Institutions want manager diversity

Updated with correction

The global spotlight on racial and gender inequality has spurred new interest among institutional owners in investing more of their assets with money managers with diverse ownership and workforces.

Recent incidents of racial injustice and long-standing inequalities in the U.S., ongoing protests and calls for change have trained the spotlight on institutional investors and the diversity of the investment managers they hire to manage their portfolios.

The current environment has spurred some asset owners to explore earmarking a portion of their assets for investment with money managers with diverse ownership, but sources said a surge in searches and hires has yet to manifest.

"Hiring diverse managers is the right thing to do. It increases the diversity of thought and of experience, which theoretically means you can better assess investment opportunities and potentially produce higher returns," said Tracy V. Maitland, president and chief investment officer of specialist fixed-income manager Advent Capital Management LLC, New York, which is minority-owned.

"Asset owners and consultants need to adopt a diversity policy that is consistent and constant," Mr. Maitland said, adding that "diverse managers need to be on equal ground with firms with traditional ownership."

Observers pointed to the existing emerging and minority manager programs of large asset owners for evidence of the efficacy of the approach, including the $148.1 billion Teacher Retirement System of Texas, Austin, the $51.2 billion Teachers' Retirement System of the State of Illinois, Springfield, and the $44.7 billion Illinois Municipal Retirement Fund, Oak Brook.

Some plan sponsors with long-standing emerging and/or diverse manager programs are working to increase their overall allocation to diverse managers and to broaden their programs to invest more in private market asset classes with more diverse-owned firms, plan officials said in interviews with Pensions & Investments.

For example, Shawn T. Wooden, state treasurer of Connecticut and the principal fiduciary of the $37 billion Connecticut Retirement Plans and Trust Funds, Hartford, will make changes later this year to the fund's emerging managers program that will increase the target allocation to the program to 8% of total fund assets, from a range of 2% to 5% now.

Currently, diverse-owned firms manage 14.6% across all asset classes of Connecticut's portfolio. Of that percentage, minority-owned firms in the emerging manager program oversee 2.9% of total assets.

"When I came into office in January 2019, I reviewed everything about the emerging manager program, which was launched in 2005. Despite its maturity and success in enhancing the returns of the fund and the opportunities it afforded to minority and smaller managers, I believe we can do more," Mr. Wooden said during an interview.

Investment consulting firms said they are fielding more inquiries from asset owners seeking help in hiring diverse managers.

Callan LLC, San Francisco, has seen new interest in "diverse managers from a broader audience. Previously, the primary investors in diverse firms were public pension funds," said Lauren E. Mathias, senior vice president and non-U.S. equity investment consultant in the global manager research group.

Ms. Mathias said in the past, investors were more interested in wider emerging manager programs than diversity-specific investment approaches.

"Institutional plans are in a unique position because they can put their money to work to make an impact" by supporting diverse money management companies, Ms. Mathias said.

She noted that Callan has been tracking diverse-owned money managers since the firm's inception in 1973 and now is tracking more than 300 diverse managers running more than 1,000 strategies.

NEPC LLC has been building its list of diverse managers and intends to increase its manager coverage by 67% over 2018 levels in anticipation of interest from institutional investors, said Samuel M. Austin III, a Redwood City, Calif.-based partner who chairs the company's new Investment Diversity Advisory Council and is co-chair of the firm's diverse manager committee.

However, thus far, Mr. Austin said there has been more talk about adding diverse managers to institutional portfolios and creating or expanding existing emerging/diverse manager programs than searches and hires.

But there has been enough interest for NEPC to run a series of webinars to educate asset owners about the investment opportunities within the diverse manager universe, he said.

NEPC's investment clients have $32 billion invested with diverse firms and about 40% use diverse managers across public and private equities, hedge funds, private debt and private real estate, according to the firm's website.

In addition to supporting diverse-owned firms, plan sponsors that invest with these managers say that performance also improves the overall returns of their funds.

Dhvani Shah, chief investment officer of the Illinois Municipal Retirement Fund, stressed that returns achieved by minority-owned managers led to strong annualized performance in periods ended Dec. 31, across all asset classes except hedge funds. Minority-owned managers run 23.3%, or $10.4 billion, of total fund AUM.

For the quarter, the fund returned net 5.8% (benchmark, 5.3%); one year, net 19.6% (18.7%); three years, net 9.8% (9.6%); five years, net 7.4% (7.6%); 10 years, net 8.8%, (8.7%). In fact, the 8.5% annualized return of IMRF over the 30-year period exceeded the fund's 7.25% assumed rate of return. Ms. Shah did not provide performance numbers for IMRF's emerging and minority-owned manager program.

She stressed IMRF "is always in the market for new talent and diversity is embedded in our program across asset classes and factors into every portfolio decision."

IMRF's emerging and minority-owned manager program launched in 2004 and Ms. Shah said its longevity and success "means we really do serve as a role model showing that it's possible to build a scalable portfolio of diverse managers across asset classes."

Teachers' Retirement System of the State of Illinois had more than $10 billion, or 22.2%, of the total portfolio managed by diverse firms as of March 31, Jose Gonzalez, investment officer of the system's $951 million emerging manager program, said in an email.

Women-owned firms managed 13.8% of the emerging manager portfolio; Hispanic-owned managers, 5.1%; African American-owned firms, 2.6%; and other minorities, 0.7%. In total, Illinois TRS invests with 31 diverse managers, some of which have graduated out of the emerging manager program to mandates within the main portfolio.

Net aggregate performance of TRS' universe of minority-owned firms as of March 31 was -3.9% for the quarter; three years, 5.1%; five years, 6%; and 10 years, 9.9%.

Aggregate net returns of all emerging managers were 9.4% for three months; three years, 9.5%; five years, 7.9%; and 10 years, 8.8%.

Multiyear returns are annualized and benchmarks were not available.

The primary goal of Texas Teacher Retirement System's $5.2 billion emerging manager program is performance, said Kirk Sims, senior investment officer and head of the program.

According to the most recent available returns, as of Sept. 30, for the year, TRS' emerging managers program returned a net 8.6% (benchmark, 6.6%); three years, 11.1% (9.7%); and five years, 9.6% (8.5%).

Mr. Sims declined to provide the performance of diverse-owned managers.

The secondary goal of Texas TRS' emerging manager program is to foster diversity of managers across the broad spectrum of the system's asset classes and Mr. Sims noted that 52% of managers in the program had diverse ownership. In 2019, 64% of the program's new allocations were to minority- and women-owned firms.

The $396.9 billion California Public Employees' Retirement System, Sacramento, established a dedicated emerging manager program in 1991, which now totals $1.3 billion.

"An ancillary benefit of our emerging manager strategies is greater ethnic and gender diversity among CalPERS external fund managers," according to the fund's website.

Anne Simpson, interim managing investment director of board governance and sustainability, said in an interview that CalPERS is "interested in all dimensions of diversity" noting that "diversity in the money management industry is going mainstream and at a pace. CalPERS will be at the forefront."

As part of an ongoing cost-cutting effort, CalPERS brought $3 billion of global equity assets previously run by firms in the emerging manager program in-house for management in the second half of 2019, leaving $500 million managed by external emerging firms in the portfolio.

Despite the enthusiasm of some asset owners for investment with minority-owned firms, diverse-owned managers said they have not had consistent inflows from a broad range of institutional investors.

During a July 16 panel on the issue of diversity in the investment management industry, hosted by the SEC's asset management advisory committee, several panelists cited a 2017 study by the Government Accounting Office which found that women- and minority-owned firms manage 1% of the $70 trillion run by investment companies in the U.S.

Gilbert A. Garcia, managing partner of Hispanic-majority owned manager Garcia Hamilton Associates LP, Houston, who moderated the SEC panel, said in an interview that the SEC's interest in this issue may spark change.

"There's something wrong if only 1% of $70 trillion is managed by diverse managers. A lot of the very large consultants are unwilling to use diverse managers in a search unless the client mandates that they do so," he said.

"Now that diversity and transparency are issues with the SEC's asset management committee, I am optimistic about change. I think this is what will push the needle for money manager diversity."

Garcia Hamilton manages $16 billion in fixed-income strategies.