More asset owners asking managers hard questions

Asset owners are increasing the pressure on their money managers to diversify their workforces, with some inquiring into the makeup of senior management as part of their due diligence.

That's the latest step in a persistent drive to institute change in an industry still dominated by white males.

Investors are keen to invest with managers with diverse workforces because they can provide a broader range of investment ideas. Studies have shown that diverse investment managers returns are similar, debunking the myth that women- and minority-owned money managers underperformed their peers. A 2019 study of the John S. and James L. Knight Foundation by Bella Private Markets and Harvard Business School professor Josh Lerner showed that for most asset classes, the returns of diverse-owned firms are not significantly different than non-diverse firms.

A 2019 survey by the University of California board of regents' office of the chief investment officer showed that 35 of its 98 managers that responded to its survey were substantially or majority diverse-owned or women-owned firms. Substantially or majority diverse- or woman-owned investment partners managed 19.6% of survey respondents' $89 billion in combined assets under management.

"While we have more work to do, we have made significant progress in advancing diversity in our workforce and among our investment partners," the UC office said in the report. To increase the UC's access to top-performing firms owned by women, African Americans and Latinos, the investment office created a program called "Diversified Returns," which they expected to implement in 2020. Officials in the UC's office of the CIO also asks money managers about their diversity and inclusion policies, programs and metrics, and developed baseline data regarding its managers' demographics.

Officials at the UC office of the chief investment officer declined to be interviewed.

When the Pension Real Estate Association formed its foundation to support diversity in the real estate industry, a wide group of asset owners supported the project because diversity supports the bottom line and guards against groupthink, said Deborah Harmon, chairwoman of the PREA Foundation and co-founder and CEO of Artemis Real Estate Partners.

"More than 27 institutions — CIOs and heads of real estate — have signed on to an institutional investor letter circulated to managers in support of the PREA Foundation mission, and others have become very vocal about the importance of diversity for their managers," Ms. Harmon said.

Investors say their actions are having an impact.

While most asset owners say responses to the diversity and inclusion portion of their due diligence questionnaire are voluntary, merely asking the questions has put managers on notice that the diversity of their employees and senior management is a performance metric.

"So much of what can be learned about a manager comes down to the character of their response to an LP's questions about diversity. Even though the data may not be great, investors can use it to have a conversation about efforts to make improvements over time," said Jennifer Choi, Washington-based managing director, industry affairs at the Institutional Limited Partners Association.

But, she said, "the makeup of teams within GPs can't and won't change overnight."

To nudge the effort along in the private equity industry, for example, the ILPA in February published a diversity and inclusion road map for private equity general partners and limited partners. The road map is designed to be a clearinghouse of best practices.

Over the summer, ILPA plans to revisit its due diligence questionnaire, Ms. Choi said. The association added sample diversity and inclusion questions to the document in 2018.

ILPA executives don't know how many institutional investors have used the diversity and inclusion metrics template. However, several asset owners say they use the diversity and inclusion questions as part of due diligence.

CalPERS officials ask private equity managers to fill out the entire ILPA due diligence template, said Megan White, spokeswoman for the $372.9 billion California Public Employees' Retirement System, Sacramento.

"However, the diversity part is considered voluntary because of state law so if they don't provide it we don't follow up," Ms. White said.

Officials at the Oregon Investment Council sit on ILPA's diversity and inclusion advisory council, said Rachel Wray, spokeswoman for the Tigard-based council, which runs the $75.6 billion Oregon Public Employees Retirement Fund. They were involved in crafting the ILPA diversity and inclusion road map.

Oregon's efforts to increase diversity and inclusion extends across its entire portfolio, Ms. Wray said in an email.

Last year, the council added a more pronounced diversity statement to its investment beliefs, she said. The new investment belief highlights the council's commitment to diversity and inclusion stating, in part, "a wide range of perspectives, ideas and opinions will ultimately produce better investment outcomes."

The council's investment belief "drives our relationship with managers and informs decisions we make internally, where, over the past few years, we have become a much more diverse investment team," Ms. Wray said.

Executives at the £10 billion ($12.5 billion) National Employment Savings Trust, London, hold similar beliefs.

"We think diversity is important at every level of the investment process — diversity of thought contributes to better decision-making," said Diandra Soobiah, NEST's head of responsible investment, in a written response to questions. NEST is a defined contribution plan established by the U.K. government in 2012 to support a workplace automatic-enrollment program.

In RFPs and due diligence meetings, NEST executives "ask hard questions about diversity" and they evaluate the dynamics between the team members, Ms. Soobiah said.

"In the past we have noted impolite behavior toward one of the very few female members of the team," she said. "When we challenged fund managers about their diversity initiatives our question was not taken seriously. Both the lack of diversity in the team and disrespect was a red flag."

NEST has also declined to invest with a manager based on the company's approach to diversity and how executives said they would handle complaints from women in the workplace, Ms. Soobiah said. "It was a warning sign of a poor company culture at the time, which didn't fit with NEST's values." She did not identify the manager.

The $225.9 billion New York State Common Retirement Fund, Albany, uses the power of the purse to support diversity in the money management industry.

The fund invested and committed $20.9 billion to minority-owned and women-owned managers in fiscal year 2019, a 24.2% increase from $16.8 billion in the prior fiscal year, said Gianna McCarthy, New York-based director of corporate governance.

A 2010 state law allowed the state comptroller to create a women and minority business asset management strategy.

The diversity of a manager's firm is "one data point we ask about," she said. "It's not the first question but eventually the manager discloses and reports the makeup of its team," she said. Posing the question is important, she added.

"When you have a large number of potential investors asking those questions, even asking the question can have a positive effect on company and management policies and goals," Ms. McCarthy said.

In addition to the women- and minority-owned investment program, New York State Common Retirement Fund has active programs to increase diversity on corporate boards and to encourage companies to adopt anti-discrimination policies, Ms. McCarthy said.

For example, in January 2019, Thomas P. DiNapoli, New York state comptroller and sole trustee of the pension plan, spearheaded a movement along with other asset owners asking 49 of the largest U.S. companies to report on their inclusion of people with disabilities across their businesses, she said.

Eleven companies agreed to participate in 2019 or in the future, Ms. McCarthy said.

"We are looking for increased diversity, which will correlate with even better returns," she said.

"It's very clear to asset managers that asset owners are very interested in diversity and advancing and integrating diversity."

There has been some progress in that many money managers now have diversity programs, she said.

The question is whether they are reaching their targets, Ms. McCarthy said. "I do think there are changes but things are going slowly."

Officials at the £30 billion Brunel Pension Partnership, Bristol, England, encourage their appointed managers to address and be transparent on the gender pay gap and diversity statistics on an annual basis, said Faith Ward, chief responsible investment officer.

Brunel officials also integrate diversity criteria into the fund's manager selection criteria and they take steps to ensure existing managers are promoting best practice, both within their investment selection and across their own operations.

Los Angeles County Employees Retirement Association, Pasadena, Calif., also includes a diversity and inclusion questionnaire as part of its RFPs, said Jonathan Grabel, CIO of the $53.6 billion pension fund.

"We believe that diversity and inclusion lead to improved outcomes for LACERA," Mr. Grabel said.

"When we conduct diligence it's a mosaic and we want all inputs. We want to evaluate everything possible" including the diversity of the managers' teams, he said.

Mr. Grabel said there has been some progress in that managers are much more aware of the importance of a diverse workforce.

"The fact that we are asking questions is not a surprise. I think that is a positive," he said. "Organizations are not at an ideal state in diversity and inclusion. Change may take time."