Beyond the pale (and male)
How are LPs factoring in DEI when investing in private equity?
While things may finally be changing, private equity has not historically been known for being an industry that reflects broader society. A recent Level 20 report found that 20% of investment professionals in European private and equity and venture capital firms are female, with just 10% of senior investment professional roles filled by women. This is an improvement on 2015, when women held 6% of senior investment positions, but there is widespread agreement that there is much more work to be done here.
Indeed, across the categories of gender, ethnic and racial minorities, people raised in low-income households and LGBTQ+, institutional investor perception of representation of these groups in private equity scored lowly in a 2022 McKinsey & Co report on diversity in the industry (the score was lower than 4 for each, where 1 was not at all represented and 10 was very well represented).
LP pressure
It is becoming increasingly clear that institutional investors want private equity managers to do better. “In future, I can see our investment committee declining funds where the team page shows just a bunch of white men,” says a senior director at a large North American pension plan. “We haven’t yet walked away for a lack of diversity, but we are not far from doing so.”
Vicky Williams, Head of Private Markets at Coal Pension Trustee Services, agrees. “Our investment committee has made clear that there will be a red line for teams on which there are no women,” she says. “That’s even for funds that would previously have been clear re-up decisions.”
Both LPs say they are offering this feedback to GPs where there is an issue, asking how they are planning to rectify their lack of diversity and discussing how they can broaden their recruitment practices.
Indeed, many LPs are already taking a proactive stance on diversity in the firms they back – although with the recognition that the industry is starting from a low base. “When you are presented with a firm that lacks diversity, just having the conversation is impactful,” says a managing director at a large asset manager. “I wish we were in a world where we could write or not write a cheque based on diversity, but right now, we need to bring these questions to the forefront and see what the response is.”
“The industry is where is it is,” agrees Jasmine N Richards, Head of Diverse Manager Research at Cambridge Associates. “The bar is low and part of our standard due diligence is to understand where GPs are on diversity. No-one is perfect, but at this point, if you encounter resistance that’s quite telling. More often than not, though, we’ve seen that people just want to do the right thing. They just need help figuring out how.”
Do as I do?
Yet LPs also need to ensure they are walking the walk on diversity themselves. “It has to start from the top,” says Nina Kraus, Principal in the Fund Investment team at Hamilton Lane. “This is the way diversity becomes part of an organisation’s values and culture. At our organisation, we talk about amplifying diverse voices, those not speaking in the room and those not even in the room – we want to find a way of bringing them into the conversation. It’s a behaviour that starts at the top.”
“If diversity is not seen as mission-critical from the top through to the bottom of the organisation, you won’t see any impact on the culture or decision-making,” adds the asset manager managing director. “And you won’t see the benefits that come from diversity.”
And the benefits, say LPs, are considerable. At a time of fierce competition for talent, the argument for casting the recruitment net wider becomes particularly strong, as Kraus points out. “If you are not thinking about expanding your talent and capabilities or looking at who is not in the room, you are only seeing part of the picture,” she says. “There are real applications to ensuring you are hiring from diverse sources.”
Improving returns
For Cambridge Associates, one of the most important benefits is simply gaining access to the best investment opportunities. “We have invested $46bn so far in diverse managers,” says Richards. “We take the view that it’s important not just to diversify by asset class and vintage year but also by the people we back. In private markets, what you’re essentially buying is someone’s networks, life experience and ability to identify opportunities. If you build a portfolio, you don’t want a homogenous view of the world – you want people with a different slant and different networks because that generates better returns.”
She adds: “Not all of our clients have this mission, but we see our role as finding the best opportunities on the market for all our investors - and that clearly includes diverse managers. This is how we’ve managed to invest so much capital in diverse opportunities.”
Getting to this point takes education and a re-evaluation of many industry norms, however. “The way we allocate assets as an industry has baked-in bias,” says Richards. “We have done a lot of work internally and with clients to rethink what a good investment looks like and to work out where the biases are so that we can make systematic change. The 2% GP commitment is often considered a magic number, for example, but it’s not – we just want alignment and so we can review this in relation to someone’s net worth. You have to think about how you make decisions and why.”
There is an increasing sense that it is not just the right thing to do, but it is to LPs’ and GPs’ advantage to work on diversity; those that don’t may well be leaving money on the table. And it’s incumbent on all industry participants to lean into this change, says Richards. “It takes us all to achieve this - we can’t be knocking from outside,” she says. “It can’t be on the shoulders of the 2% of assets globally invested with women and people of colour. Even if it’s motivated by profit alone, GPs and LPs need to change the entire industry. In the US, for example, black women are the fastest-growing entrepreneurial populations; by 2045, the US will be majority people of colour. Portfolios need to be reflective of that.”
