It's not everyday that an interdisciplinary team of Stanford University professors and researchers in the fields of finance and social psychology combine forces with industry practitioners to undertake pioneering research that illuminates deep-seeded, systematic bias in asset allocation due to race. The process of doing this research was, we believe, as unique as the findings themselves. Our study, "Race Influences Professional Investors' Financial Judgments," in the Proceedings of the National Academy of Sciences, examines how asset allocators evaluate teams of white-led and black-led fund managers at stronger and weaker performance levels.
Asset allocators operate as the underpinning of the global capitalist system, managing $69.1 trillion in mutual funds, hedge funds, real estate and private equity. This community of investors is very familiar to the readers of this publication, but the fact that less than 1.3% of these assets are managed by firms owned by women and people of color may be new information. While historically many have attributed this startling underrepresentation of women and people of color to a talent pipeline problem, our published study finds evidence of palpable upstream racial bias in the investment decisions of asset allocators. Even though financial assets are managed almost entirely (98.7%) by firms owned by white men, there has been scant, if any, research designed to shed light on the reasons for this disparity.
The evidence now indicates that asset allocators have a systematic preference for high-performing white male-led funds when evaluating them against high-performing black male-led funds. An additional implication of the study is that asset allocators view black-led funds as a riskier investment opportunity; not surprisingly given asset allocators' inability to effectively gauge the performance of these teams. Simply put, the preference for white male-led teams combined with the high-risk perception of black male-led teams at similarly high levels of performance likely leads asset allocators unknowingly to completely miss out on many high-quality investment opportunities. This practice should be concerning as it may lead to diminishing portfolio value at the highest level of performance, and because it also violates one's fiduciary duty.
Our study also points to another reality. It suggests that even if the pipeline challenge is fully addressed, high-performing fund managers of color with competitive credentials will likely continue to be undervalued. Such treatment both systematically underestimates the actual value of high-performing black male-led funds and creates racial inequity within our financial markets. Despite an entire group of managers excelling in their professional endeavors to become high-performing fund managers, such black male-led funds are likely excluded from investment opportunity sets due to asset allocators' perception of additional risk associated with these managers and their firms. This is especially alarming because without intervention, these asset allocator biases will continue in direct contrast to economic efficiency and fiduciary responsibility.
To increase racial equity within our financial system, we need to move beyond well-intentioned diverse manager programs and take a structural approach that engages the gatekeepers of the financial world to actively reduce their respective biases by examining innovative models such as the unique partnership between lllumen Capital and Stanford SPARQ and the resulting work. By helping investors develop transparent and consistent investment processes that capture investment opportunities that have historically been overlooked and underestimated, we can begin to make our capital markets more profitable, diverse, equitable and inclusive.
Daryn Dodson is the managing director of Illumen Capital, Oakland, Calif., and Jennifer Eberhardt is a professor of psychology at Stanford University and co-director of SPARQ, a university initiative to use social psychological research to address pressing social problems. This content represents the views of the authors. It was submitted and edited under Pensions & Investments guidelines, but is not a product of P&I's editorial team.