Public pension funds' definition of emerging manager still a work in progress

More public pension plans are returning to defining emerging money manager firms as those owned by women, minorities or people with disabilities.

As a result, the use of the term to describe any small, new boutique firms is declining.

The biggest change has been in Illinois. Under state law that went into effect in 2010, an emerging investment manager is defined as a minority- or female-owned business or business owned by a person with a disability that has total assets under management of at least $10 million but less than $10 billion.

But other states — including New York and Pennsylvania — also have made changes.

The term "emerging manager" goes back at least to the 1980s and often was used to describe undiscovered money managers. In the 1990s, as minority- and woman-owned firms began to open up in larger number, those firms also became classified as emerging managers.

The idea was to allow new talent — particularly minority- and woman-owned firms — to gain investment mandates, said Thurman V. White, president and CEO of Progress Investment Management Co., San Francisco, a manager of emerging managers.

Progress Investment's roster of 65 firms in its manager-of-managers programs includes one-third that are owned by white males. Mr. White said his firm is minority-owned and a key focus is helping other minority- and woman-owned firms gain access to the world of institutional investing, but that he is still open to allowing a percentage of other firms into the mix.

But in a book Mr. White wrote, Mellody Hobson, president of Ariel Investments, Chicago, argued that white males should not be included in the emerging manager category.

In a Q & A in the book, Ms. Hobson said: “The biggest problem is that you can be a white male, start a firm and be considered an emerging manager, even though typically a white male has more access and relational advantage than minorities and women do.”

In an interview with Pensions & Investments, Ms. Hobson said most asset management officials are white males and it doesn't make sense to give them a special advantage to help them succeed. “The white male already has seat at the table,” she said. “Let's go with the facts.”

While white males starting their own money management firms might disagree, pension plan executives increasingly have less room for them at the emerging managers “table.”

Both the New York state and New York City pension plans have created special allocations aimed at minority- and woman-owned asset management firms. Under Pennsylvania state law, preference will be given to emerging managers whose firms are owned by minorities or women, or firms that are based in or incorporated within the state, regardless of the owner's gender or race.

The $34 billion Maryland State Retirement & Pension System, Baltimore, encourages woman- and minority-owned asset management firms to apply to run money for the pension fund.

Public pension plans in Illinois by far have done the largest hiring relative to total assets of minority- and women-owned firms and have set the highest future targets for such hirings, according to reports to the governor and Legislature.

Not only does Illinois state law set a strict definition of “emerging,” but also the state's pension plans must set targets to increase the hiring of managers, consultants and senior staff, among others, who meet that definition.

State Sen. Kwame Raoul, chairman of the Illinois Senate Committee on Pensions and Investments, characterized the efforts by some Illinois pension funds as “a work in progress.“ He said while plans have increased mandates for minority- and woman-owned asset management firms, fees paid to those groups are sometimes smaller than other managers because the investments are passive.

But he did say he was impressed with the efforts of the $9.5 billion Chicago Teachers Pension Fund to be more inclusive.

That fund reported to the Legislature that as of Sept. 30, 34% of its assets were with money management firms that were owned by minorities, women or people with disabilities, 14 percentage points above its target of 20%.

Executive Director Kevin Huber, in an e-mailed response to questions, wrote: “You need a board and management that have a passion for inclusiveness and a belief that these managers will be successful. Put a plan in place and monitor the plan and expect to be held accountable.“

New York state's efforts to bring more minority- and woman-owned firms to the $140.3 billion Common Retirement Fund have been championed by State Controller Comptroller Thomas P. DiNapoli, who announced a commitment in 2007 to create an emerging manager program in each of the pension fund's major asset classes.

The New York state's efforts also have been spurred by a law signed in November 2010, by former New York Gov. David Paterson. The legislation, while not requiring set-asides or quotas for minority- or woman-owned asset management firms, attempted to increase opportunities for those groups.

The law required New York state to create a database of minority- and woman-owned asset managers and requires the state to hold an annual conference to make diverse groups aware of asset management opportunities.

Tyson Pratcher, a New York City-based assistant New York State comptroller, said in an interview that finding smaller minority- or woman-owned firms has required a change in attitude. “No one is ever going to lose their job from investing in a large firm that doesn't go well because everyone is invested in it. But if you were invested in a smaller firm, it can be a little risky if they have an issue.”

In New York City, Comptroller John C. Liu announced on Jan. 17 that $500 million would be added to the more than $6 billion already invested with minority- and woman-owned money managers by the five pension plans that make up the $113.7 billion New York City Retirement Systems.

Maryland's emerging manager program, which was started in 2007, has no set-asides for minority- or woman-owned firms. But legislation passed in 2008 encourages diversity for all state agencies by setting an overall goal of 25% of the agency procurement contracts be given to minority- or woman-owned enterprises.

The Maryland State Retirement & Pension system has 104 firms in its emerging managers program, managing $3.3 billion, A. Melissa Moye, chief investment officer of the Baltimore-based pension fund, said in an e-mailed response to questions. When it was launched, the program had just more than $300 million allocated to emerging managers.

Still, not every large pension plan gives preference to women and minority managers in deciding who is an emerging manager.

At the $92.3 billion Teacher Retirement System of Texas, emerging managers are defined as those with $2 billion or less in assets under management and, for private equity, the first, second or third fund.

Stuart Bernstein, director of the emerging managers program for the Austin-based pension fund, said Texas Teacher's officials are highly committed to that fund's emerging managers program. The program, he said, benefits managers by giving them the credibility of working with a large institution and it helps the pension plan because emerging managers have outperformed other managers.

As of the end of 2011, he said, total assets dedicated to emerging managers amounted to $3.2 billion, and since July 2010, TRS has increased its allocation to emerging managers by $1.1 billion.

He would not discuss percentages allocated to minority- and women-owned firms, but agenda materials for the fund's board meeting last month show the pension fund has $2 billion allocated to minority managers.

According to the Texas data, its allocation to minority managers is the second biggest among large U.S. pension funds. Only the $149 billion California State Teachers' Retirement System, West Sacramento, had a larger dollar allocation, $3.9 billion as of July 2010, the Texas data show.

But California legislators are criticizing CalSTRS and the $233.4 billion California Public Employees' Retirement System, Sacramento, for not doing enough. (CalPERs had 1.3% of its total assets, or $2.2 billion invested with minority managers, as of July 2010, according to the Texas data.)

Legislation signed into law by California Gov. Edmund G. Brown Jr. in October requires both CalPERS and CalSTRS to provide five-year strategic plans for hiring emerging managers and to report to the Legislature annually on the progress of the plan.

But California Proposition 209, passed by voters in 1996, prohibits affirmative-action programs in the state, so neither pension fund has a specific set-aside for minority- or woman-owned investment firms.

Both CalPERS and CaLSTRS officials insisted at a legislative public hearing in January in Los Angeles that they had been aggressive in recruiting a diverse set of emerging managers.

Regardless of efforts to improve hiring of woman- and minority-owned firms, many public pension plans still have no specific diversity program in effort, said Monika Mantilla, president and CEO of Altura Capital Group LLC, New York. Ms. Mantilla's firm runs an emerging manager-of-managers program and maintains a database of emerging managers that is purchased by institutional investors.

Altura's database tracks 2,000 emerging managers. As of Dec. 31, emerging managers had a 2.6% share of the institutional market, she said.