Challenges Faced by Diverse Investment Managers
July 21, 2020
By Earl Clukies
Even in the most benign investing climates, diverse investment managers face an array of challenges including financing operations, recruiting talent, and engaging top-tier service providers. Designated channels put in place by allocators often trade access and visibility for fee compression and compartmentalization. In a recessionary environment, these issues may be magnified under the guise of risk. EisnerAmper recently discussed these topics in a webinar titled “Special Considerations for Diverse Investment Managers,” with insights from the following panelists:
- William Heard, Founder, CEO & CIO, Heard Capital
- Amy Nauiokas, Founder & CEO, Anthemis Group
- Carl Powell, President, Emerging Markets & Investments Divisions, The Integral Group
Emerging managers are defined as investment managers with assets under management below a certain threshold—usually around $2 billion. Diverse managers are women or people of color who are traditionally underrepresented in the asset management industry. While the two terms are frequently used interchangeably, the distinction between the two is critical to understanding the unique challenges presented to diverse managers.
Managers launching from an established firm can generally rely on their existing network of investors and allocators. These managers are often supported by their former employers with start-up operational and investment capital. Still, they are classified as emerging managers. This puts diverse managers at a disadvantage because established investment management firms tend to not be diverse, thereby diminishing the opportunity to launch according to this model for people with diverse backgrounds. Within the emerging manager paradigm, diverse fund start-ups are competing for allocators alongside those launching with far more resources.
Top allocators tend to invest in fund managers they know rather than fund managers that operate outside of traditional networks such as Silicon Valley’s well known “boys’ club.” When webinar participants were asked which actions they believed would best help investors improve their allocations to diverse investment managers, 10% believed that companies should refocus emerging manager programs to specifically target underrepresented managers, 20% believed that companies should increase allocation to diverse investment managers, 45% believed that companies should re-evaluate the decision-making process of how funds are allocated, and the remaining 25% believed that companies should focus on hiring more for diversity within the allocating organization.
According to a 2019 Knight Foundation analysis including data from a wide range of asset classes, firms owned by white men manage a stunning 98.7% of the $69 trillion dollars managed by the U.S. asset management industry. Also observed in the study was the fact that diverse-owned funds were over-represented among the top quartiles for their asset classes. “Quantifying the performance of diverse funds and the current level of diverse ownership is an initial step to understanding and encouraging diversity in asset management. We hope to increase awareness and knowledge of this important topic and encourage enhanced data reporting in the future,” the study states. It concludes that “there is no statistical difference in performance between diverse-owned firms and their peers. Even when we adjust for risk in mutual funds and hedge funds and compare to public market returns for private equity funds, we do not find consistent differences in results. A common refrain has stated that poor performance among diverse-owned firms has precluded their receipt of greater investment; the findings of this study cast doubt on this assertion.”
When the webinar participants were asked to what extent they are satisfied with how institutional investors/LPs are allocating to diverse and underrepresented fund managers, 3.2% were very satisfied, 16.1% were somewhat satisfied, 48.4% were not satisfied but believed progress is being made, and 32.3% were not satisfied and did not think there is progress being made.
Seed vehicles that target fund managers who are women and/or people of color are a step in the right direction. However, they must be held accountable to their stated goals of actually allocating more capital to these groups.
Further, while various seeders are willing to fund either the fund management company or provide an anchor investment in the strategy, it is important to understand that all investor capital is not the same. For example, first loss capital may be better suited to higher turnover liquid strategies than long-term buy and hold. The alignment of interests and long-term goals is essential to identifying the right investors.
Virtual meetings have leveled the playing field not only for fund managers but also for entrepreneurs seeking venture capital by decentralizing access previously concentrated in business centers like New York and Silicon Valley. It has also helped to break down the barriers to entry presented by traditional networking that has put diverse managers and entrepreneurs at a disadvantage. Certainly, there are also cost benefits to not investing in travel for initial meetings, which can be helpful to diverse managers who are more capital constrained than their counterparts. Ultimately, it’s helpful to meet in person to close deals.
When selecting service providers, it is not uncommon that start-ups managed by diverse managers may “purchase up” and align their companies with the biggest and boldest service provider brands. This includes hiring the more expensive law firms and accountants that most asset managers used to show their company is legitimate for the benefit of potential investors. The added cost burden carries risk, however, and diverse managers are better off finding service partners that will align with the company strategically and for the long term.
To access the transcript of the webcast, please click here.