Want To Gauge And Enhance Diversity And Inclusion In Your Investment Portfolio? Here’s How

This article—the third in a series on diversity, equity, and inclusion in investing—examines how investment committees and boards of leading institutional investors are overseeing incorporating diversity, equity, and inclusion into investment teams and investment portfolios. What can we learn from institutional allocator best practices on defining diversity, selecting diversity metrics, taking a diversity baseline, setting diversity targets, ongoing DEI monitoring and engagement, and externally reporting DEI?

This series of articles is a product of multi-stakeholder discussion among the leadership of numerous nonprofits focused on diversity, equity, and inclusion in investing facilitated by Institutional Allocators for Diversity, Equity, & Inclusion (IADEI). It also includes results from a survey of 18 leading asset owners.

1. Defining Diversity. Diversity definitions and thresholds vary across the marketplace.

Of the asset owners who participated in IADEI’s DEI governance survey, 78% surveyed the asset managers in their portfolios about diversity and most commonly about two dimensions of diversity: gender (72%) and racial/ethnic (61%). Less commonly, asset owners track veteran (17%), disability (11%), and LGBTQ+ status and other forms of diversity (11%).

Current best practice in gauging portfolio diversity is requesting that managers ask their employees to self-identify. Another best practice is providing both a nonbinary gender option and the option not to disclose gender, as the revised Institutional Limited Partners Association (ILPA) Diversity Metrics Template does.

Of the asset owners that survey their managers on diversity, 71% set a global scope for their inquiry. Asset owners have struggled with global definitions of racial and ethnic diversity. For example, individuals who are considered underrepresented minorities in the US may represent the majority or the elites in their own countries. In addition, diversity metrics vary by regions: for example, some asset owners track locals versus expatriates in Africa, and First Nations representation is important in Canada. Accordingly, a number of asset owners only track gender diversity outside of North America. A number of asset owners are also enthusiastic about the breadth of the facets of diversity covered by the CFA
CFA
Institute’s Diversity, Equity and Inclusion Code and its principles-based approach. More specifically, the code considers generation, citizenship status, and neurodiversity as part of the full spectrum of human attributes, perspectives, identities, and backgrounds.

One Ivy League university endowment categorizes managers as diverse if their peers indicate that they do as well, and an influential asset manager tracks diversity without having specific criteria for diversity.

2. Selecting Diversity Metrics. Asset owners tend to be most focused on diverse ownership for all asset classes and diversity of carried interest allocation for alternative investment managers. Asset owners also generally gauge leadership diversity and investment team diversity as secondary matters. Some asset owners also assess diversity of the next layer of leadership and ownership in the firm to discern the diversity of ascending leaders.

Asset owners most commonly assess ownership diversity at the 20%, 25%, 33%, 50%, and >50% thresholds.

Sometimes majority-owned asset managers are thoughtful about current and emerging diverse leadership. Commonfund and other institutional allocators consider ownership, executive team status, and carry allocation when gauging leadership diversity, explains Commonfund Managing Director Caroline Greer. “The broader goal is to gauge the development of diverse portfolio managers, rather than simply focusing on the executive level.”

3. Taking a DEI Baseline. Some investment teams are constrained from surveying the managers in their portfolio for diversity. Some legal departments prohibit investment teams of state university endowments from incorporating non-financial factors, like diversity, into investment processes or even identifying diverse managers during manager due diligence. Asset owners report greater resistance from non-US managers than from US managers in terms of responding to surveys. Numerous organizations outsource assessing diversity of their portfolios to data science organizations like Lenox Park Solutions.

To ease the burden on asset managers and facilitate peer comparisons, a number of asset owners that we surveyed use the Institutional Limited Partners Association (ILPA)’s standardized diversity reporting frameworks to collect information from the asset managers in their portfolios.

A number of large asset owners reported baseline diversity statistics to their investment committees last year for the first time or are doing so for the first time this year.

4. Setting DEI Targets. Only 17% of the asset owners that IADEI surveyed set diversity targets, most commonly at the 25% threshold and for the year 2025.

A number of endowments and foundations view the endowed institution as the sole mission and discourage their investment teams from layering on additional mission, such as a diverse and inclusive investment portfolio. Other state university endowments in more conservative states are discouraged from trying to incorporate diversity into their investment portfolios.

More progressive asset owners are reluctant to set diversity targets because they do not want to stop working on diversity once they achieve the target. In other words, they do not want what they view as the “floor” to become the ceiling.

W.K. Kellogg Foundation Managing Director and IADEI Steering Committee Member Reginald Sanders explains: “Kellogg Foundation sets a target minimum percentage of meetings with diverse managers across all asset classes, established with the intention of having diverse manager exposure across asset classes.” Other asset owners mandate that every short list of managers should include a diverse manager or explain why it did not. For example, Fairview Health Services requires at least one diverse-owned manager finalist in public equity and fixed income manager searches, according to Fairview Health Services Investment Director Casey Plante.

5. Ongoing DEI Monitoring and Engagement. Monitoring is of the utmost importance: asset owners most commonly gauge manager diversity annually through annual environmental, social governance (ESG) or operational due diligence (ODD) surveys. Caisse de dépôt et placement du Québec (CDPQ) Senior Director of External Portfolio Management Anne-Marie-Laberge explains that CDPQ engages in dialogue with managers whose diversity statistics lag those of their peers. Other asset owners survey their managers on diversity every couple of years because change takes time.

6. Externally Reporting DEI. Some asset owners like Georgetown publicly disclose their diversity statistics on their websites. Others agree to be named in diverse manager press releases or to participate in diverse manager marketing videos.

Meanwhile, the vast majority of asset owners do not plan to report diversity statistics externally and some public entities are prohibited from doing so. Moreover, a number of asset owners have side letters that limit the use of their names, precluding public announcements of their investments in diverse managers.

Regardless on perspective on public disclosure, asset owners direct capital to diverse managers through private disclosure. Specifically, they can facilitate peer investments in diverse managers by offering to serve as a reference or be named in fundraising meetings. Asset owners also catalyze capital flows to diverse managers by sharing information one-on-one or through industry associations, like IADEI and its cousins, such as ILPA, Standards Board for Alternative Investments (SBAI), and CFA Institute, and Intentional Endowments Network, inter alia.

Beyond diverse-owned and led firms, the diversity of larger asset managers plays an important role, and some asset owners focus on incentivizing them toward greater diversity. Exelon
EXC
publishes an annual DEI Honor Roll, which recognizes investment and other partners for both including people of color and women in key roles on Exelon’s account teams and for additional efforts that recognize the value of DEI.

The Road Ahead. Achieving a diverse, equal, and inclusive investment value chain will be a long road. A number of catalysts provide the basis for cautious optimism.

First, the Securities and Exchange Commission (SEC) has been working on diversity disclosure guidelines as part of the anticipated proposal on human capital management. A number of asset owners look forward to commenting on the guidelines, and others are calling on SEC Chair Gary Gensler to prioritize this rulemaking as soon as possible. Similarly, the Value Reporting Foundation is revising the diversity, equity, and inclusion industry standards as part of its updating of the SASB human capital standards; asset owners must actively participate in the standard setting process by providing constructive input and critiques.

Second, a number of asset owners are broadening their focus on asset manager diversity to include diversity of a broader range of service providers, such as accounting and law firms.

Third and finally, collaborations like the idea exchanges among IADEI and its like-minded cousins listed below and the collaboration within the endowment and foundations community to produce the largest open-sourced list of diverse-owned and diverse-led investment managers that IADEI maintains demonstrate what committed peers can achieve together.

In particular in the coming days, please stay tuned for the fourth article in this series, which will focus on embedding diversity equity & inclusion (DEI) in legal and governance documents, signing DEI pledges and codes, and harnessing investment consultants toward DEI.

Acknowledgements: Institutional Allocators for Diversity Equity & Inclusion (IADEI) would like to thank leaders from CFA Institute, Diverse Asset Managers Initiative (DAMI), IDIF, Institutional Limited Partners Association (ILPA), Intentional Endowments Network (IEN), Milken Institute, One Women Initiative (OWI), Confluence Philanthropy, Standards Board for Alternative Investments (SBAI), and Value Reporting Foundation for their work to increase diversity, equity, and inclusion in the investment value chain and for generously sharing their insights and expertise.