the existence of constructive challenge in decision-making. In meetings we investigate the way a team reaches its decisions and also how it manages the mistakes it has made.
In discussing an organisation’s resourcing, it is as insightful to explore a leader’s attitude to diversity. We are focused on uncovering the illusion of unanimity, where in reality team members are hesitant or reluctant to disagree.
The freedom to disagree with consensus views must be valued by the team and a discussion of how a team works through dissenting views is useful.
Having established a good track record, any team is at risk of becoming complacent, believing in its own wisdom at the expense of other ideas. To counter this effect, many successful teams adopt an approach that invites a devil’s advocate to question the logic of a widely-held belief.
Self-perpetuating cycle of homogeneity
The exploration of staff turnover and the reasons behind recent departures can be informative in understanding team dynamics and the value a team places on diversity. The need to fill vacancies can also shine a light on a manager’s attitude to diversity.
Often we are told that a team which does not appear to be diverse is so because individuals with different backgrounds or experience do not apply to fill positions in a team. This creates a self-perpetuating cycle of homogeneity which is unlikely to be beneficial to investors in the longer term.
An understanding of alignment and remuneration is also important in appraising the team’s approach to decision-making.
A team that is remunerated as a whole rather than as individuals contributing independently may react to challenge or debate differently and this can impact the way the team accepts and manages dissent.
Returning to the increasing publicity of the importance of diversity in organisations, it is very apparent that the most visible dimension of diversity being discussed in the investment market and in the media is that of gender diversity.
Studies highlighting and exploring the dramatic deficit of women in senior roles in the investment industry, and in portfolio management in particular, are raising many pertinent questions about the roadblocks to improving gender diversity and how these may be dismantled.
Many of these questions are the same ones we ask managers during our review process. However, the recent sharpening of the focus on gender diversity is only one aspect of the diversity narrative that we explore in our interactions with teams of investment managers.
We believe that successful investment teams can come in many shapes and sizes. But we firmly believe that, other things being equal, a diverse team with shared values is more likely to outperform their less-diverse peers.
Clare Armstrong is a principal at Mercer.