Diversity and Drive
As we continue on this new and rapidly evolving decade, the development of a diverse manager base in the fund industry continues its albeit slow but upward trend. The industry’s outspoken need for more female and ethnic minority managers continues to initiate cultural changes across the investor landscape. Leading industry participants such as LACERA, Texas TRS, CalPERS, NY Common, Kresge Foundation, Mercer, AXA Investment Managers, Cambridge Associates & Railpen to name a few, have all made active structural movements to act on investment diversity and inclusivity over the recent years1. At Stable, this has been a consideration for the last 17…
We are data driven.
Our goal is to build successful strategic partnerships that capture the strong returns emerging Founders have historically generated as well as the upside from their successful growth. We do not do concessionary investing; we seek performance and statistically, studies have shown that firms with a diverse Founder experience superior returns than those without.
From an asset management industry point of view, Willis Towers Watson’s 2023 diversity study showed that across asset classes, investment teams in the top quartile of diversity outperforming those in the bottom quartile by 45bps per annum2. From a public markets perspective, analysis from Bloomberg’s hedge fund database confirm this case: funds either controlled or managed by a minority or female leader had an average return of 6.6% over the previous three years, compared to 3.9% for their peers3. From a PE perspective, an in-depth study conducted by the HHL Leipzig Graduate School of Management across 1,071 PE fund partners involved in 1,295 buyout deals by 117 funds found that diversity amongst investment decision management achieves higher IRRs.4 From a VC point of view, the Harvard Business School paper, “Diversity in Innovation” analyzed a comprehensive data set of every VC organization and investor in the United States since 1990 and noticed that the more similar the investment partners, the lower their investments’ performance. For example, the success rate of acquisitions and IPOs was 11.5% lower, on average, for investments by partners with shared school backgrounds than for those by partners from different schools. The effect of shared ethnicity was even stronger, reducing an investment’s comparative success rate by 26.4% to 32.2%.5
Along with increasing their intrinsic investment value, Founder diversity mitigates the adverse selection that can arise when picking a strategic partner. We overcome this by working with managers who have had life obstacles. These obstacles do not impact their inherent ability. By overcoming these challenges they have the knowledge and experience to overcome future obstacles. Our ‘Past, Present, Future’ framework helps uncover this, as we examine factors such as their financial upbringing, social status, parental loss etc… By paying close attention to the background of a Founder, we can analyze their motivation, resilience, and persistence, which helps to ensuring a better performance and a productive partnership. We see diversity not as an input but as an output of our analysis.
Diversity can therefore be integral to forming successful partnerships for Stable, but why is that the case?
Along with increasing their intrinsic investment value, Founder diversity mitigates an element of adverse selection that can arise when selecting a strategic partner. Utilizing our proprietary due diligence framework around a Founder’s ‘Past, Present, Future’ allows us to examine factors such as their upbringing regarding family wealth, social status, parental loss etc… and to identity those that not only come from different backgrounds but have also navigated various life obstacles that others have not. We feel that this means they are more likely to exhibit motivation, resilience, grit and persistence to generate better performance but also to engage in a productive partnership with Stable and ultimately grow their business.
This analysis of our Founders brings an inherent diversity to our portfolios with ~50% of our Partnerships being Women and/or Minority Owned. As mentioned before, we do not do concessionary investing – but instead we seek cognitive diversity – which is defined as the inclusion of people who exhibit different styles of problem solving and can offer unique perspectives because they think differently6. Generating alpha can be difficult, and outperformance requires a contrarian thought process and the ability to see opportunities that others don’t. From our experience, having this contrarian investment perception requires that a manager is comfortable being different and avoids a herd mentality. By definition, a diverse background indicates that you have grown up in a minority, which we believe provides them with a competitive edge in the markets. As such, this a key element when we evaluate potential partnerships with successful Founders.
Numerous studies confirm this correlation between racial and cognitive diversity. Most notably the Deloitte report ‘The Diversity and Inclusion Revolution’ explores the importance of first fostering inclusion, which then can breed true diversity of thought7. The report shows that culturally and cognitively diverse teams can enhance innovation by 20% and reduce up to 30% risk. Similarly, McKinsey’s Women in Workplace report evaluated the performances of 250,000 participants across 600 companies8. Companies in the top quartile for racial and ethnic diversity were 35% more likely to earn returns above the industry median, and companies in the top quartile for gender diversity were 27% more likely to outperform peers on long term value creation. Embracing background diversity provides access to a wide range of investments, deal flows, and perspectives that are not currently represented in most manager portfolios9.
This focus on cognitive diversity is also particularly relevant to our focus on partnering with Founders deploying more specialist strategies. As explored in our ‘Adverse Selection Seed of Wisdom,’ this specialist focus avoids the adverse selection that may appear in more generalist strategies, and allows us to concentrate on Founders who are differentiated and focused on a defined source of alpha in inefficient markets. Specialist Founders have a deeper, more intimate knowledge of these markets which generalists cannot replicate. We have observed that these Founders are more likely to have an atypical background from the majority of industry participants and their specialist focus has been their avenue to success with their cognitively diverse points of view allowing them to take advantage on these areas of opportunity.
There is another personal value that Founders from diverse backgrounds possess – grit. To succeed as an investment manager, you either have to depend on luck or you have to work harder than your peers, a quality that has proven to deliver results in our industry. As discussed in our ‘Seed of Wisdom – Mayweather, Money, and Motivation,’ the popular explanation is that Founders from less privileged backgrounds have had to work harder than other industry peers to even enter the realm of fund management let alone achieve success, due to the obstacles they have faced and the minimal help they have received10. A report from the Knight Foundation published in December 2021 illustrates how hard diverse managers have had to work and compete with counterparts to be where they are today. Of the $81 trillion in assets under management across the entire industry, just 1.4% is managed by minority-owned firms11.
Founders’ exposure to these challenging environments as part of their background creates a strong sense of resilience which they conceptualize and adapt to the arena in which we work in. There is also a quality bias that emerges, as the higher barriers to entry generally results in only the most innovative, intelligent and hard-working from diverse backgrounds succeed in our industry. These Founders have had to face several hurdles to establish themselves in their roles and this drive is more likely to overcome any further barriers to maintain their competitive advantages compared to Founders that haven’t faced similar challenges. Arguably this would be particular pronounced during recent market dislocations where traits associated with resilience and adaptability allow for superior navigation during these turbulent markets. Data from the COVID-19 market drawdown speaks volumes: women-led public market strategies continued to outperform male-led peers with 43% of women managed funds able to exceed their performance benchmark throughout the market turbulence, compared to 37% for their male counterparts12.
In summary, Stable’s has a desire to identify Cognitive Diversity in the Partnerships we invest in to drives outperformance and successful enterprise value growth. Our unique Stable manager background analysis looks to identity successful Founders because it seeks out two key traits that stem from diversity. For us diversity is an input, not an output:
- Contrarian investors – the key to making money investing is variant perception – you believe something that others don’t, or you see something that others don’t see. To be contrarian, you need to be comfortable being in the minority, and by definition diverse backgrounds mean you have grown up in the minority – we seek cognitive diversity, in whatever shape.
- Resilient investors – to succeed you have to rely on luck (poor strategy) or work harder than everyone else. If you come from less privileged backgrounds, you will have worked harder to get to where you are because you faced more obstacles and received less help.
We find this approach reflects our strong partnership culture and allows us to successfully back the Legends of Tomorrow to create long term value for our investors.
- “Diversity in the asset management industry. On the right track, but at the wrong pace” Willis Towers Watson 2023
- “Asset Owners and Investing in Diversity: Intention versus Action”, Morgan Stanley 2021
- “Hedge Funds Not Led by White Men Outperform Nearly 2 to 1”, Bloomberg, 2020
- “The Impact of Leadership Diversity on Private Equity Fund Performance”, Yilmaz Bekyol & Bernhard Schwetzler, HHL Leipzig Graduate School of Management
- Diversity in Innovation, Harvard Business School 2017
- “Teams Solve Problems Faster When They’re More Cognitively Diverse”, Harvard Business Review, 2017
- “The Diversity and Inclusion Revolution”, Deloitte Review, 2018
- “Women in the Workplace”, McKinsey, 2021
- “Investing in Racial Equality”, Intentional Endowments Network, 2020
- “The Link Between Diversity and Resilience”, MIT Sloan, 2005
- “Knight Diversity of Asset Managers Research Series: Industry”, Knight Foundation, 2021
- “Faster, Higher, Stronger”, Goldman Sachs Market Know How 2021