Resisting diversity could lead to termination

Foundations argue that scrutiny of investment consultants and money managers lagging on the diversity front will only move the needle so far. For firms failing to meet diversity goals set by foundations, the best recourse is to fire them and reallocate capital elsewhere, sources say.

A recent article in the Stanford Social Innovation Review asserted: "It's time for foundations and other impact investors to face the truth" regarding how their investment process perpetuates inequality.

"No more navel-gazing, no more conferring, no more research," said the article, co-authored by Tracy Gray and Emilie Cortes, who both sit on the boards of foundations in California.

The article makes several recommendations, namely that foundations terminate money managers and investment consultants that are uncooperative on diversity goals — a move multiple executives at foundations say they support.

Shannon M. O'Leary, CIO of the Saint Paul & Minnesota Foundation, said her non-profit terminated three money managers over the past 12 to 18 months because of both underperformance and a lack of diversity on their investment teams.

When the non-profit switched investment consultants in late July, the foundation also decided to move its money manager diversity survey in-house instead of having its consultant conduct the survey, Ms. O'Leary said.

By bringing the annual survey in-house, "the amount of information we were able to generate by doing it on our own was much more meaningful than having the consultant do it," Ms. O'Leary said. "Managers were more forthcoming across all aspects of the survey with pleasant, persistent outreach from the investor as opposed to a third party."

The foundation collects information on firmwide gender, ethnic and racial diversity, from lower level staff to senior managers at investment firms. The survey focuses on diversity at the investment decision-making level in addition to diversity at the ownership level of firms, she added.

Ms. O'Leary declined to name the money managers and consultant the foundation terminated, as well as its current consultant.

The St. Paul, Minn.-based foundation had $1.6 billion in assets as of Dec. 31.

"As part of ongoing diligence with our managers, we let managers know how they scored (on the diversity survey) and we have an expectation of diversity on non-diverse teams. Among our liquid managers, we've already exited a few managers where clearly diversity was not a priority," she said.

Regarding the foundation's move to a new consultant, Ms. O'Leary said "we have had tough conversations with both our prior and current consultants," related to diversity goals.

"A lot of these consultants are really resistant to changing their process to actually recommend newer funds and newer managers. So, I do view them as a critical structural barrier in the process," she said.

Ms. Gray and Ms. Cortes' December article, "How Foundations Fail Diverse Fund Managers and How to Fix It," pinpoints five structural barriers that foundations must overcome to achieve equity in their investments.

Foundations must dismantle the "risk misconception" that funds led by minorities and women are riskier to invest in, rethink criteria for investment track records and minimum fund-size thresholds, expand their horizons beyond the "handful of diverse fund managers" that investors oversubscribe to and invest "at scale" in diverse fund managers with larger mandates, the article stated. The co-authors also recommend that foundations be willing to terminate investment consultants or money managers resistant to meeting goals set by clients, whether related to workforce or investment team diversity or money manager selection.

"Foundations that want to make progress must be prepared to fire resistant advisers. If boards vote with their feet, advisers will pay attention. Foundations should instead find an adviser or consultant who is committed to diversity and add a racial equity mandate for anyone they work with," the article said.

Ms. Gray is board trustee and treasurer of the California State University-Dominguez Hills Philanthropic Foundation in Carson, Calif., which had about $23 million in assets as of Sept. 30. She also is founder and managing partner of The 22 Fund, a Los Angeles-based growth venture capital and advisory firm that plans to invest in tech-based, export-oriented manufacturing companies, including women- and minority-owned firms. The 22 Fund is working to raise its first fund.

Ms. Cortes is the treasurer for Compton Foundation Inc. in San Francisco, which had about $28 million as of Sept. 30. She is also the chief financial officer of Toniic, a San Francisco-based global impact investing network whose members have more than $18 billion in assets.

Within the investment decision-making process, asset owners should focus especially on their relationships with investment consultants and OCIOs, due to the impact these firms have on capital allocation, Ms. Gray and Ms. Cortes said in a phone interview.

In fact, the first individuals board members often interact with in the manager selection process tend to be white male consultants, who may have a bias toward funds or firms run by those of the same gender and ethnic or racial background, Ms. Gray said.

To this point, Ms. Cortes added: "You've got white (consultants) picking a portfolio … who are then selecting managers who are led by white men, who are investing in companies that are primarily led by white men. It's really hard to break the cycle."

"Unless you fire them, they will not listen," Ms. Cortes said of consultants resisting progress.

The John S. and James L. Knight Foundation, Miami, published a report in February that analyzed the percentage of assets invested with women- and minority-owned money managers by some of the country's largest charitable foundations.

Of the $63.95 billion in invested assets at 26 U.S. foundations which participated in the survey or had publicly available data, $8.62 billion, or 13.5%, was with diversely owned firms, the study found.

Juan J. Martinez, vice president, chief financial officer and treasurer of the Knight Foundation, which had $2.3 billion in assets as of Dec. 31, said in an interview that in terms of working with money managers and consultants on diversity mandates, the move to drop uncooperative firms can be a "clearer call" to make regarding consultants.

For instance, if a consultant has been tapped to hire a certain number of women- or minority-owned money managers for an investor or reach a certain percentage of managed assets in the total portfolio, the expectation should be straightforward.

"To me, it's equivalent to saying, I'm a client of a law firm and I'm asking them to give me advice on a lease and they are giving me advice on risk management. (If) they are not giving you what you are asking for, how can you keep that adviser?" Mr. Martinez said.

Geeta M. Kapadia, associate treasurer, investments, at Yale New Haven Health System in New Haven, Conn., said in an email that her team "concurs that the existing practices commonly governing due diligence and allocating investment assets typically reflect structural biases against underrepresented investors including Black, Indigenous, Latinx investors and female investors."

Yale New Haven Health System had $5 billion in assets as of Dec. 31, with approximately $3.3 billion of its total assets holding investments on behalf of associated foundations, according to Ms. Kapadia.

"We also believe that as institutional investors, we can play a special role in championing underrepresented investors and highlighting the importance of supporting these firms and their investment professionals," she added.

"At the micro level, we are engaging with our existing investment managers to better understand their positioning as it relates to diversity, equality and inclusion and how it manifests itself through their investments and staffing. We also set ourselves goals to learn more about firms and investment teams that are led by women and/or people of color, and we challenge our consultant to bring those firms to our attention," Ms. Kapadia said.

Yale New Haven Health has not terminated consultants or money managers based on diversity requirements, Ms. Kapadia said.

The health system has approximately 40 active manager relationships, of which 15% meet its definition of diverse representation, she wrote in the email. Mercer Investments LLC, Boston, is Yale New Haven Health's consultant.

Foundations may soon get new assistance on the diversity front, now that a group of more than a dozen investment consulting firms led by Verus Advisory Inc., Seattle, recently partnered with eVestment LLC, an institutional investment data and analytics firm in Atlanta, to enhance diversity data disclosures made by money managers using the database.

Shelly Heier, president and senior consultant at Verus, said the group — the Institutional Investing Diversity Cooperative — is currently focused on getting managers to report diversity data on investment teams to eVestment.

On the matter of terminating advisers resistant to moving on diversity requests, Ms. Heier said she supports this move, particularly if consultants are not aligned with the mission of foundations.

"An immediate termination may be necessary if a consultant is not mission-aligned with (their client) … whether it be on diversity or any other social, environmental or governance topic," she added.

Ideally, however, she said that consultants, money managers and institutional investors "need to work together" on diversity mandates, and that investors should be careful to set realistic goals, including deadlines, for firms to make progress.

Ultimately, Ms. Heier said: "If the consultant is saying they are not going to do it, get another consultant."