Gender and Ethnic Diversity Make Impact Investing Profitable

Impact investing is hot and only getting hotter. From reducing the carbon footprint of your portfolio to fostering women’s empowerment through gender diversity ETFs, investors are using their investment dollars to impact social and environmental change.

While the moral argument for impact investing is obvious, it turns out investing in companies with diverse boards of governance and leadership teams is also good financial sense.

Impact investing is profitable investing. More diverse companies perform better, according to findings by global management consulting firm McKinsey & Co. They found that companies ranked in the top-quartile for the gender diversity of their executive teams were 21 percent more likely to have above-average profitability than those in the bottom quartile. What’s more, companies in the bottom quartile for diversity are 29 percent more likely to underperform their peers on profitability.

And it goes beyond gender diversity: McKinsey found that ethnic diversity can have an even greater impact on company performance than gender diversity. Companies in the top quartile for ethnic and cultural diversity were 33 percent more likely to outperform their industry peers.

This makes economic sense: Board members from different industry skill sets and backgrounds can bring a holistic, objective perspective to the long-term strategy of the company, says Christopher Greenwald, head of sustainable and impact investing research and stewardship at UBS Asset Management in Zurich, Switzerland.

[Read: 10 of the Best-Managed Public Companies.]

Interestingly, there seems to be a stronger correlation between financial performance and greater female representation at the leadership level than board level, says London-based Valeria Piani, a director and stewardship analyst on the sustainable and impact investing team at UBS Asset Management. This may be because the leadership team has greater influence over operations than the board of directors. It also implies that more important than just having women represented in the board of directors, is that companies “create a pipeline to get them there,” Piani says.

From a business perspective, this, too, makes sense: Companies invest a lot of resources into new hires. For that employee to leave prematurely — say to raise children — and not return is a huge loss to a company’s human capital investment.

“Companies that are able to attract and retain talent are going to be more successful financially over the long term,” Greenwald says. And those “with policies to support women throughout their careers tend to be better at managing their human capital and attracting the best employees.”

How to invest in corporate diversity. The proof is in the profitability: Diverse companies are profitable companies. The question is, how is an investor to take advantage of this?

Adding corporate diversity ETFs to your portfolio is the easiest way. Some options include:

— Impact Shares’ NAACP Minority Empowerment ETF (ticker: NACP) or YWCA Women’s Empowerment ETF (WOMN)

— Pax Ellevate Global Women’s Leadership Fund (PXWEX)

— SPDR SSGA Gender Diversity ETF (SHE)

Or you could go even more hands-off by letting a robo advisor like Ellevest or Swell build an entire impact investing portfolio for you.

[See: The Best Robo Advisor for Different Types of Investors.]

If you’re inclined toward DIY portfolio construction, however, you’ll be facing a bit of an uphill climb. Only recently have companies begun to disclose data about the diversity of their boards and executive teams. And as of yet there are no standards of measurement or disclosure. In the absence of numerical data, investors have to turn to qualitative measures to gauge a company’s diversity.

The best tool investors have is the biographies of the board and executive team members on company websites, Piani says.

Greenwald advises linking the executives’ backgrounds to the overall business strategy. For instance, if the company has significant operations in Africa, you’d want to see someone on the board with a connection to Africa.

Likewise, “you want board members or leadership executives who understand the company’s consumers,” Piani adds. If 80 percent of the company’s consumers are Latina, there should be Latina women at the top levels.

To identify companies for their minority empowerment fund, Impact Shares screens companies for board diversity as well as specific policies that should foster diversity in the workplace, such as discrimination, sexual harassment and freedom of association policies, says Ethan Powell, chief executive officer and founder of Impact Shares.

Other company policies to look for may be unconscious bias training, equal compensation, and those encouraging work-life balance, such as parental leave for both men and women. And since diversity is important from the ground up, a company’s recruitment policies play a key role in its overall gender and ethnic diversity. Piani suggests looking at how they recruit and from where. Do they have a strong mentorship program to foster employee engagement and retention?

Compare companies within industries and geographies. Simply investing in gender and ethnically diverse companies does not equate to a diversified portfolio.

While there’s often an inclination with impact investing to build a portfolio of only the best of the best, this can lead to over- or underconcentration. For instance, the tech sector is notorious for having a low representation of women.

Similarly, Australia, U.K., and U.S. companies account for more than 70 percent of the top-quartile companies on gender diversity in McKinsey’s study while South African and Singaporean companies had the highest representation among the most ethnically diverse companies.

[See: 8 Global ESG Funds to Diversify Your Sustainable Portfolio.]

Rather than using companies’ nominal scores for comparison, look for the highest scoring companies within their respective peer groups, Powell says. This way you’re more likely to have an impact portfolio that’s diversified inside and out.

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