Advisers and asset managers have warned about the risks of putting all their eggs in one basket for years when it comes to investment.
The logic of diversification in an investment portfolio, where you invest in a range of assets and markets to avoid concentration of risk in any single area, can also apply to the teams that are making those investment decisions and giving investment advice.
One of the reasons that having a diverse team matters is that a mix of demographics, backgrounds and neurodiversity within a team can bring a broader range of ideas and perspectives to the table.
This helps firms become alert to opportunities and position themselves to deals with challenges and risks, because there is less chance of anything getting past several pairs of eyes coming at an investment decision from different angles.
Cognitive diversity refers to the range of expertise, experiences, perspectives, preferences and ways of thinking within a team
The Diversity Project commissioned Alex Edmans, professor of finance at London Business School, to reassess the business case for diversity in a recent report, Cognitive Diversity in Asset Management.
Cognitive diversity refers to the range of expertise, experiences, perspectives, preferences and ways of thinking within a team. In the report, Edmans found that diversity can give investment teams an edge – but only if well managed.
So, how much of a consideration is this for financial planners and wealth managers? Do they have more confidence in diverse asset management teams to run their clients’ portfolios and how important is cognitive diversity in the context of investment advice?
Robust decision making
Professor Edmans’ report found that diverse teams can generate a broader range of ideas, uncover blind spots and challenge biases. When the members of a diverse team come together to share their individual perspectives, it can reduce ‘groupthink’.
Groupthink is where unanimous agreement and harmony within a team takes priority over critical thought and weighing up all the options, leading to bad decisions or missed opportunities.
An environment where colleagues can challenge each other’s views is more likely to produce robust decisions
“With groupthink, people can be thinking, we’re all on the same page, so it must be collective intelligence,” says Lucy Woolrich, head of organisational development at independent financial planning firm Equilibrium.
“But it’s almost like an echo chamber where everyone’s reflecting the same thoughts and you’re perhaps reinforcing the thing that you’re missing or the aspect that you’ve not considered.”
An environment where colleagues can challenge each other’s views and suggest alternatives that are also up for debate is seen as more likely to produce robust decisions than one where dominant views go unchallenged.
“When selecting external managers, we have greater confidence in asset managers that effectively harness cognitive diversity,” says Dean Cheeseman, managing director of client investment solutions at wealth management firm Mattioli Woods.
“This confidence stems from several key factors that directly impact investment performance and risk management.”
A critical defence
For Cheeseman and his team, cognitive diversity acts as a ‘critical defence against costly behavioural biases’ when assessing external managers.
For example, a lack of cognitive diversity can lead to investment teams being trapped into outdated or narrow thinking about evolving markets due to “anchoring bias”, where they rely heavily on the first piece of information they have about a market, sector or company.
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“Asset management involves exploiting perceived market anomalies, which demands the ability to see opportunities and risks that more homogeneous teams might miss,” says Cheeseman.
“Our opinion is that investment teams where everyone thinks alike just creates an echo chamber effect, providing false comfort, while potentially overlooking critical insights.”
Mattioli Woods also thinks cognitively diverse teams are better equipped from a risk management perspective, as they can identify blind spots that could lead to significant losses.
“They understand that while this collaborative approach may slow initial decision-making, it ultimately leads to more robust investment processes and better long-term outcomes,” says Cheeseman.
Strong leadership
One of the aspects of Edmans’ report that resonates with Woolrich is creating a supportive and ‘psychologically safe’ work environment where people feel able to share their thoughts without the fear of judgment. This culture comes from the top.
“I was thinking back to previously in my career, where you think ‘I’ve got a different idea here but if I speak up, people are going to think that I’m being difficult or that I don’t understand or I’m being disruptive’,” she says.
You’ve got to have strong leadership to recognise when people aren’t actively contributing or sharing their viewpoints
“But no, you should celebrate when people bring their different perspectives and say have you considered this.”
Even if their contribution is discounted, Woolrich says this should be respectfully done. “You don’t want to damage that collaborative environment where people feel empowered to speak up and have a different view,” she says.
Unfortunately, cognitive diversity is not all ‘Sunshine, Lollipops and Rainbows’, to reference the 1960s hit by Lesley Gore. Edmans found that diverse teams may struggle to “speak the same language”, leading to misunderstandings and slower decision-making.
As a result, cognitive diversity was found to be less effective in the execution of ideas and for routine tasks. But the buck stops with leadership teams.
One of the things that struck Woolrich after reading the briefing document for Edmans’ report was the importance of leadership.
“You’ve got to have strong leadership to recognise when people aren’t actively contributing or sharing their viewpoints,” says Woolrich.
“And to facilitate those conversations where you’re talking through all the points, summing them up and making the decision as to how you’re going to move forward.
“If we’ve got a robust debate around things and people feel it’s safe to share their ideas without the fear of judgement or negative consequences, that can only enhance productivity – individually and as an organisation.”
