Diverse Managers: What Are They Good For?
Deborah Adeyanju, CFA
As mission-driven institutions increasingly focus attention on fully aligning their actions with their stated values, one place where they remain out of alignment is in the management of their investment portfolios. Most foundations and endowments have made at least some progress in ridding their portfolios of investments that cause obvious harm, for instance for-profit prisons. But the overwhelming majority have not taken the next step of investing their portfolio assets in line with their identified missions.
On top of that, most still continue to overlook diverse investment managers when awarding investment mandates. This is particularly dissonant given that the asset management industry is one of the least diverse. According to a Knight Foundation study, women and/or minority-owned firms control only 1.4% of the industry’s total assets under management (AUM). Blacks make up roughly 6.5% of the industry’s ranks; while Latinos comprise just under 6%.
So what’s holding diverse managers back? Or more pointedly, why are asset holders not making more use of the full universe of asset managers?
Quite simply, biased thinking, old-boy networks, outmoded selection processes, resistance to change, and gatekeepers that function as institutional barriers all contribute to lack of access for diverse managers.
#1 Board groupthink, tunnel vision, and biases
Boards aren’t the only ones suffering from these handicaps. They are also rife among investment consultants. One of the most common limiting beliefs is the myth that diverse talent is rare. But as Diverse Asset Managers Initiative’s (DAMI) Robert Raben remarked recently, the reality is while “most white people think we have a supply problem of people of color. In fact, we have a demand problem.”
Another problem is the assumption that working with traditional, established, read white, male managers is the safest approach. A Morgan Stanley study found that many believe allocating funds to diverse managers would result in lower returns. In other words, decision-makers simply do not believe these firms can perform at the same level as white-run ones!! This remains true despite multiple studies having found that diverse managers produce investment results at least on par with those of their white counterparts’.
Unfortunately, Boards and their advisors are either not aware of these facts, or are coming to their decisions based on other factors. Bias is one of them. To cite just one example, a 2019 Stanford study found “evidence of racial bias in the investment decisions of asset allocators who manage money for governments, universities, charities, foundations, and companies.”
#2 Risk-averse institutional gatekeepers
The industry is starting to take steps toward diversifying, both among its ranks and in elevating diverse managers. Yet, many leading consultants still do not seem to feel diverse representation is important enough to even merit a response to the DAMI Annual Investment Consulting Survey on the issue. This is a big problem considering that investment consultants “wield disproportionate influence over where institutional investors invest their capital, and these firms advise on roughly two thirds of institutional assets.”
Getting and staying on consultants' radar and regularly responding to their information requests strongly favors firms that can commit the resources in time, money, and personnel. Additionally, while most consultants describe their process of identifying and vetting managers as rigorous, it’s clear they do use some basic rules as filters. For one, size matters – bigger is better, to a point. Age counts too – managers with less than a three year track record in a strategy typically don’t get called on. Qualitative factors – one study found “it is mainly the fund managers’ non-performance attributes that drive recommendations” – are also at play. These can all clearly wind up disadvantaging diverse managers.
#3 Outmoded selection processes
This fund manager selection process heavily favors managers with scale, lengthy track records, and deep institutional networks. Prospective portfolio managers must run a gauntlet to win new investment mandates. And that’s before they even make it to the interview.
The typical RFP process involves responding to written questionnaires. These often request information on the size of the prospective managers’ existing portfolio, with the AUM cutoff for consideration often set at a level higher than the typical size of a diverse manager’s portfolio.
Respondents are also usually queried on which similar mandates they’ve won and/or clients they serve. That leads to a chicken and egg problem – if you’re penalized for not having experience, how can you attain the necessary experience? Managers are also typically asked about length of track record/operating history. That’s a valid question. But if the criteria are set too high, can unnecessarily exclude diverse managers, who quite often, are also newer and/or emerging.
How to move the numbers
Diverse managers can only do so much to move the industry forward by themselves. For there to be substantial, meaningful change, all existing stakeholders – including those on whose behalf funds are being managed – need to step up. One way they can do that is by signing up to and implementing the Due Diligence 2.0 Commitment which outlines specific steps asset allocators can take to begin leveling the playing field.
It’s well past time for mission-driven organizations to both take active steps and hold themselves and their investment consultants accountable for the results to ensure their investment portfolios reflect their missions and their values. After all, this is not just a matter of doing right. Their fiduciary duty, which requires managers to put clients’ interests ahead of their own (in this case ensuring they are not missing out on performance by arbitrarily excluding potentially high-performing diverse asset managers) obligates them to.
Want to learn more about our Racial Equity Leaders Strategy? Read our previous posts: Racial Equity Investing: What it is and Why it Matters, and Gender-Lens Investing: What it is and Why it Matters, or contact us at info@grid202partners.com.
About GRID
GRID 202 Partners is an African-American owned Registered Investment Advisor (RIA) specializing in fee-based, comprehensive financial and investment planning for individuals, couples, businesses and institutions. We serve successful, ambitious professionals and business owners, mission-driven organizations, and households that are committed both to creating wealth for themselves and future generations and to aligning their financial assets with their social impact objectives