Diversity brings economic benefits in the form of increased innovation potential, particularly in industries that are part of the knowledge economy, says CIO. (UBS)

System-level thinking is a way to view a problem as a series of complex, dynamic, and interrelated relationships impacting one another both directly and indirectly. Inequality based on personal characteristics like gender, race, or sexual orientation is an example of a system-level challenge, one that requires examining interrelated dynamics across areas like access to education, health, housing, credit, and economic outcomes for women or minorities.

In our view, there is a positive and reinforcing relationship between higher equity and inclusion, and additional opportunities for investors (all else equal). We see this relationship play out in three ways.

First, we see a positive relationship between increased levels of equality and inclusion, and economic (GDP) growth. McKinsey estimates that closing the racial wealth gap in the US would result in an additional GDP growth of 4–6% in a decade. Diversity by itself brings economic benefits in the form of increased innovation potential, particularly in industries that are part of the knowledge economy. Inclusion, however, is also critical. Increasing inclusion of marginalized communities by creating economic opportunities enables them to participate and contribute to the economy to the fullest of their personal potential. It also allows for diverse communities to collaborate smoothly and effectively.

More inclusive economic growth may result in improved outcomes for investment portfolios, particularly as it relates to specific types of companies (those with a long time horizon, for example). We see the relationship between more inclusive economic growth and improved portfolio outcomes as more indirect. This is because the benefits of inclusivity tend to pull through at the company level, via greater innovation or the earnings growth power that can stem from things like less employee turnover and better recruitment practices.

Second, we see a positive relationship between increased equity and inclusion and longer-term growth opportunities for those companies that are aligned with this theme. As diversity levels increase, and as we see a societal shift in the perceived importance of diversity, equity, and inclusion, we expect to see increased stakeholder pressure (from governments and investors) for companies to become more inclusive (and more diverse). We also expect that a more equitable and inclusive society where marginalized groups have increasingly higher purchasing power will create opportunities for companies that cater to them, while expecting these companies to be more inclusive and diverse entities themselves. And finally, as more traditionally marginalized individuals have access to better education and experience, the pool of potential skilled workers ready to take their seat at the helm of companies continues to expand.

Third, investing to improve key “access” areas is critical to creating a more equitable and inclusive society, and may present comparable or improved risk-adjusted return opportunities. By “access” areas, we refer to four core areas where systematic access gaps based on gender, race, or sexual orientation exist: quality education, homeownership, healthcare, and capital. As we have noted before, each of these areas is uniquely tied to each community’s prospects to build wealth and contribute to their full potential.

For example, homeownership is a strong predictor of household wealth, particularly for low-income households for whom housing price appreciation tends to be a large component of overall wealth. In the US, in 2019, Black and Hispanic people over 55 were approximately 25% less likely than white people to own their homes. Similarly, in 2018, research by Freddie Mac found that members of the LGBT community were 15 percentage points less likely to own a home than the national rate.

Access to capital is another important area, yet, women and people of color face systematic barriers to business and investment financing. To be sure, private investment is only a component of the total investment needed to address these gaps, and many require government investment or policy. In public markets, investors can seek opportunities in companies that provide products and services to help meet access gaps, or in sustainable fixed income with use of proceeds that target these gaps.

Overall, we see multiple investment opportunities across equities, fixed income and private that align with this theme — enabling investors to invest for a more equitable and inclusive society, and for financial returns. For more on CIO's Longer Term Investments Theme Diversity and Equality, including a look back at 2021 and the investment case for diversity, see the full report, published 7 April 2022.

Main contributor: Amantia Muhedini

This content is a product of the UBS Chief Investment Office.