Diversity and Drive

As this rapidly evolving decade progresses, the number of diverse investment firm Founders continues its slow but upward trend. Leading asset owners such as LACERA, Texas TRS, CalPERS, CalSTRS and NY Common have all made structural changes to act on diversity and inclusivity over recent years.

At Stable, cognitive diversity has been a core consideration for the last 17.

The reason?

We are data driven.

Our mission is to build a future of shared success between Asset Owners and investment firm Founders.  We build strategic partnerships to capture the strong returns emerging firms have historically generated, as well as the upside derived from the growth of their firms. We are not concessionary investors; we seek performance.

Statistically, studies have shown that firms with diverse Founders and teams deliver superior returns than those without. Willis Towers Watson’s 2023 diversity study showed that across asset classes, investment teams in the top quartile of diversity outperform those in the bottom quartile by 45bps per annum.

Within public markets, analysis from Bloomberg’s hedge fund database shows that funds either controlled or managed by a minority background or female leader had an average return of 6.6% over the previous three years compared to 3.9% for their peers.

From a private equity perspective, an in-depth study conducted by the HHL Leipzig Graduate School of Management across 1,071 private equity fund partners involved in 1,295 buyout deals by 117 funds, found that diversity within investment decision-making functions delivered higher IRRs.

In regard to venture capital Founders, the Harvard Business School paper, “Diversity in Innovation” analyzed a comprehensive data set across asset managers in the United States since 1990 and concluded that the more diverse the investment partners of a firm, the greater the performance of their funds. For example, the rate of successful monetization of individual investments via acquisitions and IPOs were 11.5% higher among partners from different schools than those with shared school backgrounds. The detrimental effect of shared ethnicity was also considerable with more ethnically diverse investment partners increasing the comparative rates of successful monetizations from 26.4% to 32.2%.

Numerous studies find that gender and ethnic diversity correlate with cognitive diversity. Most notably a recent Deloitte report ‘The Diversity and Inclusion Revolution’ explores the importance of first fostering inclusion, which can then breed true diversity of thought. The report shows that culturally and cognitively diverse teams can enhance innovation by 20% and reduce risk by up to 30%. Similarly, McKinsey’s Women in Workplace report evaluated the performances of 250,000 participants across 600 companies. Companies in the top quartile for gender and ethnic diversity were 35% more likely to deliver investment returns for investors 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 diversity provides access to a wide range of investments, deal flows, and perspectives that are not currently represented in most Asset Owners’ portfolios.

Based on all this data, we believe diversity can be integral to superior investment performance. We also believe that it can be integral to building successful investment firms.

Building on gender and ethnic diversity, we go deeper and seek certain backgrounds and personality traits that we believe drive better returns. Our ‘Past, Present, Future’ diligence framework helps uncover a broad set of life experiences as we examine factors such as socio-economic background and family dynamics. There is a huge mosaic of data that makes up the journey a would-be Founder has been on to become the investor they are today. When understanding the backgrounds of the Founders we back we seek out two key traits that stem from diversity which we believe are fundamental to the correlation between diversity and superior investment performance – resilience and variant perception.

• Resilience – to succeed you have to rely on luck (poor strategy) or work harder than everyone else. Founders from less privileged backgrounds often will have had to work harder to get to where they are because they faced more obstacles and received less help.
• Variant perception – 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 this cognitive diversity, in whatever shape.

A report from the Knight Foundation published in December 2021 illustrates how of the $81 trillion in assets under management across the entire industry, just 1.4% is managed by minority-owned firms. As discussed in our Seeds of Wisdom ‘Does childhood background impact investing?,’ data suggests Founders from less privileged backgrounds have had to work harder than more privileged peers to even enter the realm of investment management, let alone achieve success. A quality bias thus emerges as higher barriers to entry generally result in the most innovative, talented and hard-working Founders making it through. Adaptability and nimbleness are particularly on show during dislocations where such traits provide the opportunity for superior navigation of turbulent markets. Data from the COVID-19 market drawdown shows women-led public market strategies outperformed their male peers with 43% of women managed funds exceeding their performance benchmark compared to 37% for their male counterparts.

We seek cognitive diversity as a driver of returns. The inclusion of people who exhibit different styles of problem solving and can offer unique perspectives because they think differently seems to us an obvious advantage that all investment firms should harness. Understanding the backgrounds of the Founders we back, and the investment experience that shaped them as a result, is a key part of our due diligence.

• “Asset Owners and Investing in Diversity: Intention versus Action”, Morgan Stanley 2021
• “Diversity in the asset management industry. On the right track, but at the wrong pace” Willis Towers Watson 2023
• “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, 2022
• Diversity in Innovation, Harvard Business School, 2017
• “The Diversity and Inclusion Revolution”, Deloitte Review, 2018
• “Women in the Workplace”, McKinsey, 2021
• “Investing in Racial Equality”, Intentional Endowments Network, 2020
• Knight Diversity of Asset Managers Research Series: Industry”, Knight Foundation, 2021
• “The Link Between Diversity and Resilience”, MIT Sloan, 2005
• “Faster, Higher, Stronger”, Goldman Sachs Market Know How, 2021
• “Teams Solve Problems Faster When They’re More Cognitively Diverse”, Harvard Business Review, 2017