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September 16, 2019 12:00 AM

Identify and eliminate racial biases

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    Diversity cartoon
    Roger Schillerstrom

    No longer can the institutional investment industry deny that subconscious racial bias exists and often screens out minority firms that could add value to asset owners' portfolios.

    As reported in the Aug. 19 issue of Pensions & Investments, a study led by four Stanford University academics and joined by three executives at Illumen Capital, a venture capital and private equity firm, found that there are "systemic racial disparities in how investors evaluate funds and allocate money."

    The study asked 180 primarily white asset allocators to evaluate the investment skills of four fictitious venture capital teams based on one-page descriptions. Two of the teams were led by black male managing partners and two led by white male managing partners.

    One black and one white team had strong performance credentials, and one black and one white team had weak credentials. The allocators were asked to evaluate the fictitious teams on their overall investment performance, their investment skills, apparent competence, social fit and how much the teams were likely to raise.

    The results were unambiguous. The asset allocators did not rate the strong, black male-led team as favorably as the strong team led by a white managing partner, even though the two teams had nearly identical credentials and track records.

    Further, the asset allocators could not distinguish between the stronger and weaker fund management teams led by black men.

    The study noted that minority and women managers invest only 1.3% of the $69 trillion in global financial assets under management across mutual funds, hedge funds, real estate, and private equity, an unacceptably small amount.

    This must change, primarily because it is unjust to exclude a group of talented professionals from an opportunity for success simply on the basis of the color of their skin. The asset allocators in the study graded the black teams not on the basis of the credentials presented in the one-page reports, but on the color of the teams as shown in accompanying photos.

    It must change because excluding a talented team with a record of success from a portfolio's roster of managers would impose an opportunity cost on the return of the portfolio. That is, with the excluded team the return would be higher. That becomes a real cost that would be borne by the sponsor of the portfolio. This applies not only to venture capital, but also other private equity, common stocks, bonds and real estate.

    Unfortunately, it will not change until all asset allocators accept that they probably harbor subconscious biases, particularly racial bias, as illustrated by this study. Then they must take steps to overcome those biases for the benefit of the funds they manage.

    In fact, as the paper noted, asset owners should work to "overcome their biases by revamping their investment criteria and strategies, and ensuring they are knowledgeable about the success of firms led by people of color." The time to make these changes is now.

    They must ask their consultants to introduce successful minority (and women-led) firms to them even before they are looking for a replacement or additional manager, and to keep those firms before them until an opportunity to hire occurs.

    While the old adage claims that familiarity breeds contempt, in business familiarity breeds confidence. The more asset owners are exposed to successful minority- and women-led firms, the more likely they are to overcome any subconscious biases they have.

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