It was not too long ago that boardrooms were largely dominated by white men of advancing years, with personal networks used to source board candidates. Female board members were a rarity. The preference for candidates to have previous boardroom experience was a consistent barrier to entry for women. A catch-22 situation existed. Why did it take so long to realise that omitting 50% of the population from the board reduces the potential of a company? The answer is best left to social scientists rather than an asset manager. So why are we talking about it?
The fact is that from an investment perspective, we recognise that cognitive diversity leads to better decision making, and the best way to benefit from this fact is to have people on boards with diverse characteristics. More on this point later, but first let’s take a look at where we are and where we have come from.
UK taking the lead
The UK was among the first to recognize the benefits of cognitive diversity and led the way in attempting to address the gender imbalance. Initially, the government set up the five-year Davies Review (2011 to 2015) and, more recently, the Hampton-Alexander Review (2021). The latter called for women to comprise a third of boardroom representation within FTSE 350 companies. With the current FTSE Woman Leaders review the bar has been raised even further. As a result, the UK can point to some progress; most companies have a gender balance on their board. The recommendations are now to get more women into those most senior roles of Chair, Chief Executive and Finance Director.
At AAM, we have predominantly engaged with companies falling short of sufficient diversity. This has largely proved successful. However, we are increasingly taking voting action against directors at those companies where progress has been slow.
Of course, we recognise that gender is just one form of diversity, and our engagement activities increasingly focus on improving all forms of diversity. Over the past few years, the Parker Review in the UK has acknowledged the need for companies to improve the ethnic diversity of Boards. The first target encouraging FTSE 100 Boards to appoint at least one director from an ethnic minority background has largely been met – 89% at the end of 2021.
Other regions, such as Europe and the US, also have some good initiatives that tackle gender and racial representation. However, momentum in the Far East − particularly Japan − has lagged somewhat. Traditionally, boardrooms in Japan have been almost entirely male dominated. In recent years though, the government has introduced a voluntary directive encouraging companies to target 30% of management positions to be filled by women. This is now filtering through to the boardroom, as evidenced by many of our Japanese investee companies having recently appointed their first female directors.
Diversity brings opportunity
While all these reviews have good intentions, implementing their recommendations is sometimes difficult. One major obstacle is that there is often an insufficient pool of diverse talent in the pipeline – mostly because companies are fishing in the same pools of talent rather than thinking outside the box. This predicament can, in turn, lead to over-boarding of the most highly sought-after candidates. This is particularly apparent in the more traditionally male dominated sectors, such as engineering and mining.
Challenges aside, the journey of building a diverse Board is worth pursuing as mounting evidence shows it does improve a company’s performance, not only in terms of decision making but also through risk management and the ability to identify opportunities. It helps to drive change throughout organisations where employees, suppliers, customers, and the community can identify with the people leading these companies. These are important points for us as investors. A 2021 global research report from Bank of America, for example, indicated that a lack of diversity leads to less innovation, weaker revenue and cash flows, and lower employee retention. And a 2020 Citi Global Perspectives and Solutions report showed that if four key racial inequality gaps – wages, education, housing, and investment – were addressed 20 years ago, $16 trillion could have been added to the US economy.
In our opinion, there is no downside to improving diversity in the boardroom and we are pleased to see that good progress is being made, with many companies publicizing their commitments to diversity. We will continue to use our voting and engagement activities to push companies to be authentic in their diversity commitments and to encourage further change in the names we choose to invest in.