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: Corporate diversity gives you an edge in stock investing — these six companies fit the bill

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To boost investment returns, look for companies with lots of diversity.

That’s the conclusion of yet another study confirming this investing tactic.

Below, you’ll  find six examples of companies that fit the bill. They come from the portfolios of three ESG (environmental, social and corporate governance) mutual fund managers who outperform their benchmarks.

But first, a look at the five key takeaways from a new Bank of America study that found diversity pays — for investors.

1. S&P 500
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companies with gender diversity on their boards see 15% higher return on equity (ROE).

2. ROE (return on equity) is 8% higher at companies with ethnic and racially diverse workforces.

3. Higher diversity means a lower risk for bad earnings surprises.

4. Companies with management and workforce gender diversity have 20% higher price-to-earnings multiples, and higher price-to-book values. Their cost of capital is lower.

5. Since 40% of global equity inflows now go to ESG investment funds, companies are more likely to attract capital if they have greater diversity, because this boosts their overall ESG ratings.

Those are the highlights of a Bank of America study called “Everybody counts! Diversity & inclusion primer” published in early March.

It’s not the first study to uncover those insights. A 2020 McKinsey study called “Diversity wins: How inclusion matters” found similar results. Saturna Capital, which has its own proprietary ESG ranking system, links board diversity to performance (and also higher ESG ratings).

To find out why this happens, I talked to some of the best-of-the-best thinkers in ESG. By this I mean portfolio managers who beat their Morningstar benchmarks and indices significantly over three years.

They offer three reasons.

1. Diversity stifles groupthink, so it brings better decisions. “When everybody is the same and thinking the same way, they consider fewer exogenous events,” says Scott Klimo, chief investment officer at Saturna Capital, who also helps manage the Saturna Sustainable Equity fund
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It outperforms its benchmark index and fund category over three years by around 3 percentage points, annualized, according to Morningstar.

2. Diversity brings broader experience and connections in new markets, and with different kinds of potential clients. This helps businesses grow, says Jake Walko, director of ESG investing & global investment stewardship at Thornburg Investment Management. Thornburg’s Better World International Fund
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beats its index and fund category by over 6 percentage points, annualized, over the past three years, according to Morningstar. Conversely, a lack of diversity can be a red flag, says Walko. “We think it is a very compelling signal that other problems might exist.”

3. Companies open to hiring women and minorities consider a broader talent pool. This gives them an advantage, says Sid Jha, who helps manage the Pax Global Environmental Markets Fund
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“There is no mandate that says white men have a monopoly on good ideas,” he says. His fund outperforms its Morningstar benchmark index and fund category by nearly 2 percentage points, annualized, over the past three years.

Diversity stocks

Given how many studies show that diversity helps performance, it’s surprising how slowly companies are moving in that direction. More than 75% of the Nasdaq’s
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roughly 3,200 companies do not have at least one woman and one under-represented minority or LGBTQ member on the board, says the Bank of America study.

To come up with short lists of business that do much better, Bank of America screened for companies where at least a third of board members and top management were women, and where at least 25% of board members were people of color.

Below are six companies that pass the Bank of America test — and are also holdings of one of the outperforming ESG fund managers I cite above.

First, a few guidelines that will help you in your hunt.

Consumer-facing industries have better diversity. Manufacturing and business-to-business companies tend to come up short. So do companies in the financial, tech and health-care sectors, according to Bank of America. Korean and Japanese companies have fewer females on boards, says Klimo, at Saturna Capital. And if you are analyzing data on Japanese and Indian companies, be warned that “diverse” simply means “foreign,” cautions Walko at Thornburg. Likewise, in Europe “diverse” can mean the person simply comes from another country.

Citigroup

At global bank Citigroup
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40% of board members are female, notes Bank of America. Not only that, the bank takes steps to improve diversity in management throughout the ranks — and disclose its progress. “We see that as a proxy for great management,” says Lei Wang, portfolio manager at Thornburg’s Better World International Fund, which owns the stock.

Given Citigroup’s high ESG ranking at Thornburg, it’s no surprise to me that this is the only bank I know that uses at-home rapid Covid-19 tests in collaboration with Harvard researcher Michael Mina. Being able to bring traders and other employees back to the office safely probably gives the bank an edge over competitors. Beyond that, Wang likes Citigroup’s emerging markets exposure in areas including consumer finance in Asia. Citigroup is also fairly cheap relative to other international banks.

Estée Lauder

Over half of the top managers at Estée Lauder
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are female and nearly half the board members are female. That might not seem surprising, given that this is a cosmetics company. But it’s not a given, cautions Klimo at the Saturna Sustainable Equity Fund, which owns Estée Lauder.

The Japanese cosmetics company Kao (KAOOY) doesn’t have a single woman on its board, which may be part of the reason why Estée Lauder outperforms, he says. Klimo likes the defensive nature of the cosmetics industry, and also the growth prospects for Estée Lauder in China. Though his fund holds the stock, he notes it is expensive at current levels.

Best Buy

At electronics and appliance retailer Best Buy
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half of the board is female, and people of color make up nearly a third. Under (female) CEO Corie Barry, Best Buy has done a great job of sprucing up stores, improving the customer experience and motivating the sales staff, says Klimo, whose fund owns the stock. Beyond diversity, Best Buy gets good grades in Saturna’s ESG model for environmental and social initiatives. The company is trying to increase its renewable energy consumption (lots of rooftop space for solar panels), and it pays associates better than minimum wage.

American Water Works

Half of the board members at utility American Water Works
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are women, and 38% of managers are female, says Bank of America. But the utility has a real commitment to diversity throughout the company, says Jha, whose Pax Global Environmental Markets Fund holds this name. That will come in handy since the sector has a big need for new workers because of its aging workforce. “They want to attract the broadest possible workforce to fill those needs,” says Jha. American Water Works has low earnings volatility compared to other utilities. It’s also reducing operating costs and investing the savings. This improves results since regulators link utility revenue to capital investment trends.

TJX

At popular retailer TJX
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over 40% of board members are women, and over half of top managers are female, according to Bank of America. It ranks well by other ESG measures, says Klimo. But it gets a demerit for sales of fast fashion apparel, a negative for the environment. He like the business for the strength of its buyers’ network, which consistently brings in apparel that sells well. This creates a treasure-hunt quality, which keeps customers coming back.

Tractor Supply

Rural retailer Tractor Supply
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which sells tools, clothing and supplies to recreational farmers and ranchers, pops up in Bank of America’s screen because a third of the board members are female. It’s also making a big push to improve gender and ethnic diversity throughout the company, says Klimo. A recent addition to Klimo’s Saturna Sustainable Equity fund, Tractor Supply did a good job of adjusting its business to the pandemic. Now it should benefit as the economy improves and people come out of hiding — trends that support reopening plays such as retailers.

Michael Brush is a columnist for MarketWatch. At the time of publication, he had no positions in any stocks mentioned in this column. Brush has suggested Citigroup in his stock newsletter, Brush Up on Stocks. Follow him on Twitter @mbrushstocks.

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