DEI - still a work in progress
What should LPs and GPs be doing to really move the needle?
Diversity, equity and inclusion in private equity may be a subject of discussion in many firms, but how much progress have they actually achieved? And what should LPs and GPs be doing to really move the needle?
It has been more than three years since diversity, equity and inclusion (DEI) rose to the top of the corporate agenda as protests spread across the US following the shooting of George Floyd by a police officer and as the pandemic shone a light on social inequality. Back then, many LPs and GPs pledged to increase their efforts to improve the diversity in the private equity industry. DEI investment programs and initiatives to hire from broader pools of candidates and to retain diverse talent had already been in place in many institutions and firms for several years already, but 2020 was supposed to be a watershed moment when momentum for change was unstoppable.
So where does the industry stand today? And what needs to come next? We showcase the perspectives of four leading investors.
Where are we now?
A 2021 study conducted by Harvard Business School Professor Josh Lerner and Bella Private Markets for the Knight Foundation showed that just 4.5% of US assets under management in US private equity is managed by minority-owned firms and just 1.6% by women-owned firms. This has increased, from around 2% and 1%, respectively in 2013, but it is still some way from being representative of society. The figure for the asset management industry more widely is just 1.4% - and that has barely changed over the past 10 years.
Just 4.5% of US assets under management in US private equity is managed by minority-owned firms and just 1.6% by women-owned firms
Progress has been slow. “We have seen some changes in the industry as both public and private markets have slightly shifted their focus,” says Kirk Sims, Senior Director of Emerging Managers Program, Teachers’ Retirement System of Texas. “There has been a growth in emerging manager programs among public pension plans, for example. However, the issue is that these programs are finite – they only have so many dollars to invest in emerging managers.”
“We have made some progress,” says Raudline Etienne, Founder & CEO of Daraja Capital. “The fact that it is a topic of conversation and the fact that our fund exists are both evidence of progress. But you can’t get away from the fact that so few assets are managed by diverse-owned firms. The reality is that wealth creation in this industry is for the owners. The participation of diverse principals is improving, but the number of people who can create generational wealth from this business is not improving. There’s a lot more work to be done at institutional level and in terms of entrepreneurship.”
The participation of diverse principals is improving, but the number of people who can create generational wealth from this business is not improving.
And in some areas, progress has gone backwards. “We saw many institutions focus on diversity after 2020 largely because others in the community expected it of them as opposed to because it was the right thing to do,” says a founder of a platform that supports and invests in emerging managers. “The numbers haven’t really changed because some of the institutions that focused their efforts on diversity have since pulled back as the conversation has moved elsewhere.”
“The atmosphere has changed,” adds Sims. “A decade ago, people were enthusiastic and trying to find ways to connect. Today, people are trying to find ways not to connect. That’s a new challenge.”
But it’s not all bad news. “I am an optimist,” says a DEI officer at a US public pension plan. “We have seen things change and in different pockets.” She points to figures from the CFA Institute. “The institute developed and launched a DEI code less than two years ago,” she explains. “It already has 160 firms signed up, representing $18trn of AUM. That is a sign of real progress. It may not be going in a straight line, but it is positive that people are interested in understanding how to make changes.”
What should come next?
McKinsey recently published its latest report on the impact on company performance of diversity in executive teams. Companies in the top quartile for both gender and ethnicity are 9% more likely to outperform their peers, it finds, while those in the bottom quartile are 66% more likely to underperform. The findings suggest that there is a clear correlation between diversity and company performance.
So what can LPs do to advance DEI in the funds they back?
Consider the returns. “I hope the conversation will pivot towards returns,” says the founder. “If institutions are truly returns-focused, they should be focusing on diverse-owned firms. These are managed by people with a different lived experience, perspective and networks from others – they can uncover opportunities that others don’t see. That drives returns.”
Think about diversity holistically. “LPs should look at the demographics of the GPs they back,” says the founder. “They need to look at gender, race and ethnicity, but also LGBTQ+, veterans, people of different socio-economic backgrounds, people who went to different schools and so on. This all drives better decision-making and outcomes. And I’m talking specifically about the investment partners here because if you don’t have the power to make investment decisions, that’s not additive.”
Ask: where’s the money? “The work around DEI is necessarily iterative,” says the DEI officer. “The first step was measuring numbers – how many diverse individuals do you have in your team? We’re now moving on to what the impact is, where people sit in an organization and what economics they are achieving. And it has to take in all aspects of diversity because this is just good risk management. When you look at a decision from all angles, it’s far likelier to be a better one.”
Think bigger. “I see this as equal opportunity,” adds the DEI officer. “We can’t just look at diverse-owned managers; we have to look at the big firms and institutions to see what their pipeline is like for diverse talent. If we only measure ownership, the big firms will just give up because they can’t meet that metric. So we have to look at many different criteria that these firms can meet so that we can move the needle. We want folks to be everywhere so that the industry really is representative of society.”
Etienne agrees. “LPs are now trying to encourage change at larger firms and ensure that it comes from the very top,” she says. “That signals seriousness of intent and purpose. We are making progress, but we have to focus on the firms that manage the majority of assets because diversity is an issue everywhere.”
Build networks beyond the obvious. “Think about the fact that networks exist that don’t necessarily intersect with your own,” says Etienne. “When anyone offers to introduce me to someone I agree because I am intentionally diversifying my network.”
“Look for conversations outside your business school profile,” says Sims. “You will get access to ideas outside your comfort zone, lead to better decision-making and include options you wouldn’t normally include.”
Listen and learn. “I am encouraged by the number of people who come to learn how we have built our program and how we engage with organizations,” says Sims. “We also host an annual conference and lots of people come to the that – people can always learn to do more. Every pension fund has a limited amount of money, but we can give advice and actively engage with people and organizations – we can provide a blueprint for people early in this journey.”
They need to look at gender, race and ethnicity, but also LGBTQ+, veterans, people of different socio-economic backgrounds, people who went to different schools and so on. This all drives better decision-making and outcomes.
