Access and Opportunity
Social and economic devastation arising from the worst global public health crisis in a century coupled with outrage over prevalent systemic racism across America has led to increasing pressure across societal sectors to do better to embrace and reflect the diversity purportedly at the heart of American values.
The political world saw this shift in mindset as Democratic presidential nominee Joe Biden selected Kamala Harris to run with him as his vice president, the first Black American woman and the first person of South Asian descent to appear on a major party ticket.
In the business sector, where Black professionals still account for less than 2 percent of all roles across the asset management industry, investors are also facing increasing pressure to demonstrate that they can continue to deliver value and profit while also actively working to dismantle anti-Black business practices and models.
As demands from the Black Lives Matter movement are reaching the boards of portfolio companies and the desks of investment teams, conversations about racial and economic injustice have quickly intensified within the investment community. A lack of allocation to diverse-owned firms, generally referred to as firms with 51 percent or greater ownership by minorities, women, or disabled persons, is becoming a central theme in the call to action for investors today.
In response, Robert F. Kennedy Human Rights’ Compass Investor Program—a network of investment decision makers who collectively control nearly $7 trillion in assets under management—has released a list of concrete actions the business community can take to better the lives of Black Americans.
High on that list is a call for institutional investors to allocate more capital to managers from diverse-owned firms within the asset management industry. Today, these firms represent just 1.3 percent of the $69 trillion in assets under management globally.
Although diverse-owned firms have recently grown in representation, increasing by 33 percent from 2013 to 2019, growth has been minimal within the private equity industry. Only 9 percent of private equity firms are diverse-owned, and only 7.5 percent of the total annual private fundraising dollars are allocated to diverse-owned private equity firms.
Investors unwilling to face the causes of this disparity often attribute this minimal growth to concerns over performance—concerns that financial returns show are without merit. A 2019 report by the National Association of Investment Companies found that these overlooked and underfunded diverse-owned firms produce top-quartile performance. Furthermore, firms with greater gender diversity exhibit less than average risk compared with companies lacking diversity, as women were shown to manage more for downside risk, rather than focusing more narrowly on absolute return.
Federal legislation is one avenue that may create the push needed to encourage allocators to proactively invest in diverse funds. A proposed bill in 2019 called for requiring various entities, including those registered or registering with the SEC, to consider at least one diverse asset management firm during the request-for-proposal process. Such discussions indicate a shift in thought, providing an opportunity for growth and a step in the right direction. But they also highlight a gap that can be filled by institutional investors today, as they consider stepping up their allocation in the midst of a growing health crisis and continued inequality.
Some diverse manager programs have emerged in the industry as long-term commitments to diversity and racial equity as institutional investors allocate dedicated pools of capital to diverse funds. The New York State Common Retirement Fund and the Teacher Retirement System of Texas have established such programs, leading their public-pension peers in the fight for equity. These programs aren’t perfect, but they offer tangible solutions to addressing the race and gender gap in the sector.
On average, however, few institutional investors are committing capital to diverse-owned private equity firms. Despite programs in place to address this issue, diverse-owned funds are being screened out by investors during the due diligence process because of the cost of investment associated with diverse manager strategies. Investors may view larger, more established funds as more advantageous, especially from a cost and fund-size perspective, due to established operational platforms, more assets under management, and residual fee streams from prior investments.
Compounding the problem is the global health crisis. The COVID-19 pandemic and an ongoing mislabeling of capital allocation to new managers as “too risky” has meant that even though conversations about race are taking place today, diverse managers face greater challenges in obtaining capital in the current market environment. Institutional investors are paying closer attention to the operating capabilities of managers and, given the lack of face-to-face relationships combined with work-from-home policies, they may find it easier to re-up with an existing manager to whom they have prior commitments and put new relationships on the back burner.
Against this backdrop of a global pandemic and work-from-home challenges, investors still face growing pressure to address ongoing racial inequities. In order to tackle the race debate, institutional investors may continue to allocate capital to “major diverse players,” many of whom may now fall into the emerging manager category, despite being a minority- or women-owned firm, as their AUM sit around the $1 billion mark. This poses an even greater problem for diverse managers, as the interchangeability of the terms “emerging” and “diverse” obscure and may hinder a diverse manager’s ability to raise capital, as they compete with emerging managers who may be wrongly labeled as diverse.
Supporting “major diverse players” and emerging managers should not be a way out of the call to action for greater racial and economic equity at a challenging time. Instead, diverse managers should be fairly assessed, and institutional investors should view the current environment as an opportune moment to create the change needed in the asset management industry, focusing on the investment case for diverse-owned private equity firms and regarding them as well-equipped managers that can provide excellent opportunities to gain alpha even amid global health and economic crises, just as their white-owned counterparts would.
After all, profit and social impact need not be contradictory.
Achieving true racial and economic justice will require a concerted effort that the investment sector can well meet. Institutional investors hold plenty of power for positive change within their portfolios, and they should critically assess who manages that money along with how it is being deployed. Providing access to capital to communities of color, particularly the Black community—whether through the allocation of funds to diverse managers in the asset management industry or in the allocation of funds to Black neighborhoods, small businesses, banks, and schools across America—will help to create a healthier, wealthier, and more economically equitable society, one that in turn is better for the bottom line.
NGom is manager of Robert F. Kennedy Human Rights’ Compass Investor Program.