Diversity in Investing

By Axel Steinmetz

Investing is one of the least diverse professions in the world. While other professions have grown their number of women and people of color, money management has stayed mostly white and male. In our most recent semiannual, the 2018 Mid-year Report, we initially touched upon the issue but a larger post is required to discuss the issue further. We’ve divided up this post into four sections: why we care, what the issue is, where the problem comes from, and what VVI can do. First, we would like to discuss why we are writing a post like this in the first place.

I) Why We Care

There are two types of reasons for why we feel like boosting the diversity efforts of the club is a net positive: because it’s beneficial to the club and because it’s beneficial to the world.

  1. Benefits to the World

As a club, we want to expose people from all different backgrounds to investing. As we’ve said, investing is not diverse at all, and if we can inspire even a few of our members to pursue asset management as a career we think that’s a good thing. We feel some innate responsibility to accept a diverse membership base as well, mainly because we’ve all grown up believing it’s the right thing to do. While we cannot convince people to follow a career path they aren’t interested in, boosting overall knowledge of investing is a huge positive for people of all cultural groups. Management of money is important for everyone, and we believe people can learn those skills through responsible investing.

Yes, increasing awareness about investing is a benefit, but the world quite literally benefits from diversity of investing as well. There’s plenty of statistically significant proof that more diverse investment teams produce better results, and that makes a real different in people lives. Institutional clients for funds are often made up of pension funds for retirees, endowments for schools and religious organizations, and trusts of wealthy individuals and labor unions. All these organizations are affected by the decisions asset managers make. Diversity in investing leads to better results, which on some level means that American retirees do better.

Management teams are working on their own diversity efforts, but we should emulate those efforts in our own club as well. Simply put, if more diverse teams aggregately produce better results, then we should strive for a diverse team in VVI.

2. Benefits to the Club

At the end of the day, our goal with recruiting is to bring in the best team of new analysts we can who we think are going to product the best results for the fund. We can’t let in everyone, because demand for any investment club is so high that our membership base could easily grow to over 200 and we cannot effectively educate that many people or make use of that many analysts for a portfolio of around twenty holdings. Essentially, we must restrict the supply and focus on recruiting those who show the most potential.

With that being said, all the research indicates that a more diverse team produces better investment results, and thus the best group of recruits that we can accept is by definition a diverse one. Here’s some of that research:

  • Meredith Jones’ book, Women of the Street, cites a number of studies concluding that female money managers are more successful. In one 2001 study, researchers “examined account data for 35,000 household accounts held at a large discount brokerage. They found that women tended to outperform men by a margin of roughly 1%.”
  • Another study references in the book found that during the financial crisis in 2007–2008, “the account values for women fell by 13 percent, compared to 16 percent for men. During the same period, 38 percent of female retirement investors either held their account balances steady or actually made money, compared with 34 percent of male investors.”
  • Finally, “Hedge Fund Research, Inc. (HFR), found that women-owned hedge funds gained 9.06 percent for the period January 2000 to May 2009, compared with 5.82 percent for the composite hedge fund index.”

At this point, a fair point may actually be, “why isn’t the club all women?” To be fair, I think that’s a great idea and someone at Michigan should start that club. On the other hand, then I couldn’t be in the club, and research also shows that this may not be the best option either. Gender diversity among all genders is important, and research supports that as well:

  • A 2018 report by Merkley et. al titled “Cultural Diversity on Wall Street: Evidence from Sell-Side Analysts’ Forecasts” studied 15,000 sell-side analysts and found that, “exogenous drops in analyst cultural diversity can reduce forecast accuracy by up to 16% relative to the unconditional mean level of accuracy.”

It’s worth noting that the top three studies are a little dated, but not all that significantly so. Some think that Wall Street has gotten smarter since the 2008 recession, but many also think that Wall Street hasn’t changed as all. Nonetheless, the last study is as new as one can hope for, and my bet is that future studies on this topic will confirm these older studies.

While this hypothetical discussion of what the perfect group of analysts may be interesting, it’s not very practically applicable. We and every other team of analysts just want to recruit the best members regardless of someone’s look. Recognizing that human talent comes from everywhere is important, but is a somewhat unremarkable conclusion for 2018. Regardless, I thought the actual research was interesting and wanted to include it.

Conveniently, our goal of wanting to expose many types of people to investing is in agreement with our other goal of wanting to recruit the best team–not that we expected research to show that a particular group would be worse–but it’s a benefit nonetheless.

Now with the background knowledge of why the club is interested in this issue, we can dive into more of what the issue actually is.

II) What the issue is

“Diversity” as an investing term does not refer to the variety of the people who do it; it refers to a diverse portfolio where the investor holds a number of assets to decrease risk exposure. The diversity issue we’re talking about is different, and it has to do with a lack of diversity in money management both within Michigan and the broader investment community.

Within Michigan, our friends in other investment clubs have told us it’s been difficult to recruit women and underprivileged minorities. For the Winter 2018 semester, 7.7% of Ross students were black, hispanic, or two or more under represented minorities, and 11.5% of Michigan students were for the same semester. For reference, black and hispanics make up over 30% of Americans. However, low representations of minorities in the University and business school suggest a broader detachment between students of color and business within Michigan. Women make up almost half of Ross, but the number of women in the marketing track at Ross is significantly higher than the finance track.

According to a New York Times study, The University of Michigan ranks first in percentage of students from the top 1% and last in the overall mobility index among the top 25 highly selective public institutions.

Beyond the Michigan, diversity in investing is a problem in the broader financial world.

  • A study by Morningstar found that, “less than 10 percent of United States portfolio managers at mutual funds and exchange-traded funds are women.”
  • A separate Morningstar study released in 2017 found that, “Women and minorities are locked out of some of Wall Street’s most lucrative positions, managing just 1.1 percent of the $71.4 trillion of the industry’s assets.”

One of my early value investing mentors is female, and she told me a story I’d like to include here. When she was in a two month training program 35 years ago, she was the only female in a class of 40. She remembered thinking how different it would look in 40 years, but she told me it hasn’t really changed. Investment conferences that she attends are still dominated by men, and while there are a few women scattered amongst the hundreds of men, the representation of women is not nearly enough.

To conclude this section, I’d like to stress that many in the business world are thinking about these issues. Every year, the Ross School of Business issues a long diversity report that focuses on goals and actions for increasing diversity and inclusion, banks hold exclusive recruiting events for minorities and women, and other financial institutions are focused on these issues as well (relatively new positions in financial institutions like “Head of Diversity” suggest their intentions). However, the financial sector still has a diversity problem, despite these active efforts. The obvious question is why, which we will examine in the next section.

III) Where the problem comes from

Money management’s diversity has lagged behind other careers even compared to careers in similar categories of professionalism. While just 10% of money managers are women, The New York Times found in 2015 that, “37 percent of doctors, 33 percent of lawyers and 63 percent of accountants and auditors were women” according to the New York Times. Minorities have also severely lagged behind. After thinking about this issue and talking to some who are far more knowledgeable than me, I’ve come to three main causes for why investing has failed to catch up. In no particular order those are misconceptions as to what investing is, Wall Street’s bad reputation, and perceived high barriers to entry.

  1. Misconceptions in Investing

There are many misconceptions of what investing is, and how it compares to other financial careers. Many think finance is very homogenous. People we’ve talked to who aren’t in business don’t know the difference between what VVI does as a club versus investment banking or consulting clubs. Many freshmen come into Michigan saying they want to do finance, but what does that mean? In reality, finance is a massive umbrella term which covers all sorts of careers. What VVI does as investors is completely different from what an investment banker does, a day trader, or an accountant at a company. Sure, all careers involve working with money, but there’s often very little crossover between all those careers. When I showed my premed friend an excerpt of this article, her response was, “what even is investing.” For many, all financial careers blur together.

A Bloomberg opinion piece by Matt Levine I was reading recently had a quote about this issue in relation to the 2008 crisis that I thought I would share:

“Business and financial journalism has always had a bias toward the great-man theory of business and finance, because colorful quotes from larger-than-life CEOs about their personal rivalries and triumphs and failures and goals and values and extracurricular activities tend to be more conventionally interesting (and easier to explain) than, say, the cash waterfall of a synthetic collateralized debt obligation on residential mortgage-backed securities.”

Even business newspapers, publications that people from outside the business world already find confusing sometimes, will report news in a more accessible fashion for the general public. The truth is that investing is not an abstract profession. This sounds obvious, but it’s easy to wonder if a phrase like “cash waterfall of a synthetic collateralized debt obligation” is made up.

Part of the misconceptions about what investing is comes from a lack of money-related classes taught in America’s education system. We’ve learned the work of lawyers and politicians through history classes and the work of doctors and scientists though science classes. Yet it’s no secret that American students are lacking in financial literacy. According to a Huffington Post article from 2015, “only 22 states require a high school course in economics, only 14 states require a course in financial education, and a mere 5 percent of students claim to have learned about money from an educator.”

Personal finance course were taught at my high school, but only for those students who the school didn’t think would go to college. The assumption they made is that those of us who were college bound would learn how to effectively manage money there, or that we would have the skills and resources to learn on our own. The result is a lot of students with little financial knowledge, both for their personal money management and professional aspirations. I believe greater financial literacy among American students would increase awareness about investing, and while I don’t have the proof, making the jump from a good financial background to learning about investing is a lot easier than the jump from no financial base whatsoever to investing.

There nothing inherently difficult about investing over other “highly skilled” professionals like lawyers, doctors, or engineers. The hardest math I’ve ever done in fundamental financial analysis is division, and the most more important skill is understanding what certain numbers mean and then acting on those numbers. Sure, there are technical skills which investors must have to make good decisions, but that’s true for most professions.

2. Wall Street’s Bad Reputation

Investing often gets a bad rep, and perhaps rightly so. Many assume that stock investors are always greedy. While that may be true for some professionals in Wall Street, the vast majority of investors are genuine people working to help their group of clients. At the end of the day, it is about maximizing returns, but that’s not a bad thing.

For the bad actors that are on Wall Street, those people aren’t value investors. Stories of insider trading involves traders profiting off short term stock market gains, and even if the investors somehow learn of something they shouldn’t have, then they should wait until the news becomes public to everyone else before acting on it.

There’s a stereotype that Wall Street is just a bunch of white men in suits, and that probably intimidates a lot of people (it intimidates me for one). Fear of losing money is also a reason why many don’t own stocks. We’ve all heard horrific stories of people losing a lot of money in the stock market, and that can scare people away.

Now to tie it into diversity. According to a study by featured on ABC by Neuwirth Research, African Americans are, “35 percent less likely than whites of similar means to invest in the stock market.” And further in the article, “Good Morning America contributor Mellody Hobson, who is also president of Ariel Capital Management, said the disparity lies in part on big social and cultural differences.” Also, research shows that people are likely to go into the same careers their parents are in. I can now present my hypothesis that some of the reason there aren’t more African Americans in investing is because black children are less likely to be exposed to stocks while growing up. Just to be clear this is a hypothesis, and whether Wall Street’s bad reputation plays a role is debatable. Logically this line of thinking makes sense to me, but there are some significant limitations to this theory as well.

First, at best this only helps explain why the number of African Americans in investing is low, and says nothing for any other race. It also says nothing about women. Also, it only helps explain, and is by no means a full explanation. I don’t have all the answers, and I don’t think anybody does. Hopefully this next explanation can help provide more color on where I think the diversity issue comes from.

3. Perceived High Barriers to Entry

Another misconception is high barriers to entry with the business. The barriers to entry in investing are present, but lower than other careers in business. Ultimately, investors are judged on their returns, and that’s a good thing. If you do well, you’ll be rewarded. In other professions people are judged by more subjective factors. With investing, everyone one is judged compared to one thing only, and that’s the S&P 500.

Practicing investing doesn’t even require a large capital base. Many virtual portfolios are free to use, where anyone can gain real investing experience with no risk. Investors including

Mohnish Pabrai of Pabrai Investment Funds say the best way for younger people to get into investing is just to start doing it.

Now, I’ll compare investing to consulting. Consultants give advice and assistance to business for a fee, with the goal of actually helping the businesses they consult for. My point here is simple: who’s going to listen to your advice without any track record or anyone of importance vouching for you?

A fair counter argument would be to say that anyone can start small, offering volunteer help for local businesses and gain a track record that way. Also, there’s plenty of material online for how to teach yourself consulting techniques like growth share matrices or Porter’s five forces. However when you start from scratch, I believe that’s fundamentally harder to do with consulting than it is for investing.

What about investment banking? Surely you can see where I’m going with this one. While you can teach yourself about the financial services investment banks provide, good luck facilitating a local merger between two of your favorite local restaurants. In short, it’s a lot easier to get practical experience with investing than other financial careers.

Also, there’s a lot that goes on behind the scenes with consulting and investment banking. You can look at consulting case reports and investment bank press releases, but you don’t get all the information they do. With investing, everyone has access to the same information with public market investing (in theory). Everyone generally works with the same materials between SEC filings, earning calls, articles, and wherever else analysts can find information as long as it’s not insider trading (See our Thoughts on Expert Network blog post for more on this).

Yes, connections matter like with any profession, and your early mentors will probably largely define your investment strategy. At the end of the day, those who have connections are still much more likely to get internships in the field. I myself am a beneficiary of this. But I still think the barriers to entry with investing is a lot lower than other financial careers.

IV) How to begin to fix it

As just one investment club, our ability is frankly limited. Having at least a framework for what we can do is important just to have some sort of assessment of the issue, but it’s much bigger than just our one club.

The first step is awareness, and there are two types. As a club, we need to continue to learn more about the diversity issue, and part of that comes with time. We’ve been in contact with a couple of the diversity clubs on campus already, but continuing to learn more about the issues is important for us. Second, we want to spread awareness in what our club does. Hopefully I have presented some good arguments for why investing is a good career for anyone. Again, there are a lot of misconceptions for what investing actually is, and by raising awareness for what we do specifically, we can begin to clear up some of those misconceptions.

Second, we need to focus on broadening our recruitment efforts to get people from all corners of Michigan. Other business clubs have diversity events or women’s events during their recruiting season, and those events are great. We look forward to hosting similar events of our own, with the goal of promoting interest among groups historically left out of money management.

Third, we should continue to raise awareness and talk to all types of people about investing all year round, and not just during recruiting. These issues transcend the club, and thus we should focus on them throughout the year.

Conclusion

At the end of the day, we at VVI cannot force people to consider careers that they have no interest in pursuing. Investing is challenging, and it requires constant focus. Value investing specifically requires a lot of patience and attention to detail, and we understand it’s not something everyone finds fascinating. But through giving this issue attention and care, we believe affect change in our local academic ecosystem. VVI will be doing its part to expose more people from all walks of life to investing. We think that’s a good thing.

Victors Value Investments

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Victors Value Investments (VVI) is the undergraduate investment club at The University of Michigan.

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