Should you consider DEI in your retirement portfolio? There has been much controversy regarding DEI (diversity equity and inclusion), none have discussed its effects on retirement portfolio performance. I seek to answer whether these factors improve or detract from retirement portfolio performance. Diversity refers to the presence of different identities and experiences, including:
- Women,
- Racial and Ethnic Minorities,
- LGBTQ+ Individuals,
- People with Disabilities,
- Veterans,
- Socioeconomically Disadvantaged Individuals,
- Older Workers,
- Religious and Cultural Diversity
- Neurodivergent
Why DEI?
Historically, one of the arguments for diversity equity inclusion was that diverse teams make better decisions than homogenous teams. The Harvard Business Review published Why Diverse Teams Are Smarter. As far as I know, no formal research has been done to apply DEI factors to investing.
Passive Vs Active Investing
Generally, there are two approaches to investing: passive investing and active investing. Vanguard is probably the most noted facilitator of passive investing. Believers in passive investing feel that portfolio managers, can’t consistently beat the returns of the index they seek to beat, especially after fees. Names like Fidelity, T. Rowe Price are is one of the names known for active investing. Active portfolio managers seek to best the returns of the index, using all manner of tactics.
The challenge, I believe that exists with passive investing is while you may implement your investment strategy, passively, how is that strategy developed in the first place. Arguably that adds some active component to passive investing. For example, some people may extoll the virtues of the S&P 500 index, while others may prefer a broader based index such as the MSCI All Country World Index (ACWI). Once an index is chosen, an investor and or their adviser has decisions or choices on how to implement the strategy. Apple, Chase, and COSTCO are included in the list.
To make that more tangible, Vanguard has asset allocation funds and so does iShares, an exchange traded fund (ETF) based facilitator of index investing. While both have a 60% stock 40% bond portfolio, they use different indexes to implement that portfolio decision. Apparently, the portfolio managers don’t agree on the same underlying Index to track and the percentages of each. Now let’s turn ourselves back to the retirement portfolio DEI factor-based investing.
Can DEI Matter In Investing?
Through YourStake a values based research company, let’s compare the Russell 1000 VS. the MSCI KLD 400 (KLD) VS. a portfolio that was developed by the optimizer of YourStake (we’ll call it YSO). The Russell 1000 represents the largest 1000 companies in the US. I thought I would use US based in this index to show the effects of diversity equity and inclusion. I compare that with the MSCI KLD 400. It is designed to provide exposure to the common stocks of companies that KLD determines have positive environmental, social, and corporate governance (ESG) characteristics. As you can’t directly invest in an index, I selected the Vanguard Russell 1000 and the iShares MSCI KLD Index which replicate the pure index.
YourStake has developed a portfolio optimizer (YSO) to optimize portfolios based on the MSCI ACWI Index for selected environmental, social and governance factors. That means that once factors are selected from its library, it then removes companies from consideration from the index and then seeks to create a best fit portfolio from the remaining ones based on a client’s risk. YourStake offers over 150 different values for one to select. I chose the following factors to represent DEI in their optimizer because I thought they were the best fit to the definition given earlier:
- Diversity Score
- Best Workplaces for Women
- Women on Boards
- LGBTQ+ Equality Score
- LGBTQ + Discrimination Prohibited
- Discrimination Violations
- Best Companies to Work For
- Board Racial Ethnic Diversity
My five-part series in October 2024 gave five different ways for you to evaluate your investments:
- Risk adjusted
- Values adjusted
- Fee adjusted
- Tax adjusted
- Stress adjusted
As you might expect, the chart below shows that from a values-adjusted return perspective the KLD and the YSO DEI were the best. The KLD is represented in purple and the YSO DEI in green.
This next chart shows that depending on how you incorporate DEI factors into your portfolio you can get a better return from a risk and return standpoint.
After a 10-year hypothetical “look back”, the KLD gained a 249.2% increase in value, the Vanguard Russell 1000 a 253.3%, and the YSO DEI an impressive 381.1%. *
You may decide that the values adjusted returns of the KLD index, while slightly lower in total return than the Russell 1000, make it a better choice. However, I believe the biggest take away from this data is that YSO DEI portfolio had the highest values adjusted returns and the highest risk adjusted returns. How you define DEI may alter the results.
Hopefully this encourages you to incorporate DEI and other values factors into your investment portfolio.
Conclusion
Considering DEI factors is one of the choices you have in seeking return in retirement portfolios. It is not a given that you do not necessarily have to give up financial return to align with your values. Arguably one of the most difficult aspects of investing is sticking with an investment strategy. In my experience, people who incorporate their values into their strategy tend to stick with the strategy. Often simply staying with the strategy is the best way to get financial return.
This approach may also check many other boxes regarding evaluating your investments. YourStake is not an investment adviser but provides its services through investment advisors who choose to use their research. This article shows that should you choose to pass through a mutual fund or exchange, traded fund, or take the precision of a direct indexing approach, you can potentially have superior returns aligned with your DEI values.
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