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ESG Matters (Part 1): Diversity Measures

Why the focus on more women in the sector is imperative to the industry’s success.

Art by David Plunkert

On a sunny day in April, execs took their seats on a moss-covered stage at the penthouse of the Parker New York hotel. Outside the room, “ESG” was displayed in large, white letters, embedded into a wall of ivy — the befitting setting for the forum “Why ESG Matters,” held during the S&P ESG Ratings launch on April 11. After much debate about risk factors and the tipping points of standards measuring environmental, social and governance (ESG) data, gender, as it often does, became a starting point for a discussion about board diversity.

“First of all, our board is 50% women,” said Susan Story, president and CEO of American Water Works, a company where ESG is brought up “during every earnings call.”
The audience applauded.

“So’s ours,” a fellow panelist chirped.

But as a female CEO with a board full of women, Story is still a deep minority.
Although the number of women and people of color on boards is rising, research shows it’ll be decades before it reaches gender parity. Studying the split of directorships in the Russell 3000, since 2012, the number of men of color has inched up from 6.7% to 7.8% in 2018. Women of color have ticked up from 1.5% to 2.6%. The total number of women has made the most strides, from 11.5% to 18.4%, according to data from Institutional Shareholder Services Inc. (ISS), CIO’s parent company. In 2018, there were 2,563 Caucasian men chairing boards of directors; 112 Caucasian women; 190 men of color; and eight women of color, 

“In Europe, the regulators are requiring companies to report on various [ESG] factors in their portfolio, which is again, forcing the investment departments to take this into consideration,” said Matt Armas, global head of Fixed Income Portfolio Management (Insurance) for Goldman Sachs Asset Management. The factors for ESG valuation of assets are still being considered, but may be released over the summer. They’ll require a companies such as GSAM to come up with their own framework.

Managing Director Mike Siegel noted, “A lot of it is: ‘What’s the easiest to measure.’” Environmental will likely use carbon metrics, and the social will likely be the most difficult to measure. On the governance side, it’s the percentage of outside directors, and the number of women directors that will indicate diversity of thought. 

Of 102 investor organizations surveyed by ISS’ Governance Principles Survey, 45% believe that a lack of at least one woman on the board may show a fault in the recruiting process. To address the issue, investors preferred a soft method, such as engagement, to hard actions, such as withholding vote support from particular directors.

The sticking point seems to be finding the data, according to a recent survey by Allianz Life. “63% are interested in learning about the number of women on the board of directors, and the number of minorities on the board of directors before investing in a company, but 33% say they feel that information would be difficult to find,” according to Allianz. The percentage hikes to 76% for those finding ESG factors difficult to research.

The Sustainability Accounting Standards Board (SASB) Foundation, working to chisel a richer set of standards to incentivize firms, says the area that may need the most work is “certainly diversity, certainly in inclusion, the whole space of human capital,” CEO Madelyn Antoncic, Ph.D., told CIO. “Diversity is so important to have different perspectives, different views, and there’s so much evidence. For example, when it comes to women on boards and women in senior management, there’s a lot of evidence that shows these are better-run firms because they have different perspectives.”

With data linking board diversity to better returns, it’s institutional investors who are making the difference.

“The investor groups are the ones that are going to the corporations and saying, ‘We want you to report.’ They want to see what corporations are doing,” Antoncic said. “At the end of the day, an investor can be able to get his arms around what the corporations are doing and then they step up and they say, “OK, I am going to invest in the best users of my capital.” And so if a corporation is not sustainable, then an investor is not going to want to put his money there.”

In fact, the most improvements have been made in the past 18 months to the S&P 500, where 6.2% of new directors were women of color, and 11% are men of color, according to ISS.

Moving the Needle

When it comes to the some of the largest pension funds in the US, California’s Proposition 209, which declares it illegal to grant a preference to any individual or group on the basis of race, sex, color, ethnicity, or national origin, can make it tricky. It means the California Public Employees Retirement System (CalPERS) and the California State Teachers’ Retirement System (CalSTRS) are not allowed to give women-owned, minority firms preference over white male-owned firms when it comes to emerging manager programs. But it does not affect their corporate engagement efforts of corporate diversity, which allows them to ask for more diversity from their management teams.

And so CalSTRS Chief Investment Officer Chris Ailman, fully cognizant he’s representing teachers’ investments, (and teachers skew overwhelmingly female), was one of the first CIOs to pound the table against “stale, pale, and male” money managers and group think, often closely inspecting teams for women and diversity.

Ailman’s thinking has been proven by McKinsey & Co. researchers, who note “companies in the top quartile for racial and ethnic diversity are 35 percent more likely to have financial returns above their respective national industry medians” and “companies in the top quartile for gender diversity are 15 percent more likely to have financial returns above their respective national industry medians.”

State Street has been presenting the issue for years and gained national attention with its Fearless Girl statue facing down the Bull on Wall Street in New York (where someone has since given her a cape). And identical twin statues now appears in the London Financial District. “If women were working at their full capacity it would actually increase GDP in every market that they looked at,” Lynn Blake, executive vice president of State Street Global Advisors (SSGA) and CIO of Global Equity Beta Solutions, told CIO.

Of the 1,265 companies in the US, UK, Australia and Japan targeted by State Street’s gender diversity project, 35% have added women to their boards. The key to making the changes was State Street’s size.

“We are a very large asset manager. Our vote matters,” said Blake. “If they didn’t add a woman to the board, we would vote against the chairperson of the nominating governance committee. Starting next year, we’ll actually vote against the entire nominating committee, which would be a large subset of the board.” Technology and energy sectors have been the biggest challenge and continue to lag relative to other industries.

#MeToo Accountability

Reflective of just about every corner of the financial industry, private equity is dominated by white males. Yet general partners (GPs) have been adding chief diversity officers, and creating programs to recruit more diverse employees, according to Emily Mendell, managing director of the Institutional Limited Partners Association (ILPA), a global trade association for some 4,500 institutional limited partners in the private equity asset class. “That being said, if you’re a smaller organization you may feel like you have some trouble keeping up, but I think there are ways for smaller organizations to make meaningful strides as well,” she said. “Limited partners have a fair amount of power.”

When the #MeToo movement hit Silicon Valley, and the media focused its lens on the poorly behaving venture capitalists (VCs) and GPs, causing firms such as Binary Capital to shut down funds due to sexual harassment, ILPA realized limited partners (LPs) may face their own headline risk if they don’t check bad behavior or work to improve diversity inclusion. ILPA updated its due diligence guidelines to include questions for GPs about diversity and inclusion (D&I), family leave policies, whether firms track promotions and departures of women and minorities (and what the numbers bear out), and added a template that asked the GPs to give the breakdown of their firms by gender, race, and level or position. It also created a code of conduct in relation to diversity, harassment, discrimination, and workplace violence.

The goal is for LPs to be positive, not punitive, and encourage GPs:  “You’re not going to be penalized for not having the numbers today, but we want you to start to measure them, and we want you to start to implement policies that are going to promote D&I,” said Mendell.

Mercy’s Team 

Nine months ago, Mercy Health System created an ESG questionnaire used for manager due diligence across all asset classes. One of the components of this checklist asks for information regarding the diversity of the firm, including senior leadership representation, as well as the quality of personal development and feedback for all employees (including minorities). These questions are among many Mercy asks about the firm’s organization and culture, to help Mercy understand whether or not the firm is the type of partner that would align well with Mercy’s values. Additionally, Mercy asks about how ESG (including diversity) is considered in the investment process, especially focusing on governance (which includes diversity on corporate boards and within management teams).  

“Many academic studies—I won’t quote them all—have shown that diversity of thought leads to better outcomes, and we want the best outcomes we can achieve on behalf of Mercy,” said Deputy CIO Elizabeth Jourdan. Although it’s hard to quantitatively link Mercy’s $2.8 billion fund (that beat its benchmarks on an absolute and risk-adjusted basis in FY18) to the new diversity paradigm, Jourdan believes the positive performance has much to do with its manager selection. 

 “We’re being very thoughtful around the kind of partners we want to work with,” said Jourdan. “First and foremost, investment returns are our top concern. Our ESG questionnaire is just one input of many we use to select our partners; and all else being equal, those who reflect our values and score highly on our ESG questionnaire will rise to the top of the list.”

Mercy’s internal due diligence team of three is actually all female, with one from Taiwan and another from Albania, and the entire investment team is 50% female. Responsible for investigating managers across all asset classes, Jourdan believes it works: Mercy’s team culture is very inclusive, and team members feel empowered to make investment recommendations, instilled by the leadership of CIO Tony Waskiewicz.

Part 2: Feeding the Diverse Pipeline.

Related Stories:

CalPERS Puts ‘Laser-Like Focus’ on ESG, Board Diversity, and Executive Pay

At Pension Bridge: How Susan Oh Is Raising Diversity Awareness for Female Investors

Asset Managers Weigh How to Boost Women on Company Boards