Asset Managers Who Prepare for Increased Transparency on DEI May See Big Returns

Within an asset management firm’s website may be a page that signals its commitment to diversity, equity, and inclusion (DEI) in ownership, leadership, employment and even investing practices. The commitments and aspirations are both admirable and responsive to the increased scrutiny by investors and asset allocation decision-makers of diversity among the investment management firms they are considering.

Soon, however, asset managers will likely need to provide investors – and regulators – with more than just a URL regarding their DEI efforts. As Securities and Exchange Commission Chair Gary Gensler’s remarks to the Senate Banking Committee on September 15 remind us, both market forces and the SEC are driving a movement towards increased disclosures, reporting and hard metrics from asset managers about diversity in their workforce and management ranks.

Currently, such DEI reporting and disclosures are mainly encouraged, but the ongoing ramp-up provides firms with a unique window of opportunity to fortify their DEI bona fides sooner rather than later, and to take ownership of their DEI narrative before the harder questions start coming in earnest.

Perception v. Reality: DEI in the Asset Management Industry

The focus on DEI in investment management is largely a response to statistics reflecting that, while progress has been made, the value of assets under management (AUM) by minority- or women-owned firms remains relatively low. According to a Knight Foundation report released in December 2021, “diverse representation in terms of AUM has increased over time, particularly for private equity and hedge funds.” Yet diverse-owned firms controlled only 1.4% of assets under management.

Similarly, women and minorities are still underrepresented at the board and senior management levels within asset management firms and fund complexes, though these numbers have also ticked up slightly.

“Consider telling your complete DEI story,” Maurice Collada writes.

Seemingly unimpressed by the pace of DEI progress in the industry, the SEC Asset Management Advisory Committee’s (AMAC) Subcommittee on Diversity and Inclusion issued a report and recommendations in July 2021, making it clear that the subcommittee believes the asset management sector has a real diversity problem:

• “Of the $70 trillion in global financial [AUM] across the investment universe, less than 1% are managed by minority-owned or women-owned firms.”
• “. . . ownership interests by women and people of color in asset management firms remain startlingly and disproportionately low, by any and every objective measure.”
• “Women and people of color also remain dramatically underrepresented (by all objective measures) at the board and senior management levels within asset management firms and fund complexes. This severe underrepresentation also extends to general employment within the industry.”

Disclosure and Reporting: From Suggested to Mandatory?

The AMAC subcommittee’s DEI recommendations, while adopted by the AMAC as a whole, remain just that – recommendations. But the road from recommendation to regulation is not necessarily a long one, and there is a genuine possibility of the SEC moving away from principles-based voluntary disclosures on DEI metrics to mandatory, comprehensive, standardized disclosures.

In remarks to the AMAC when receiving its recommendations, Chair Gensler noted that transparency is “a key first step in improving the diversity and inclusion practices of the asset management industry,” accomplished by methods which could include “requiring disclosure of aggregated demographic information about an adviser’s employees and owners” or “information about an adviser’s diversity and inclusion practices in its selection of other advisers.”

Gensler reiterated the emphasis on detailed DEI reporting in June 2022, saying that “the markets benefit from consistency and comparability that investors can then use to make decisions. That will tend towards having some potentially detailed disclosures.”

And as indicated above, Gensler confirmed before the Senate Banking Committee as recently as September 15 that the SEC will soon release guidance to promote diversity among asset managers.

That is consistent with the AMAC subcommittee’s focus on identifying “areas where increased transparency on matters of diversity and inclusion would have specific benefit relative to investors’ description of what is ‘material’ to their selection of investment advisers and investment funds.”

Recommended Steps

After noting that the “quantitative data on the lack of diversity and inclusion, the qualitative ‘human’ side of experiences shared by women and people of color in the industry, and the call by investors for more transparency on diversity were all compelling (independently and collectively),” the subcommittee recommended that the SEC take the following actions regarding reporting and disclosure by registered investment advisers (RIAs) and investment firms:

• Transparency of Diversity Within a Firm: Require enhanced disclosure in SEC filings by investment advisers required to be registered under the Investment Advisers Act of 1940 (particularly Form ADV), to provide transparency on issues of gender and racial diversity in the workforce, officer ranks, and ownership ranks of advisory firms.
• Fund Board and Fund Adviser Diversity: Require enhanced disclosure in SEC filings for investment companies required to be registered under the Investment Company Act of 1940 (particularly Form N-1A) to provide transparency on gender and racial diversity on the fund board(s) of each fund, as well as issues of gender and racial diversity in the workforce, officer ranks, and ownership ranks of advisory and sub-advisory firms employed by each investment company registrant.
• Transparency of Business Practices for Consultants Who Recommend Investment Advisers and Investment Funds: Require RIAs who serve as either asset allocators or consultants for asset aggregators and/or allocators to include disclosure on whether and to what extent their policies include diverse asset management firms in the pool of those considered and/or selected.

As with any proposed regulatory push, not everyone is on board. For example, in remarks to the AMAC in July 2021, SEC Commissioner Hester Peirce voiced concerns about the AMAC’s “focus on government-mandated diversity classifications” for the asset management industry.

“Would such classifications disempower, rather than empower, people?” Peirce asked. “What if, for example, an African American woman who owns an asset management firm prefers to be identified by her Wharton finance degree and her deep knowledge of fixed-income markets rather than her ethnicity or gender, the characteristics the recommended SEC disclosure mandate might emphasize?”

Industry Action on Transparency

Regardless of SEC action, investors, especially institutional investors, and private fund industry groups will likely demand more DEI information and increased transparency when selecting asset managers and investments, if they have not already.

According to a 2022 Coalition Greenwich study:

• 73% of institutions say DEI standards now factor into their choice of asset managers, with a third of those institutions rating DEI as an “extremely” or “very” important consideration. 
• Almost 90% of U.S. foundations and endowments say that DEI standards play a role in manager selection, with 56% considering DEI to be a “very” or “extremely” important factor.
• 72% of public pension plans say DEI considerations factor into their manager selections, with more than a third describing DEI as “very important” to their selection process.
• Approximately two-thirds of corporate pension plans say DEI can influence manager selection, with slightly less than a quarter rating that influence as “very important.”

In response to these market forces, several investment industry organizations have created digital DEI surveys, guidance, and reporting standards. For example, the CFA Institute launched its Diversity, Equity, and Inclusion Code for the Investment Profession in the U.S. and Canada in February 2022. 

Similarly, the Institutional Limited Partners Association (ILPA) issued a DEI Roadmap focused on private equity managers, which includes the ILPA’s Diversity Metrics Template for PE firms as part of the organization’s Diversity in Action initiative focused on PE managers. Among the scores of signatories across the PE spectrum backing the initiative are some of the world’s largest and best-known private equity managers. 

Forthcoming Obligations Present a Current Opportunity

Whether expected by investors or required by regulators, greater transparency and detailed data about DEI efforts – and results – will likely become industry standard for asset managers in short order. Often and understandably, the initial reaction of asset managers and firms to new or additional reporting demands, no matter the subject, is to see them as burdensome or unnecessary. In this case, however, they could present an opportunity to improve your organization and potentially increase AUM as investors, particularly large institutional ones, incorporate DEI into their asset allocation decisions.

Even if it makes a firm uncomfortable to report on standard diversity metrics, there are other ways to think about DEI.

While hard metrics may have been accepted as the bottom line in the past, such numbers may not tell the whole story. Rather than strictly focusing on the data, consider telling your complete DEI story – specific actions, individual successes, demonstrated commitment, personal testimonials – whether on a website, due diligence questionnaire (DDQ), marketing materials, or even internally. For example:

• A firm could craft a narrative rather than just preparing a spreadsheet.
• Describe efforts to work with diverse service providers and support of women-and minority-owned businesses.
• Highlight contributions to organizations focused on underrepresented populations.

Even if Form ADV or a DDQ boils diversity down to “traditional” metrics like race and gender, consider looking at, and approaching, DEI more holistically – like implementing organizational programs and systems that promote inclusivity and equity. Some examples could include: more flexibility for personnel with different personal demands; providing childcare resources; training around unconscious bias and inclusive intelligence; supporting affinity groups; administering a mentorship program that includes everyone; standardizing interview and review processes to eliminate bias; and reevaluating promotion criteria.

The list could go on and on.

Go “Below the Surface”

Another idea for looking at, and approaching, DEI more holistically is to consider assessing other below-the-surface forms of diversity that also reflect the richness of your people, such as socioeconomic, educational, geographic, generational or experiential backgrounds, military service, or (invisible) disability challenges.

DEI is not easy – especially for smaller firms in highly specialized industries. However, in viewing DEI through a broader lens, and embracing DEI as an opportunity, all indications are that asset management firms will likely strengthen their organization, potentially achieve better returns on their investments and increase AUM, and if nothing else, will be better prepared for the hard DEI questions that are coming.

This article is adapted from an alert to clients of Kleinberg Kaplan. Author Maurice Collada III is a partner of the firm, advising both start-up and seasoned private investment managers in all aspects of their business, including the formation, spinout, structuring and ongoing operation of private investment funds and managed accounts of all types. He is also experienced with SEC registration and examination and ongoing compliance with the increasingly complex private investment management regulatory regimes.

Mr. Collada thanks Juwon Park for her important contributions to the article.