Mutual fund boards and diversity through the lens of Modern Portfolio Theory

John Hancock board chair Hassell McClellan writes diversity and inclusion can be more about the bottom line than morals

Hassell McClellan is the board chair at John Hancock Funds, independent trustee and chair of the compliance committee at Virtus Mutual Funds, lead independent director of the Barnes Group and associate professor (retired) of Finance and Policy at Boston College’s Wallace E. Carroll School of Management. He is also a member of the Mutual Fund Directors Forum Risk Oversight Working Group.

For mutual fund boards, diversity and diversification are impactful topics that are subject to much discussion and debate. The contexts, however, in which these two words with essentially the same definition are used have resulted in considerable divergence of perspective and receptivity.  For example, skepticism and negative stereotyping often shape the discourse and perspectives within fund boards when the topics of board composition and “diversity” arises.

Asset “diversification,” on the other hand, is a core tenet of Nobel Prize-winner Harry Markowitz’s Modern Portfolio Theory (MPT) and has been widely embraced in asset management and the mutual fund world. Diversity’s accepted perceived value in this context is its potential for maximizing expected returns and reducing risk.  Indicative of this view is the common practice for numerous fund complexes to extol the diversity of their funds and platform offerings with such affirming language as “Build your own portfolio” or “Explore our diverse selection of funds.” Moreover, a factor in the tremendous growth of index fund investing is its characterization as one of the simplest and most cost-effective ways to diversify.

Data and recent studies on diversity in fund boards and management, on the other hand, clearly indicate that diversification has notably lagged. As a consequence, mutual fund boards may unconsciously be failing: (1) to optimize the strategic benefits of diversity/diversification; and (2) to lower the risk of less effective overall decision-making.

When the issue is the desirability of diversification in boards and asset management, the views of a significant number of mutual fund directors thus appear to be dichotomous, if not myopic. This phenomenon is particularly perplexing when stakeholder practices, gatekeeper decisions and analytical data increasingly indicate: (1) diversity in asset management leadership is becoming a factor in asset owners’ decisions; and (2) a strong correlation between diversification in decision-maker leadership and both enhanced decision-making and financial results.

Recent Goldman Sachs Group data indicated that among 500 large-cap mutual funds, the performance of funds with at least one-third of manager positions held by women beat the performance of funds with no women by one percentage point for the first eight months of 2020.

Comprehensive McKinsey studies have strikingly shown that gender, ethnic, racial and cultural diversity tend to be correlated with better financial performance compared to less diverse companies.

McKinsey’s research has specifically indicated that firms in the top quartile for ethnic and cultural diversity were 33% more likely “to have industry-leading profitability” while companies in bottom quartile performance in gender and ethnic/cultural diversity “were 29% less likely to achieve above-average profitability than” other companies.

The research also suggests that companies with ethnically diverse boards were 43% more likely to experience higher profits. On the stakeholder side, some distribution platforms have indicated that a lack of organizational diversity may be a factor in decisions to remove select funds from their platforms. Yet, in the face of increasingly compelling data, the pattern of both overtly and covertly discounting the benefits of board member diversification continues to be an impediment to greater diversity on mutual fund boards.

Are fund trustees truly indifferent (or temperamentally resistant) when it comes to ethnic, racial, cultural and gender diversification of boards? Or do these rationalizations reflect an adherence to deep-seated memes and/or predispositions to negative and misinformed views of the net benefits of “diversity” despite growing evidence to the contrary.

One common impediment to realizing the benefits of diversity/diversification in board composition is the often-heard retort that boards and managements should focus primarily, if not exclusively, on “qualifications” in making trustee selections and avoid sacrificing “quality” for the sake of diversity.

This perspective implies that actively pursuing trustee diversity/diversification inherently requires quality trade-offs and/or is inconsistent with prudent and fiducially responsible management and/or board behavior.  This rationalization leads to a fallacious and gratuitous view of trustee diversity/diversification and the perception that the pursuit of board diversification lies outside the boundaries of “normal,” appropriate, or expected board and trustee selection practices.

Indeed, some board members and executives find it challenging to consider board and management diversity as a strategic benefit to shareholders. The above perspective is also frequently extrapolated to conclude that diversity is pursued for its intrinsic sake or “political correctness” to address documented inequities, outright discrimination, or to enhance the inclusion of populations historically excluded.

Increased board and management diversity/ diversification can certainly assuage some of the impact of historical discrimination and bias, both conscious and unconscious. As noble, however, as these objectives may be, they undervalue the increasingly strategically imperative justification for investment by mutual fund boards in greater diversity/diversification of members’ backgrounds, experiences, and perspectives.

An Imperative Perspective

The foundation, in fact, for increasing diversification on mutual fund boards is rooted in three strategic imperatives:

  1. Trustees on mutual fund boards oversee investment practices and decisions. And while it is critically necessary to be knowledgeable in the use of data analytics and algorithms, seasoned managerial intuition remains an invaluable component of prudent decision-making and investment oversight by boards. As reflected in the outcomes in numerous 36b litigation cases, even courts are inclined to respect the primacy of prudent judgement and conclusions by trustees. But here again, collective prudent judgement is generally derived from careful and comprehensive analyses based on information drawn from as many relevant and diverse sources as possible. And as organizational performance research and real-life examples have demonstrated, homogeneity in thinking often results in taking on avoidable risks and, consequently, generating unpleasant and non-prudent results.The inherent oversight nature of fund boards in asset management is prudently balancing risk and return, which brings us again to Markowitz‘s Modern Portfolio Theory regarding the diversification of assets and risk management. Few fund board members unequivocally doubt that portfolio diversity/diversification can have a positive impact on fund “performance” by smoothing out unsystematic risks. Industry experience and numerous studies generally affirm that a “portfolio” composed of different kinds of assets will, on average, generate higher long-term returns while lowering the risk of holding any individual securities or securities of similar characteristics. Improved risk assessment and risk oversight by fund boards via trustee and management diversification/diversity would seem to offer potentially higher returns as suggested earlier by Goldman Sachs’ data.


  1. Additional support for the benefits of board member and executive diversity can be found in the field of behavioral finance where Amos Tversky and Daniel Kahneman, for example, have suggested that individuals/investors generally exhibit loss aversion or place more weight on pain associated with a loss than the joy associated with a win. It would be expected that individual perceptions of risk and risk-tolerance levels would be influenced by the diversity of their experiences, imbued values, and even behavioral DNA. Diversity in risk behavior and decision making among individuals with essentially common core values and doing the same tasks can contribute to improved organizational decision making.Erik Larson, entrepreneur and former Adobe senior director, found that inclusive teams make better business decisions 87% of the time.  Also, decisions made and executed by diverse teams delivered 60% better results. These data suggest that it is logical to conclude that diversity in risk tolerance will help “smooth” out the risk(s) of being wrong attributable to “correlated” behavioral attitudes toward investments where risk-adjusted returns are key measurements.


  1. The diversification of fund boards can have real revenue and asset-acquisition implications. Asset managers seeking mandates and allocations are increasingly finding that potential clients have a heightened and genuine interest in the diversification profile of fund boards and managers’ investment and back-office teams. Retirement plans, pension funds, foundations, and corporations are increasingly making assessments and decisions wherein diversity is looked upon favorably. Moreover, important entities such as Institutional Shareholder Services and Glass-Lewis are considering diversification on boards a relevant factor in how they assess companies.


With these three strategic imperatives in mind, and modern portfolio theory and its foundational underpinning of diversification (diversity) as an accepted beneficial investment approach, why would mutual funds, charged with improving risk management and long-term performance, not apply a similar lens and perspective on diversification in board composition?”

John Hancock board chair Hassell McClellan

Instead of being viewed as “outside” normal operational and strategic behavior, mutual fund boards might do well to view diversity as simply a logical risk-reduction strategy. Since it is accepted that there may be short-term costs associated with diversification in investment portfolios and implementing allocations to specific stocks, so too should boards accept, without negative judgements, that there will be some costs associated with enhanced searches to achieve increased diversity/diversification in board composition.

Investments in greater diversity/diversification, if perceived and articulated as risk-reduction actions rather than divergence from what mutual fund boards were created for, would fully align with shareholders’ expectations, namely, to optimize total risk-adjusted returns.

Given the evidence-based potential for improved and “risk-reduced” decision-making, pursuing greater fund board diversity should be straightforward. Yet one intransigent remaining “meme” often blocks mutual fund and corporate boards from connecting the dots. This is the often-expressed view that somehow actively pursuing gender, ethnic and/or cultural diversity disadvantages other select groups.

Nothing could be further from the truth as suggested by the Nobel Prize-winning standard-bearer of free enterprise and conservatism in corporate governance and monetary economics, Milton Friedman.  Friedman, who famously argued that corporate leaders had no responsibility to anyone except shareholders, also emphatically observed, “Most economic fallacies derive from the neglect of this simple insight, from the tendency to assume that there is a fixed pie, that one party can gain only at the expense of another.”

Improved returns through better decision-making can result in higher growth and a larger “pie.” The very growth of today’s mutual fund industry is, in fact, a testament to the legacy of diversification initiated by investment trusts created in the Dutch Republic in the late 1770s to provide small investors with opportunities to diversify their holdings.

Introduced to the United States in the 1890s, diversification by mutual funds to investors other than wealthy individuals and/or only individuals in the financial-services industry commenced in force with Fidelity Investments’ and others’ aggressive marketing of mutual funds to more “diverse” socioeconomic segments of the population.

The reality also is that populations from which investors are drawn are increasingly more diverse and therefore the potential for future growth in the industry may be from these diverse segments.  Analyses by the Boston Consulting Group, for example, indicate that not only are women increasing their share of private wealth but that: (1) the amount of private wealth held by women was expected to grow by over 37% from $51 trillion in 2015 to over $70 trillion by 2020; and (2) women are likely to be the biggest recipient of the greatest transfer of wealth in the history of humankind.

A Strategic and Modern Portfolio Theory Approach

The growing evidence that diversification/diversity offers the potential for positive benefits and improved outcomes underscore the advisability for mutual fund boards to actively reconcile Modern Portfolio Theory’s “diversification” principles with strategically sound board recruitment, trustee selection and board composition initiatives. As such, at least eight critical board actions are imperative:

  1. Articulate diversity through the lens of diversification as a tool for both lowering the risk of under-informed correlated perspectives and improving decision-making.
  2. Avoid the conceptual trap of unconsciously equating increases in diversity with dilution of quality rather than as a proven tool for lowering risk and volatility in outcomes.
  3. Visualize and contextualize diversity as optimizing returns by having a portfolio of decision-making assets that improve overall decision-making.
  4. Seek greater understanding of how increased diversity can be a tool for growth and expansion of the company’s assets versus being a zero-sum game which disadvantages some at the expense of others.
  5. Develop greater understanding of how competitive positioning, fund flows and access to potential markets can be enhanced by improving diversity across the entire organization.
  6. Acknowledge and embrace the potential costs (e.g., search, recruitment, time) associated with pursuing board diversity/diversification as an investment in achieving better total returns and performance.
  7. Resist succumbing to the fallacy that diverse candidates with desired skill sets and backgrounds do not exist or are hard to find.
  8. Communicate that diversity via diversification across the entire organization, including the board, broadens analytical perspectives, risk reduction, and the firm’s performance.

Risk reduction and optimizing decision making are inherently strategic choices for boards and not intrinsic values-based mandates, whether it be in asset diversification or diversity in board composition. There is no moral-based “do the right thing” or “act in the common good” rule that makes fund board and management diversification and/or diversity imperative. Moreover, boards and asset managers are within their discretionary rights to ignore this perspective.

Compelling evidence continues to emerge, however, that viewed through modern portfolio theory’s lens on diversification, investment in the diversity of all assets – financial and decision-makers – reflects prudent and well-advised strategic behavior as a way of providing optimal risk-adjusted returns for shareholders.