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Gender-Lens Indexing for Both Values and Value

Going beyond the numbers with the Morningstar Women’s Empowerment Index.

As the coronavirus pandemic drags on, working women continue to suffer. Recessions typically hit men hardest because they are overrepresented in economically sensitive areas, such as manufacturing. But the societal lockdowns and school closures designed to prevent the transmission of COVID-19 have taken a heavier toll on women. According to the International Labour Organization: "Women are disproportionately employed in critically affected sectors such as service, hospitality, and tourism and are also impacted by the shifting of economic activity into the domestic sphere, where they carry the majority of increasing levels of unpaid care work."

Women in many countries will see their career trajectories derailed and the gender wage gap widen as a result of the pandemic. In the United States, nearly 2.2 million women left the labor force between February and October 2020, according to the National Women's Law Center. A study of Japan by the Massachusetts Institute of Technology and Tokyo University found that women have suffered economic impact 3 times as large as males.

This is an issue of both equality and economics. Goal 5 of the 17 United Nations Sustainable Development Goals describes gender equality as a "fundamental human right," and as the "foundation for a prosperous world." Societies that tap into the full potential of their populations are more competitive and companies that promote gender equality can achieve better results, according to research by McKinsey and Credit Suisse. "Cognitive diversity," which results from mixing backgrounds and perspectives, improves decision-making.

The Morningstar Women's Empowerment Index highlights companies committed to equal opportunity and access. Index analysis reveals that "gender lens investing" is about both values and shareholder value.

Indexing Gender Diversity
Good research on diversity and inclusion goes beyond the numbers. While it's important to count how many women are represented at various levels of a company's workforce, policies, such as parental leave, are also critical. For the purposes of measuring company-level gender diversity, Morningstar Indexes partners with specialist research firm Equileap, whose Gender Equality Scorecard assesses companies on 19 criteria across four broad categories:

  1. Gender Balance in Leadership and Workforce
  2. Equal Compensation and Work-Life Balance
  3. Policies Promoting Gender Equality
  4. Commitment, Transparency, and Accountability

Equileap also examines a company's legal record when it comes to gender discrimination and sexual harassment. This ensures that savvy executives are not just finessing numbers, saying the right things, and crafting policies that look good on paper. Deeds must be measured, not just words.

The Morningstar Women's Empowerment Index targets 200 large- and mid-cap U.S. stocks selected by Gender Equality scores. The index is designed as a core equity exposure that delivers a similar risk/return profile to its market segment. Qualifying constituents are therefore weighted by their equity value, minimizing turnover and maximizing liquidity. Sector weights are also kept within 2 percentage points of market weight. Not only does this reduce deviation, it recognizes that dynamics related to diversity and inclusion can differ by sector.

The Morningstar Women's Empowerment Index's sector weights can be examined to compare gender practices across areas of the economy. As of late December 2020, when the index was reconstituted (membership reset), it maintained an above-market weight in:

  • Healthcare
  • Consumer Defensive
  • Financial Services

Meanwhile, the index maintained a below-market weight in:

  • Technology
  • Industrials
  • Basic Materials

The underweight in technology has hurt performance relative to the market since the index's launch in mid-2018. Some of the index's energy stocks also detracted from returns. And it was hard to keep up with the market if you didn't hold Tesla TSLA, which has experienced meteoric share price appreciation but did not make the cut on gender equality criteria.

Gender Diversity for Shareholder Value
Looking forward on a long-term basis, though, it's encouraging that the Morningstar Women's Empowerment Index tends to select companies with competitive advantages and healthier balance sheets than its market equivalent. The Morningstar Global Risk Model can be used to measure the index's exposure to various factors, or sources of return. According to the exhibit below, the index has higher exposure than the broad market benchmark from which it is derived to the Economic Moat and Financial Health factors. Economic moat is a measure of sustainable competitive advantage assigned by Morningstar equity analysts, extended by an algorithm to broaden coverage. Morningstar has observed that portfolios with heavy economic moat exposure, or strong corporate quality, provide superior downside protection.

Financial Health uses quantitative inputs to assess the strength of a firm's financial position. It ranks companies on the likelihood that they will experience financial distress by considering leverage and equity volatility. Higher scores imply stronger financial health and therefore a lower risk of bankruptcy.

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Here are some index constituents scoring well for gender equality that also contribute to the index's strong exposure to corporate quality and financial health:

  • Eli Lilly LLY is a healthcare company that gets significantly more weight in the Morningstar Women's Empowerment Index than in its broad market equivalent. Eli Lilly scores well for gender diversity on its corporate board, in its executive ranks, at the managerial level, and in its workforce. The company also has strong parental leave policies and stresses gender diversity within its supply chain. Morningstar Equity Research views Lilly as a wide-moat company as a result of one of the strongest developing drug pipelines in the industry.
  • Verizon Communications VZ also receives well above-market weight in the index because of its gender practices. Like Eli Lilly, Verizon can boast strong female representation at all levels of the workforce. The telecommunications player, which receives a narrow moat rating on the strength of its wireless business and the oligopolistic nature of its industry, also scores well for equal pay. Verizon has strong policies when it comes to equality of opportunity, employee abuse, and supply chain diversity.
  • General Mills GIS is one of several consumer defensive companies that is overrepresented in the index because of its gender practices. The company's board is very diverse from a gender perspective, as is its workforce overall. Parental leave and flexible working also contribute to an inclusive culture. While changing consumer tastes have forced the company to pivot, it retains a competitive edge because of its brand equity and preferred status with retailers, in the view of Morningstar Equity Research.

Meanwhile, when the Morningstar Women's Empowerment Index reset its membership in December 2020, several companies were ineligible because of legal problems related to gender discrimination and sexual harassment. These included:

  • JPMorgan Chase JPM
  • Hewlett Packard HPE
  • Walmart WMT

With just 200 constituents, the index is bound to miss out on some highfliers. But the index's preference for high-quality, financially healthy companies position it well for the long term. As the knowledge economy grows, human capital become ever more critical to corporate success. Companies serious about gender diversity are maximizing the potential of their workforce and benefiting from cognitive diversity.

These results support the conclusion that gender diversity investing is not just about making the world a better place. It's also about risk and return. Companies committed to gender equality are not just advancing human rights. They are also maximizing shareholder value.

Dan Lefkovitz is a strategist on the Morningstar Indexes team.