Is ESG the True Fiduciary Path Forward? ~401(k) Specialist Magazine

Long-term capital preservation and appreciation: why investing in diverse teams creating innovative products is the best exercise of fiduciary duty

Originally published by 401(k) Specialist Magazine
Authored by Betsy Moszeter

If the primary objective of fiduciary duty standards is to act in the best interests of plan participants, then a fiduciary’s duty is to do whatever is required to preserve participants’ capital and purchasing power into the future. The best exercise of fiduciary duty then requires us to ask, what are the most likely paths to achieving that?

Minimizing downside risk is the capital preservation portion of the equation, and today it clear that the most dangerous long-term risks to purchasing power are in systemic threats to the economy itself. These largely revolve around climate disruption and resource degradation. Subsequently, long-term portfolio risk is avoided in not owning the causes of those threats, as their continuing growth is unlikely.

Preserving purchasing power is also about seeking the most likely paths to capital growth. “In today’s fiercely competitive global economy, it is serial innovation that drives and sustains growth.” The research has been expertly summarized by the Center for Talent Innovation in Innovation, Diversity, and Market Growth. In fact, that has always been the case in the U.S. economy – growth has always occurred where innovation is taking place (think: cars replacing horses and buggies), and sustained growth only occurs where serial innovation takes place.

If you are a fiduciary whose duty it is to preserve capital and make sure it exists to serve future needs, it stands to reason that the best place to invest is in the most innovative solutions to our current systemic risks. To execute on that goal, the order of operations in stock selection is critical. To arrive at the best chances of success in maximizing future wealth preservation and purchasing power, one must first evaluate the underlying investment’s reason for participating in the economy, i.e. the products and/or services they are producing. To evaluate what a company is producing and whether it is expected to thrive in our rapidly evolving economy, a public equities investment manager can borrow from the preferred data points of private equity managers: Is their product or service meeting an unmet need? Is the product or service set doing something to lower the risk profile of the economy overall? Is it innovative in a way that is simpler and more economically productive so that it will gain market share from competitors and have better margins? Is it going to scale?

Only by starting with this foundational information can stock selection succeed at maximizing the chances a company will take market share from their legacy economy counterparts and provide capital preservation and growth for its investors.

Stock selection on this basis is best determined by analysis of where the underlying company earns revenues: does it get paid to cause a primary system-level risk that is undermining the economy’s ability to thrive, or, does it exist to provide a similar service to the economy without causing undue risk? Meaning, is it creating innovative products and services that are increasingly in need and demand, or is it stuck in the old paradigm of ‘produce what used to work and hope consumers don’t catch on?’

Second, within a prudently curated set of these innovation-driven companies, the wise fiduciary will seek those run by diverse management teams and boards of directors. Why? Because teams with diverse backgrounds, experiences, education and expertise, will bring more information to bear on every situation and will overall make better decisions than will more homogeneous teams. More and better inputs equals better decision making, simple as that.

Directly on the point of investing in innovation as a prudent means of preserving and building wealth, companies with above-average diversity at the top of the organization earn innovation revenue materially higher than those without. To maximize chances that today’s innovation creators will sustain growth through serial innovative, invest in those doing so today under the leadership of a diverse team at the top. In Diversity Proves to be a Key Ingredient for Driving Business Innovation, Boston Consulting Group reports innovation revenues 19 percentage points higher at companies with diverse management teams – 45 percent of total revenue vs just 26 percent.

In addition, diverse leadership at the top of the organization tends to create a more workforce throughout the organization, which has proven to drive radically higher levels of innovation. As Annie Duke explains in her book Thinking in Bets: Making Smarter Decision When You Don’t Have All The Facts, “Diverse viewpoints allow for the identification of a wider variety of scenarios deeper into the [decision] tree, and for better estimates of their probability.”

Further, one should invest in more diverse teams, because not only does diversity drive serial innovation, it drives share price performance (put another way, as I mentioned above, innovation is a good predictor of performance). In CS Gender 3000 by Credit Suisse, they found that in publicly traded companies with just 25 percent of senior management seats held by women, the compound annual growth rate (CAGR) was 2.8 percent compared to an annual decline of 1.0 percent in the MSCI ACWI during the same time period. Further, as the percentage of seats held by women in senior management, so did the annual returns: they found a CAGR of 4.7 percent when 33 percent of senior management was women, and a staggering 10.3 percent when half of senior management was women.

McKinsey & Company’s research found a similar statistically significant relationship between a more diverse leadership team and better financial performance. In their report Why Diversity Matters, the reported that companies in the top quartile of gender diversity were 15 percent more likely to have financial returns above their national industry median.

And back to the initial point about a fiduciary’s duty to manage downside risk, companies lacking board diversity suffer more governance-related controversies. In those companies with at least minimal board diversity, MSCI found fewer instances of bribery, corruption, fraud, and shareholder battles.

It is well understood that the main determinants of long-term capital preservation are a company’s product/service mix, and emphasis on innovation to create long-term outperformance as clear. To further optimize opportunities for growth and capital preservation, the wise fiduciary will, in addition to the above qualities, also seek firms led by diverse teams. This is not a social good, nice to have feature, it is demonstrably important in predicting better corporate outcomes, especially over the long-term. As evidence shows, this approach will confer likelihood of long-term benefit on many critical metrics, including share price performance.

Given the benefits that investing in the most innovation-driven companies run by the most diverse teams are likely to bring, prudent 401(k) administrators, consultants and participants should take action now, as winners will pull further ahead and laggards will fall further behind.


Nothing in this article should be construed to be individualized investment advice. Additional important disclosures can be found here.