Racial diversity essential to securing the best staff and highest profitability

The disproportionate health and economic impact of the Covid-19 pandemic on people of colour, and the widespread Black Lives Matter (BLM) protests against systemic racism and police brutality have dramatically increased people’s awareness of racial discrimination across a multitude of fields and industries, fuelling investors’ desire to address racial and social equity.

There is not just an ethical or moral reason to view investments through a racial lens, but a real economic reason too. A recent study from McKinsey shows that firms in top quartiles for gender and racial/ethnic diversity are more likely to generate above-average financial returns. In 2019, companies that led on racial diversity outperformed those least diverse by 36 per cent in terms of profitability.

Yet, in the US, only one per cent of Fortune 500 CEOs are black, although African-Americans represent more than 13 per cent of the US population. In the UK, only nine CEOs of the FTSE 250 are from an ethnic minority, despite ethnic minorities representing 13 per cent of the population. Some 60 per cent of the UK public listed companies do not have any ethnic minorities on their boards.

“Diversity is one of the key factors that influence returns,” states Shaunak Mazumder, global equities portfolio manager at Legal & General Investment Management in the UK. “A diverse workforce allows you to have different perspectives, to bring more innovation, challenging the status quo, which is beneficial in a longer-term business." Ethnic minorities in the workplace allow firms to broaden their horizons, to think about different cultures and aspects of the business, which is crucial for companies looking to expand internationally.

Diversity makes a firm more sustainable, which improves its stock price and shareholder returns. But while corporates have made progress on disclosing gender diversity information, there is still very little data available on ethnic diversity.

Shareholder engagement is particularly effective in this space. “We are looking for companies we can engage with, and we are assessing them on targets to increase diversity, pushing them to start disclosing on these metrics,” says Mr Mazumder.

The BLM campaign and increased awareness of the ethnicity pay gap has pushed many corporates, including Facebook, Alphabet and Microsoft, to commit to increasing the number of people of colour they employ in leadership positions, as well as increasing diversity targets in their workforce.

While, in the not-too-distant future, companies will start reporting on ethnic diversity, the next more challenging step will be getting them to disclose their ethnicity pay gap. This will increase awareness of differences in salaries and positions held by ethnic minorities. In the UK, where gender pay gap regulation came into force three years ago, “there is still a lot of room to go.”

Yet, there is no data that shows the explicit linkage between diversity and performance, which makes it difficult to promote racial diversity as a concept that companies must embrace, points out George King, senior wealth manager at London-based Maseco Private Wealth and former head of portfolio strategy at RBC Wealth Management.

“There is strong correlation between having diversity policies in place and better performance in firms. But it is hard to make the next step and say there is causality between the two,” argues Mr King.

Firms that have introduced diversity policies may have also taken other enlightened measures, such as flexible working, transparency of reviews and generous parental leave, all of which contribute to employee retention and higher profitability.

“The biggest problem” is that too many people think that if diversity cannot be proved to generate higher profitability, then companies are not going to bother promoting it. “The starting point should be that a diverse group of people certainly has no negative impact, and that diversity is only additive,” Mr King says. People are not even aware of all the potential implications of diversity in attracting clients or revenues.    

Another wrong belief is that proactively embracing diversity means hiring a “mediocre” black person or woman instead of a “high quality” white man. “While the large majority of white people sitting in their seats are also just OK”, white senior managers should realise that they are not going to find this “amazing black person” just waiting behind their desk – they need to go and look for the best candidate and create the conditions to encourage people of colour to join the company.

Generally speaking, black people are not going to be interested in, or comfortable with, joining white-dominated industry sectors, such as asset management, where promotions seem out of their reach.

It is important to promote diversity at all levels. “What is going to increase your ability to attract superstar women or non-white people is that you have more than just one token, exceptional diverse person.”

Could racial quotas perhaps be the solution? Or is there the risk of producing unintended consequences, such as discriminating against white men?

“I have always found this topic to be immensely frustrating, because let’s say a white male is being discriminated against. The next thing you would say is ‘join the club’,” argues Mr King. Non-white people have been discriminated against massively for a long time.

However, the risk is that such policies have little impact. “Changing policy without changing hearts and minds doesn’t really have an effect.”

‘He is a good cultural fit’, is the most frequent tagline that senior white people use when hiring. “What that means is that 'he looks like me, he acts like me, he sounds like me and he has my same background.' While diversity is more than race or gender, the starting point must be to proactively seek someone who does not just look like you,” says Mr King.

Exerting pressure

The BLM movement is likely to provide “an incremental shove” for consumers of investment products towards sustainable products. Increased interest may put pressure on companies to provide racial diversity data, believes Mr King, envisioning the creation of an international organisation which could demand companies provide more data in this area. “Once you have the data, you can really exert pressure and drive change,” he adds.

Interest in racial diversity may be reaching a tipping point, just like the concept of stranded assets and carbon footprint has escalated enormously in the past few years, despite existing for decades. “Change happens slowly until that suddenly happens often in a watershed.”

Indeed, since the brutal killing of African-American George Floyd by a white police officer in the US, the volume of conversations on diversity and racial justice has increased over time in trend line, from a normal level of five per cent or less of total data to 15 per cent per week, reports Eliot Caroom, manager, ESG research and products at Truvalue Labs. The San Francisco-based firm applies AI to analyse unstructured data from a variety of sources, capturing “real-time perspectives” from a variety of stakeholders, rather than just limiting the ESG analysis to what companies report quarterly or yearly, which is both scarce and inevitably biased.

“We have seen a big spike in racial justice data, which is a financially material category for many companies and industries.”

Racial diversity in companies is not just a moral or ethical issue, but is about assessing risk and opportunity for the business. “If your brand is not diverse, you make decisions institutionally that are racist, even if they are unintentionally so. When your brand becomes known as racist or sexist, and you are called out by the public, the risk is reputation damage.”

For instance, despite some recent progress, beauty brands have historically enabled a constant erasure of people of colour, and the industry is now being urged by the BLM movement to disclose the diversity of their leaderships, as “the choices they make can perpetuate racism or help address it.”

On the opportunity side, there is clear evidence of racial discrimination in hiring processes. Research shows that CVs from people of colour are ignored at disproportionate rates, with racial discrimination in the hiring process ranging from unconsciously discarding a CV that has a name associated with a certain ethnicity, to having negative biases linked with someone’s skin colour during the interview process.

Academic research from Harvard Business School, Stanford University and the University of Toronto Mississauga, found that businesses are more than twice as likely to call minority applicants for interviews if they submit “whitened” resumes, scrubbed of racial clues, than candidates who reveal their race.

Best practices, such as blind hiring practices, would prevent any biases, allowing businesses to hire a more talented workforce which is able to offer a variety of perspectives on problems, and consider the needs of a wider range of customers.

“Diversity is a tremendously important ESG factor. Embracing hiring practices that are known to improve diversity makes the world a better place and improves company performance by getting the most talented candidate, regardless of their skin colour. There is an opportunity cost in not fixing unconscious bias in hiring processes,” explains Mr Caroom.

While there is a lack of data with regards to racial diversity and outcomes achieved, it is possible to get a window into companies’ performance and seriousness via other indicators, says Sonia Kowal, president at Zevin Asset Management, a Boston-based boutique investment management firm specialised in socially responsible investing.

“If the company is a large employer, does it have a well-developed policy and set of systems for recruiting and considering diverse candidates? Does the company study and have an awareness of the impacts that its products and services have on black communities? As investors, we try to assess how these qualities translate into unaddressed risk or potential opportunity,” says Ms Kowal.

Network problem

Given the deep racial problems in the US criminal justice system, screening out unacceptable companies, such as those with a history of exploiting communities of colour, or firms with substantial involvement in incarceration and detention, is just one part of socially responsible investing.

It is essential to address racial injustice through shareholder advocacy, pressing companies to make changes that improve risk management and create a positive social impact. This means supporting proposals that ask firms to improve workforce diversity, while voting against a board slate sends a strong message to firms, and it can also propel a dialogue about diversity and inclusion.

Diversity is positively associated with more customers, increased sales revenue and greater relative profits, according to a 2013 Catalyst report. This message is critical in the tech sector. A study commissioned by Intel estimated that the tech sector could generate $300bn to $370bn in additional annual revenue if the racial/ethnic diversity of tech companies’ workforces reflected that of the talent pool.

Rather than a pipeline problem, it is more a lack of diversity within firms’ own networks that is holding back recruitment. Big tech companies, such as Apple, Amazon and Google, have been doing “a terrible job” at improving their networks, and empowering, retaining and promoting people of colour. This becomes a “huge business risk” for them, because they have never represented their customer base – a situation which gets worse over time, says Ms Cowal, whose firm has done substantial impact investing in the sector.

Although white Americans currently make up approximately 60 per cent of the US population, according to the US Census Bureau, projections from the Brookings Institution show that, by 2045, white people will no longer make up the majority.

“The only thing we have found that improves diversity is when executives are incentivised around hiring, retention and promotion. I think that’s really important and we are starting to get some fashion there,” adds Ms Cowal, explaining that Zevin has filed shareholders proposals at Apple, Alphabet and Amazon over the years to meet their business need of finding new talent, and put measures in place to tie executive compensation to goals around diversity.

But it is not just asset managers that must take responsibility for racial justice – individual investors should also be made accountable. “Race-neutral does not exist,” says Ms Kowal. “Either as an investor you are being an active racist or you are not.”