Why did we begin building the Next Economy Social Index in 2013? Why release results & open it up to client assets five years later?
We often say that the economy of the next decade is unlikely to look like that of the past. That’s because economic and environmental risks are continuing to materialize, and technology-based solutions to these risks are rapidly unfolding.
This ultra-dynamic landscape means that we as investors need to stay on our toes as we evaluate relevant risks and opportunities. Diversity and inclusion are important elements of a thriving, sustainable economy.
Wait, remind me about the Next Economy?
The Next Economy is an indefinitely sustainable economy driven by companies that are creating innovative products and services designed to solve systemic risks. It is undeniable that the global economy faces immense systemic risks–climate change, resource degradation and scarcity, widening inequality–that threaten to undermine the economy’s continued prosperity. Yet, these fundamental challenges present an opportunity for companies across the economy to create solutions to these risks, from renewable energy to sustainable agriculture. Today, the primary centers of innovation and efficiency are individually and synergistically creating the basis of the Next Economy. As a result, we believe the innovative companies that proactively address these risks are leading long-term economic growth and are our best sources of future wealth creation.
So what’s new?
Staying ahead of innovation is critical to the success of the firms we invest in and our own portfolios. Given the rapid pace of change, innovation itself and innovation-based stock-selection risks lagging the next technological advancement or development. Therefore, we do everything practical to stay ahead and mitigate this risk at the security and portfolio levels. Enter the proliferating real-world evidence and academic research that diverse teams, both inherent (race, gender) and acquired (experience, cultural background), outperform homogeneous teams in a variety of material ways:
- Diverse teams perform at higher levels than homogenous ones because they are more creative. The logic is certainly there; a wider variety of inputs from team members enables a team to better identify problems and develop solutions.
- Non-homogenous teams tend to outperform because they evaluate more facts and process those facts more carefully.
- Research demonstrates that companies with more women are more likely to introduce radical new innovations into the market over a two-year period.
- Diverse teams are more likely to achieve both short and long-term goals than homogeneous teams.
Since Green Alpha has always sought out innovation leaders across industries, we were not surprised that our initial gender-diversity evaluation of our Next Economy investment universe already showed materially higher female leadership than exhibited across the broad equity markets.
This led us to conduct formal back-testing of our Next Economy universe to evaluate whether companies with strong female representation in management or on the board of directors outperformed companies without significant female leadership. For more than a year, we continued to run tests using various levels of female inclusion to identify a point at which a certain number or percentage of female inclusion made a quantifiable difference. We also evaluated other factors, such as: does female influence in specific roles matter more or less than overall inclusion rates? Our evaluation of academic research and testing on our own models presented a compelling case for creating a gender-diversity oriented version of our Next Economy Index.
We became convinced that one of the best ways to boost a company’s ability to compete involves hiring diverse team members and giving them ample support and influence. In a rapidly changing world, the ability to innovate is really the only dependable competitive edge that exists for a company. Since the diversity of a company’s leadership and workforce is a proven way to increase the probability that the company will be able to continuously innovate, diverse teams simply make better long-term investments.
Our curiosity and research never stop.
Gender diversity is clearly just one material aspect of any given team’s composition, but an important one. And it is one we can currently quantify in the investment process as a starting proxy for what we really desire – diverse teams producing innovative ideas. As we access more company-level data, as the universe of companies creating solutions to the global economy’s primary risks expands, and as more companies maximize their potential by removing barriers so historically excluded people can thrive, our investment methodology will continue to evolve across all our portfolios, including the Next Economy Social Index. Now, with more than five years exploring the data and two years of track record in the portfolio, we are convinced that this is a compelling way to build a portfolio intended to outperform the market over the long-term.
The academic research is clear. The logic behind it makes intuitive sense. Now, empirical returns are showing it too: diversity works.
Want to compare the Social Index to other Next Economy portfolios? Take a look at our Investment Portfolios page.