Create Change By Changing Who Controls the Money
By Ruth Shaber, MD; President of the Tara Health Foundation and co-founder of the Diverse Investing Collective
Investing 101 is all about diversification of assets, but we rarely talk about diversifying the team managing these assets. In 1952, Henry Markowitz, a white male economist, introduced modern portfolio theory which continues to be viewed as the gospel within institutional investing circles. A key concept within this foundational doctrine is the importance of diversification in constructing optimal portfolios; however, the importance of diversification is certainly not adhered to when looking at the people making investment decisions.
Close to 80 percent of asset managers today are male and white. Homogenous all male – and mostly white – teams are an outdated approach to developing cutting-edge investing strategies for today’s world. I’m not the first to proclaim this; but I hope I’m one of the last to have to do so.
There are countless articles scrutinizing the lack of venture capital lending to women- and diverse-led companies. Yet, there’s been little to no movement over the much bigger issue: who controls the allocation of the trillions of dollars invested in traditional asset classes (stocks, bonds, etc.) for the millions of mainstream investors around the world.
Indeed, only 1.4% of total U.S.-based assets are managed by diverse-owned firms. Over the past 20 years the number of female fund-managers has remained unchanged at 14%. And people of color remain significantly underrepresented at around 20% while comprising more than 40% of the US population.
It shouldn’t be the case.
In fact, it’s hypocritical for investment professionals to preach diversified portfolio strategies to clients when the teams managing those investments lack diversity.
Today, women attend business school at rates similar to men, and join financial services firms in entry level positions at rates higher than men. And women of color are 21% of entry level positions. However, both women and people of color are not being promoted into positions with power to manage money. According to McKinsey, for every 100 men promoted to manager, only 86 women are. And from entry level to C-Suite, representation of women of color falls by 80%.
Talk about a lack of return on the total talent pool!
My years of research leading to the publication of The XX Edge: Unlocking Higher Returns and Lower Risk agree with what other reputable scholars have concluded: diversity is an outperformance strategy for both social and financial returns. When women manage money there is more social impact. For instance, from the microfinance literature, we know that women who are given access to loans are more likely to share that money with their families and their communities. This enhanced social impact plays out across all asset classes. For example, women entrepreneurs are more likely to take underserved populations into consideration in their product design and women CEOs of Fortune 50 companies pay more attention to ESG factors.
And what about financial returns? Teams that are made up of people from diverse backgrounds see new opportunities, identify risk differently and manage their budgets more efficiently. Of the huge amount of evidence that demonstrates improved financial returns from diversity, one of the most convincing studies came from Vanguard. The researchers reviewed investment teams for over 2,600 US active equity funds from 2008 to 2001 and found mixed-gender and funds outperformed all other teams, including all-male and all-female teams, and outperformed the benchmark by 38.9 bps per year. Another study from WTW’s in 2020 looked at 400 products across a number of asset classes over several years, including benchmark-relative returns and found “investment teams with diversity, in particular ethnic diversity, tend to generate better excess returns.”
So, why haven’t we moved the needle? First of all, we need to overcome our implicit bias that wrongly tells us that women and people of color don’t belong at financial decision making tables.
But another important contribution to why we are stuck is a lack of transparency and accountability. We can’t change what we can’t see and currently the backgrounds and composition of portfolio management teams is unknown to most investors.
We Need to Create a Systems-Based Approach to Finance
In my long career as a physician and healthcare executive, I saw many changes in the healthcare industry in regards to transparency and accountability. Over thirty years ago the healthcare industry came under fire from external compliance groups about their lack of disclosure in measuring performance. A report from the Institute of Medicine (IOM) highlighted the egregious amount of patient deaths that were preventable in U.S. hospitals. There was uproar. For many years, these healthcare organizations yelled, complained and resisted having to measure and report on their outcomes. But, after decades of public pressure, and countless unnecessary deaths, the vast majority of them realized that transparency and accountability was essential if the system was going to improve and bad outcomes were to be prevented. As a result, these same healthcare organizations that actively resisted the need to report, have figured out how to improve and are proud to disclose their statistics. Today, healthcare firms pay to be measured and certified; it’s a huge cost burden to comply but it is the letter of the law. Most importantly, it has improved care and outcomes and allows consumers of healthcare (patients, insurance companies, employers, etc) to make informed decisions about where to take their business.
Like healthcare, everyone is impacted by the finance industry. How money is invested - which companies and innovations are funded, which CEOs are ousted, which climate policies are reinforced - impacts all of our lives. And, the majority of these decisions are being controlled by teams that don’t reflect the population these decisions impact. Like healthcare, the finance industry will eventually have to comply with public pressure to be transparent and accountable as to who is allocating capital.
We've got a long way to go to create the type of transparency we need so that all investors can make informed decisions about where to take their business.
To raise the stakes, we must recruit asset owners (yes, all of you) to demand transparency.
Active Strategy: Canning Complacency
It’s time to break down financial engineering at its core.
Like any industry, centuries of best practices, continued education, scrupulous research and of course, technology, have improved our abilities in the field. Today, high-net-worth investors care about ESG, impact investing and have other varied core values that guide their decisions. But 95% of the wealth is in capital markets, so retail investors can have tremendous impact, too.
A good financial engineer should be able to make money for them regardless of what constrictions they are handed. Pushback from family offices that they could lose money, or the folks that are entrenched in the “that’s the way it's always been” shouldn’t stop progress.
Indeed, the people who have the money must demand transparency around the demographics of their fund management teams. It’s the first but hardest step. What keeps them from doing so is complacency and “that’s not the way we do business”; nothing more.
Let’s Shift the Investing Paradigm
Since the dawn of the investment industry, capital allocation decisions have been designated by one sliver of the population: older white heterosexual men. Expanding fund management teams to be more diverse will be the revolution we need from the finance industry. In the same way that the healthcare industry emphasized measurement and transparency to improve patient outcomes; the investment industry must do the same to improve both financial and social returns. And as the people who own the money, it is up to us to demand this transparency. Women and people of color have long understood that change starts with asking questions. Let’s start by asking more questions of our financial advisory teams. Let’s push back on the push back. Let’s change who controls capital.
Visit https://diverseinvestingcollective.com/ or email info@diverseinvestingcollective.com to learn how you can diversify your fund teams to change the face of finance.