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The DEI Dilemma for Private Fund Managers (Part 2)

By February 22, 2022July 27th, 2022No Comments

Investors and employees are united in pushing fund managers to prioritize DEI

In Part 1 of our series on the “DEI Dilemma,” we explored how fund managers are increasingly expected to integrate DEI considerations into their investment strategy, often as part of an ESG program or other sustainability mandate.

Fund managers also face pressure to improve how they address DEI concerns at the enterprise level, with a specific focus on whether there is diverse representation across the firm and whether workers are treated fairly. There are many benefits to a DEI-oriented approach to human capital management

For instance, a diverse workforce can help a firm avoid groupthink and create an environment for innovative investment ideas.  Employees who feel like they are valued and heard will likely be more willing to work hard and contribute to the firm’s success. Maintaining a collaborative and nurturing work environment can be just as important of an ingredient to a firm’s success as the strength of the investment strategy and the skill of portfolio managers.

In Part 2 of this series, we examine how investors and employees are pushing DEI to the top of the agenda for private fund managers.

LPs want their managers to take diversity seriously

Institutional investors have been gradually adding more questions to their manager due diligence checklist in recent years, with questions on DEI appearing on DDQs across the industry.

According to a recent report published by the Institutional Limited Partners Association (ILPA), a group that includes more than 550 institutional investors representing over $2 trillion of private equity assets under management (AUM), GPs and LPs are taking concrete steps to advance DEI both within their organization and in the industry more broadly. The report, which was published as part of ILPA’s Diversity in Action initiative, showcases how the initiative’s 180 signatories are integrating DEI into both their investment activities and organizational practices.

For example, the study found that 59% of LPs/allocators collect DEI metrics from their managers, with 22% of LPs indicating that progress on DEI will be considered as a factor in the decision to invest in a successor fund.

In response to this increasing demand from investors, ILPA recently updated its due diligence questionnaire (DDQ) and Diversity Metrics Template, drawing on the revised UN PRI Limited Partners Private Equity Responsible Investment DDQ. ILPA added 12 questions to the DEI section of the due diligence forms, noting that the updated version features more globally relevant designations for race and ethnicity and more inclusive information on gender/diversity through the addition of a nonbinary designation. The DDQ further asks about firms’ willingness to require and implement DEI policies; the presence of a code of conduct that covers harassment, discrimination and violence in the workplace; and details on the implementation of policies that work to recruit and retain staff from underrepresented groups.

The revised DDQ is already making waves in the investment management industry. Nasdaq recently agreed to align with ILPA’s Diversity Metrics Template by committing to collect DEI data from private fund managers and make it available to investors free of charge via the Nasdaq eVestment platform in an effort to “improve transparency and disclosure standardization across the industry.” The data became available on February 16, 2022 and includes diversity metrics on hundreds of investment firms as well as aggregated diversity metrics for the board and senior management of private funds’ portfolio companies.

Here is a preview of the types of DEI-related questions managers can expect from current or potential investors:

  1. Does the firm have a DEI policy or initiative?
  2. Does the firm disclose U.S. Equal Employment Opportunity Commission’s (EEOC) EEO-1 form?
  3. Does the firm track data on race, ethnicity and gender, including additional categories of diversity, such as LGBTQIA+ and disability?
  4. Have there been accusations of racial discrimination and sexual harassment against the firm?
  5. How did the firm respond to these accusations (e.g., independent investigation)?

Employees are using their voices to demand progress on DEI

Employees are also a growing pressure point for fund managers, especially at large asset management firms that may employ thousands around the world. This attention has only intensified in the aftermath of the COVID-19 pandemic (which disproportionately impacted minority groups) and the numerous social justice movements and rallies (which heightened awareness of systemic racism). Many employees, regardless of socio-economic background, status and salary level, began to look inwards at how they and their employers may be contributing to social injustice, which has naturally led to increasing calls for action on racial equity and DEI more broadly.

The asset management industry was among those sectors where calls for progress on DEI were heard the loudest, in part because the industry has had one of the poorest track records when it comes to diversity. According to research by Investment Company Institute (ICI) and McLagan, as of late 2020 women represented 41.8% of the asset management industry’s workforce while minorities made up 30.5%, with Black financial professionals accounting for just 6.5% of the total workforce. The disparity is even more significant in the senior leadership roles, where 83.7% of executives are white and 74.6% are male.

But even those asset managers with active DEI efforts still fell far short of where many employees wanted them to be. For instance, in 2021 one of the world’s largest asset managers with a stated commitment to DEI was accused of workplace discrimination and harassment by a former employee, who claimed that she was “ sexually harassed and discriminated against on the grounds of [her] race, religion, and gender.” This high-profile case sparked similar accusations and internal investigations at other financial firms, resulting in an industry-wide feeling of comeuppance as previously “untouchable” figures were held accountable for discriminatory actions. This wave of employee protests and callouts is likely only to continue, particularly at the largest firms, until tangible actions are taken to hold everyone accountable.

If firms have not engaged with their employees on feedback related to DEI initiatives, and efforts they would like to see the firm undertake, the time for this type of honest engagement is now.

Recommendations for fund managers on their DEI journey

No investor or employee is going to expect an investment management firm to make significant progress overnight on DEI issues, but prioritizing tangible action is key. There are several steps that fund managers can take TODAY to demonstrate their intentions and to respond to pressure from different stakeholder groups.

  • Collect and review the firm’s diversity statistics, with data at a minimum on employee race and gender. Some managers may want to go further and also collect data on LGBTQIA+ status, disability status and veteran status.
  • Set specific diversity targets for both existing employees and new hires. This may also involve instituting a training and retention program aimed at ensuring diverse employees have access to equal resources and opportunities to rise through the ranks. Firms with relatively low turnover, or those that do not have open positions on a regular basis, should develop DEI priorities and efforts that the firm can work toward now, such as partnering with a non-profit focused on promoting DEI in finance. Solicit employee feedback on these targets and priorities before finalizing the DEI plan.
  • Talk to recruiters about diversity priorities to make sure diverse candidates have access to job postings and an entry point into the talent pipeline. Some managers may also want to consider taking a different approach to campus recruiting by extending opportunities to students at colleges that aren’t typically on the radar of Wall Street firms.
  • Educate employees about DEI issues, such as unconscious bias and racial discrimination. Ideally, these training programs should come with support from senior leadership to show that DEI is a priority across the organization, and should be led by experts on DEI topics.
  • Consider conducting a DEI audit. A third-party evaluation of firm culture can lead to a better understanding of which systemic behaviors may need to be addressed in order to build a welcoming and inclusive environment for current and future employees. For example, State Street recently committed to an external civil rights audit as part of its DEI efforts.

These initial steps are only the beginning, but they can help set up fund managers for success long-term, especially as DEI priorities and demands shift in response to the changing times. We urge you to stay curious and diligent as these conversations evolve. Silver will continue to share best practices and looks forward to engaging with our clients on these important issues as they continue to unfold.