I need to start this column with a disclaimer. I am white and male. This will surprise nobody, and not only because the accompanying photo makes my gender and ethnicity quite obvious. Finance, and its surrounding fields like financial journalism, remains a white male club to a stunning degree.
There are ample arguments that this is unfair, along with other arguments against intervening. But this important debate is beyond my scope today. Rather, the point is that if investors want better outcomes, they would be better served if capital is allocated by diverse teams.
And the issue is not just about white males. When a team or market is dominated by any ethnicity, it tends to make worse decisions.
Behavioural psychologists have long established that markets are prone to herding and groupthink. It makes sense that a homogeneous team will be more prone to these problems. Now, the effect has been startlingly well demonstrated in academic experiments held far apart in Texas and Singapore.
A team of academics put together trading simulations in both places. The numbers available to traders enabled a precise grasp on how they priced them compared to fundamental value. Some groups were kept homogenous, with all the traders in the market from the region’s dominant ethnic group, while other markets were made diverse. Traders could see their fellow traders, and were screened to ensure they had similar knowledge and skill.
The findings: in a diverse market, traders scrutinised others’ behaviour more, and were less likely to assume that prices were reasonable. In homogeneous markets, traders trusted others.
As Evan Apfelbaum of Massachusetts Institute of Technology, one of the report’s authors, put it: “It’s not a story about diversity boosting performance, it’s about homogeneity tanking it. It’s about making white people do a better job.”
The extent of the effect was stunning. Pricing accuracy was 58 per cent higher in diverse markets, and this gap was consistent in Texas and Singapore. Prices were lower in the diverse markets, with no bubbles. And traders made more pricing errors when surrounded by co-ethnics. Homogeneity, in short, made them overconfident.
This matters, because overconfidence is the vital ingredient in bubbles. They form when greed overcomes fear leading to overconfidence. And this leads to a further argument on gender. Groups of men behave differently and more responsibly when women are among us. Adding women should create a similar benefit in terms of diversity.
But specific female characteristics make this all the more important. Women are far less likely to suffer from overconfidence, and they tend to be more risk-averse.
Research in 16 countries led by Suzanne Duncan of State Street found endemic overconfidence, with 69 per cent of investors claiming to be above-average. Men strongly tended to account for successes in terms of their own skill, while blaming failures on others or on external events. Women had exactly the opposite tendency.
It is not surprising, therefore, that many studies show female investors outperforming men. This makes the negligible female presence in investment management seem all the more scandalous.
A report by Barclays shows that in the five years to March 2011, hedge funds run by women and minorities returned 82.4 per cent, while non-diverse funds returned only 51 per cent. They did this with much less volatility, and with a far smaller drawdown during the 2008 crisis. Yet only 3.3 per cent of all hedge funds were run by women or minorities,
Whatever one’s opinion on social policy, there is a pressing need for a more diverse body in markets. Diverse teams deliver better results; diverse markets allocate capital more efficiently, without bubbles.
This involves no unfairness to white men. Let’s use an analogy that should appeal to my fellow white males, with baseball and cricket. In both sports, it is useful to have a mix of left-handers and right-handers.
If a line-up is exclusively right-handed, a team will take a left-hander over a slightly more gifted right-hander. This is better for the likely results of the team. Not even the unlucky right-hander can complain that it is unfair.
The same arguments apply to injecting ethnic and gender diversity into investment teams, and in particular into making sure that teams do not develop all-male overconfidence. Everyone could benefit from an investment industry less dominated by white men.