Practical analysis for investment professionals
09 March 2015

Diversification of a Different Kind

On 18–19 September, CFA Institute will host Alpha and Gender Diversity 2017 in Toronto, the latest in its series of Women in Investment Management events. Attendees will have opportunities to discuss gender diversity, foster professional development, and meet their peers from other regions in North America.

Several studies show a positive correlation between diversity and better decision making in companies as well as between women’s empowerment and financial performance. They have also linked women CFOs with more conservative reporting. These findings have led to the creation of gender-lens indices, funds, and exchange-traded notes (ETNs), enabling institutions and individuals to align their investment strategy with their values.

Certain sectors typically have more women in management. On average, the companies in the MSCI World Index have 12% women in management and on their boards. Consumer discretionary has 13%, and both health care and utilities have 14%. But only 10% of the managers in the MSCI World IT companies are women, and the materials and industrials sectors are also relatively weak in the area of women’s leadership.

The managers of the PAX Ellevate Global Women’s Index Fund used the constituents of the MSCI World Index as the starting point to create a gender-lens portfolio. They developed a process to select about 400 companies with the top gender scores in that universe, although the actual number of companies in the portfolio fluctuates throughout the year because of corporate actions.

The constituent companies are selected based on the percentage of women on the board and in executive management positions. The portfolio managers consider whether the company has endorsed the Women’s Empowerment Principles (a joint initiative of the UN Global Compact and UN Women). Finally, they screen companies based on the treatment of women throughout the organization.

With nearly $70 million in assets under management, the fund is benchmarked against the PAX Ellevate Global Women’s Leadership Index. The index is weighted based on the market capitalization of the components. The fund replicates the index, but more weight is placed on the gender alpha score. For example, companies get extra credit for having three women board members.

“From March through the end of November 2014, our index outperformed the MSCI World Index by 110 basis points or 1.1%,” says Julie Gorte, senior vice president of sustainable investing and portfolio manager at PAX Ellevate Global Women’s Index Fund. “You need to take that with the appropriate caution because anything can outperform for eight months, but it’s encouraging.”

Also noteworthy is that the index was not constructed to have a specific risk profile. But selecting the top 400 companies in terms of their gender score formed an index with superior risk performance. Compared with the MSCI World Index, it has a lower beta and a higher dividend payout ratio.

The Matterhorn Group at Morgan Stanley was approached by clients who wanted to invest in accordance with their values. Among the market research, a study by workplace research firm Catalyst stood out. It found that companies with three or more women on their boards had a 46% better return on equity, a 60% better return on invested capital, and an 84% better return on sales.

“We know it’s not a causal relationship,” says Eve Ellis, a portfolio manager at the Parity Portfolio Strategy. “However, neither are any of the financial metrics like consistent profitability or earnings per share.”

Matterhorn Group leveraged this information to create the Parity Portfolio Strategy, which is designed to make money for investors while having a social impact. The fund first screens for US-headquartered companies in the Russell 3000 that have at least three women on their boards. Next, the portfolio managers do a fundamental analysis on the investible universe, which has grown in the past two years from about 250 companies to about 280 companies.

“We’re bottom-up focused although top-down aware,” says Ellis. “In our quantitative analysis, we look at whether a company has free cash flow, how much it has, and what it is doing with it. We also look at profitability and valuation.”

Then, the portfolio managers do a qualitative analysis focusing on the business model, adaptability, management strength, and capacity for innovation or leadership. Finally, they use a risk-focused approach to construct the portfolio and allocate assets.

The portfolio managers look for value, and they have a buy-and-hold mentality. The portfolio is concentrated. At any given time, it has 20 to 30 names in it, and there is little turnover. It is also well diversified, although it currently has no energy companies. It has almost 15% in consumer discretionary and nearly 6% in consumer staples. More than 25% of the assets are allocated in financials, including a large bank, a small community bank, and two REITs.

The strategy is defensive, and the objective is to outperform in bear markets. Ellis notes that there has not been a bear market since the portfolio’s inception, but on down days, it has done particularly well. It is built to have a beta of between 0.8 and 0.9, and the beta has been at 0.85. It was also designed to have less exposure to risk, so the standard deviation is lower than the standard deviation of the market.

“We don’t discuss AUM or specific performance, but I can say we’re pleased with our results,” she says. “We’re doing what we set out to do. Now that we have a two-year track record, we can start talking to larger institutional investors because they care about this issue too.”

Barclays Women in Leadership Total Return USD Index and ETN look at the universe of US-headquartered NASDAQ and NYSE listed companies. First, there is a low-level hurdle for liquidity and market capitalization: micro-cap companies are excluded. Next, the companies are screened and ranked according to certain gender criteria. Companies that have women CEOs rank above those that do not. The companies are ranked by the highest to lowest percentage of women on boards, with a floor at 25%. A company with a woman CEO and 30% women on its board ranks above a company with a woman CEO and 10% women on its board. They both rank above a company with a male CEO and 30% women on the board, and a company with a male CEO with 10% women on the board is not eligible. After ranking all the companies, Barclays picks the top 10 ranked companies in each of the 10 stock market sectors for inclusion in the index.

“In theory, we would have 100 companies in the index,” says Sue Meirs, a director in Structured Products at Barclays. “In reality, we have 83 companies in the index because several of the sectors don’t have 10 companies that meet the criteria of having a female CEO or at least 25% women on their board.”

The index is rebalanced quarterly and market capitalization weighted once the companies are selected. Moreover, the exposure to any one company is limited to 5%.

Typically, the index contains 10 companies from the consumer discretionary sector. The index may have two or three companies from the energy and telecom sectors, depending on the quarter. Currently, six companies are in the materials sector.

Meirs points out that the same type of philosophy, strategy, and methodology can be extended to other groups within the diversity spectrum as long as it is possible to collect the data. In September 2014, Barclays launched the Return on Disability Index and ETN based on the premise that companies that employ and serve people with disabilities will be more profitable.

“Investors are always looking for superior management,” adds Gorte. “It’s logical that when companies avoid groupthink, put more options on the table, and look at them more carefully, they do a better job over the long term. What struck me is how quickly that thesis proved out in investment.”

The preceding article originally appeared in the March/April 2015 edition of CFA Institute Magazine

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

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About the Author(s)
Sherree DeCovny

Sherree DeCovny is a principal of Sententia Partners, which produces thought leadership content for clients in finance, technology, supply chain, logistics, and international trade. She is a research principal of Chain Business Insights, which provides research, analysis and business intelligence on blockchain technology in supply chain management and trade finance. DeCovny has written for leading journals and authored several books and reports in her field.

2 thoughts on “Diversification of a Different Kind”

  1. Melissa says:

    Interesting. It makes sense that having more diverse Boards would have better results in the long-run. I think that plays to “two heads are better than one.” If everyone has the same back ground, it would be less likely to have variation in approaches. That is a negative in strategic decision-making.

  2. I just listened to James Brown’s ” Its a Man’s World” , so this piece is acutely timely. The conclusions are not surprising in the least, and I am immediately led to observations of nature where one cannot exist without the other and where balance is the equation of efficiency and good process.

    My female finance students will dig the research as well! Thank you for sharing.

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