Increasing pressure for greater diversity

The push by asset owners to increase investment with traditional and alternative money managers that have diverse ownership and workforces is sweeping through the industry at an ever-accelerating pace, in response to societal pressure — including that of their own constituents — for more diversity in every part of life.

Public pension funds in Illinois, for example, began to invest with early stage, small and diverse-owned managers nearly two decades ago in response to state code that set an aspirational goal of 20% of plan assets be invested with minority-, woman- and disabled-owned firms.

While other asset owners also launched so-called emerging manager programs that included investment with diverse and new managers over time, many other institutional investors were more moved to act by the 2020 death of George Floyd to seek investment with money managers that have well-developed internal diversity, equity and inclusion practices. The aim is to better reflect the makeup of society within each company as well as produce better returns resulting from a more diverse workforce.

Investment with diverse-owned money managers by asset owners and other investors still has a long way to go.

A 2021 report from the $2.9 billion John S. and James L. Knight Foundation, Miami, showed that just 1.4% of the $82.24 trillion of U.S. assets under management in the foundation's sample was run by diverse-owned firms as of September 2021.

By comparison, 1% of U.S. assets in 2016 were managed by diverse-owned firms, according to the foundation's Knight Diversity of Asset Managers Research Series: Industry report.

That low percentage of AUM is expected to increase, given that more asset owners aim to expand their investments in all asset classes with diverse-owned managers.

Asset owners seeking investments with diverse managers have a new focus on firms specializing in private markets strategies, including private equity, real estate, private credit and infrastructure, as they move away from public equity, said Alexandra Wallace Stone, managing principal and consultant at Meketa Investment Group Inc., Westwood, Mass.

She also is co-chairwoman of the firm's emerging and diverse manager committee, which she founded in 2015.

As they increase their investment with diverse managers, asset owners also want to know more about all money managers' DEI practices as they upgrade, revamp and increase allocations to their diverse manager programs, industry sources said.

"We've seen progress over time as money managers increase their DEI practices and provide more information about them because larger asset owners are pressuring them to provide more transparency," said Meketa's Ms. Wallace Stone, as well as for other service providers such as brokerage, technology, asset servicing and law firms.

As DEI-focused investing has expanded, some large asset owners that launched emerging manager programs nearly two decades ago have adapted their programs to specifically include diverse-owned money managers.

The $66.1 billion Teachers Retirement System of the State of Illinois, Springfield, for example, launched its emerging manager program in 2005 to comply with the state's 20% minority-owned and emerging managers investment target.

The fund's allocation to what now is called the diverse portfolio totaled $18 billion as of March 31, accounting for 27% of total fund assets. All but one manager in the portfolio is diverse-owned, said Jose Gonzalez, investment officer, diverse and emerging managers.

One of the challenges for building and maintaining diverse portfolios is manager sourcing, Mr. Gonzalez said, noting that "you have to keep the pipeline robust because (diverse) managers in certain asset classes — private equity, private credit, real estate debt and others — won't accept a lot of money from asset owners so it's not always easy to invest. It's very important to have a very good network to make good connections with diverse managers."

Mr. Gonzalez said diverse money managers know that the Illinois Teachers' fund has a strong commitment to investing with diverse firms and he hears from between five to 10 diverse-owned firms every day by email or phone. "Every day, someone gets in touch with me to talk about our program," Mr. Gonzalez said.

The emerging managers program of the $204 billion Teacher Retirement System of the State of Texas, Austin, was founded in 2005 — not because of a state mandate, but instead due to a focus on smaller, newer managers. The program now has "a focus to engage with diverse managers," Kirk Sims, emerging manager program director, said in an interview.

Texas Teachers' emerging manager portfolio totaled $2.8 billion or 1.4% of total plan assets as of Dec. 31, but there is not a target allocation in the system's asset class structure, Mr. Sims said. He noted that in 2021, 46% of all investments allocated by Texas Teachers was to diverse managers.

"It's important to work with emerging managers because it's not just diversity of individuals that we're seeking, but also diversity of thought," Mr. Sims said.

The diversity breakdown of the money managers in Texas TRS' emerging managers program as of Dec. 31 comprised non-minority, 47%; Asian Americans, 18%; women, 14%; African American, 13%; Hispanic American, 7%; and disabled, 1%.

Illinois Municipal Retirement Fund, Oak Brook, has not only added diverse-owned managers to its existing emerging manager program, but also is seeking to recruit more diverse candidates to join the $53.8 billion system.

At present, 44% of IMRF's investment team is made up of women and people of different heritages, including African Americans, Latinos and Asian Americans, said Angela Miller-May, the fund's chief investment officer.

"Recruiting is competitive and it's difficult because public pension funds can't pay what money managers do," she said, adding that the fund will offer paid internships this summer to two candidates from diverse backgrounds to further increase the diversity of the investment team.

Like the Illinois Teachers' fund, IMRF also has exceeded the state code's aspirational 20% goal of assets invested with minority and emerging managers. IMRF's investments across all asset classes with diverse and emerging managers totaled $13.5 billion — 25.1% of total assets — as of Feb. 28. Diverse managers invested 91% of that total with the balance managed by emerging managers, Ms. Miller-May said.

Other large pension funds have expanded and refocused their diverse and emerging manager programs.

The $45.5 billion Connecticut Retirement Plans and Trust Funds, Hartford, revamped its long-running emerging and diverse manager program, the Connecticut Horizon Fund, which debuted in 2005, and launched a new version of the program in 2020. The fund has been relabeled Connecticut Inclusive Investment Initiative, or Ci3 for short.

The changes in the program include "a dramatically increased allocation to emerging and diverse managers between 5% to 10% of total plan assets from the former target of between 2% and 5%," said Raynald Leveque, deputy CIO. Ci3 had total assets of $1.9 billion or 4.3% of total fund assets as of March 31.

The changes to the program include making smaller commitments to emerging and diverse managers than they would receive within one of the funds' regular portfolios, Mr. Leveque said.

Another change in Ci3 is the formal establishment of two tiers of managers: one for newer managers and one for firms that are ready to be transitioned out of Ci3 into the funds' regular portfolios, where they will manage larger assignments, Mr. Leveque said.

One of the "meaningful changes" in Ci3 is the addition of private markets investments to emerging and diverse managers, Mr. Leveque said.

The diversity makeup of CRPTF's 23-person investment team by gender is 59% men and 41% women; by background, 68% employees are white and the balance are people with diverse backgrounds, Mr. Leveque said.

The $104.3 billion Massachusetts Pension Reserves Investment Management Board, Boston, approved the creation of the FUTURE initiative in May 2021 to help MassPRIM achieve the goal of at least 20% of total plan assets managed by emerging and diverse money managers across asset classes as required by a state law passed in January 2021.

The four key components of the initiative are reducing barriers for smaller diverse and emerging managers; enhanced DEI reporting to collect more detailed information about money managers' diversity throughout their organizations using data from Lenox Park Solutions Inc., Boston, a technology and data analysis company that focuses on DEI metrics; improving diverse and emerging manager sourcing through a manager-of-managers approach; and continuing to invest with diverse managers, said David Gurtz, MassPRIM's deputy CIO, in an interview.

MassPRIM's board approved a $1 billion allocation in November to emerging and diverse managers over the next two years that will be administered by five external consultants and money managers.

As of Dec. 31, MassPRIM had $7.5 billion or 7.2% of total plan assets invested with emerging and diverse managers.

Despite asset owners' strong demand for money managers' in-depth DEI data, it is not always easy to obtain the information they need.

For example, about three-quarters of the money managers from which MassPRIM wanted DEI information responded to a DEI survey request.

But that response was pretty good, said Mr. Gurtz in an email, noting "we were encouraged with the engagement rate to our initial Lenox Park Solutions DEI survey, which, at more than 75%, according to Lenox Park Solutions, was greater than double what firms (that) attempt to collect this data on their own can receive."

"As this was our first year (of surveying managers), Lenox Park expects that constructive conversations with managers will prompt the rate to improve as been the case with every organization that has collected this data for multiple years," Mr. Gurtz added.

Connecticut Retirement Plans and Trust Funds also has had some pushback from money managers when they are asked to describe their diversity practices, said Deputy CIO Mr. Leveque.

The state treasurer, Shawn T. Wooden, who oversees management of the state pension and trust funds, "asks all managers for their diversity through all levels of their companies," Mr. Leveque said.

Messrs. Leveque and Gurtz did not identify uncooperative money managers.

As for the progress made in advancing investment with diverse firms and more money managers providing their diversity metrics, the industry still has a long way to go to achieving true diversification, sources said.

"We are not setting the path forward for true diversity in investment management," said Illinois Municipal's Ms. Miller-May, adding "I don't think we're there yet. We have a lot of work to do to make diversity commonplace."

Veteran money manager Tina Byles Williams, founder, CEO and CIO of Xponance Inc., a Philadelphia-based multistrategy manager focused on diverse managers with $14.9 billion under management as of Dec. 31, counseled: "We all need to take a step back and ask what am I trying to do? What part of the cookie do I want to bite?"

There is a merger of factors right now between diversity and investing as asset owners seek to meet their goals of investing more with diverse-owned managers in response to societal pressures and from their own constituents, as well as to generate returns, Ms. Byles Williams said.

One area of that conflation is focused on money managers' willingness to be transparent in providing the true level of diversity within their companies, Ms. Byles Williams said, noting "we should be mindful of the slippery slope when the level of diversity is lowered via a particular metric or a manager's reluctance to provide full transparency. There's no excuse for a manager not to provide diversity metrics."