Private equity fund management teams led by women or people of colour have historically been the exception rather than the rule. This could all be about to change, however, with a groundswell of institutional capital shifting towards programmes focused exclusively on female- and minority-led funds.
Big money moving towards diverse GPs
Some of the largest LPs investing into private equity have earmarked meaningful amounts of capital to support the establishment and development of emerging and diverse-owned managers. Notably, many U.S. public pensions funds have implemented such programmes recently.
The reasoning behind this change in allocation strategy varies for each institution. For some, diverse and emerging managers are the next generation of the private equity industry. Forging relationships with these GPs will build partnerships that are less fee-intensive than a stable of large investments with established fund managers and have the potential to generate increased returns.
The California Public Employees’ Retirement System (Calpers) is perhaps the highest profile example of this approach. The $449 billion pension fund has recently made $1 billion of commitments to programmes aiming to help launch new GPs managed by TPG and GCM Grosvenor. Calpers is overhauling its private equity programme after its CIO said last year that underinvesting in the asset class after the global financial crisis caused the system to miss out on between $11 billion and $18 billion in returns during a “lost decade”. It sees investing with emerging managers as beneficial in two ways: research shows that earlier, smaller funds outperformed later and larger funds. As a large LP in these funds, Calpers will also likely be able to negotiate preferential economics, further increasing returns and reducing the impact of management fees across its portfolio. Secondly, by building relationships with managers early in their career, the pension fund will be high up the list of co-investors when high quality deals are sourced.
For other institutions there are legal requirements to channel capital to minority-owned asset managers. These laws aim to redress the gender and ethnicity balance of the investment industry, and LPs are moving quickly to meet these allocation targets. Massachusetts Pension Reserves Investment Management Board, for example, is mandated to invest at least 20% of its assets in diverse and emerging managers after a bill was signed into law in 2021. Last year, this change saw the $93.2 billion system allocate $424 million to diverse private equity and venture capital managers, including female-founded firms.
Research by New Private Markets last September highlighted nine other pension funds and insurance companies that have dedicated allocations for diverse or emerging managers, with more than $40 billion of assets earmarked for these programmes.
Looking to the future
This development could prove vital to the next generation of private equity managers. With many LPs reaching allocation thresholds, competition for capital is fierce and the fundraising environment is increasingly challenging.
Despite this, it’s arguably the best time ever to be an emerging manager, particularly one with a diverse founding team. Many large institutional investors are allocating meaningful amounts of capital to programmes supporting the development of these firms, aware of the potential for outperformance they offer. A survey for McKinsey & Co’s The State of Diversity in Private Markets: 2022 highlighted the desire on the part of LPs to channel capital towards diverse GPs. This report found that CIOs at institutional investors, when faced with a choice between two comparable private equity firms where one deal team is more gender-diverse than the other, would allocate twice the capital to the more diverse team. This effect was more pronounced for firms with a more racially and ethnically diverse deal team: the survey found LPs would allocate 2.6 times the capital they would pledge to a comparable GP.
In addition to this LP appetite, the service provider ecosystem is also taking steps to help emerging managers overcome some of the challenges that come with founding an investment firm. At IQ-EQ, our Launchpad programme aims to address the gender imbalance in the private equity industry by offering advice, support and preferential service terms to women launching their first fund. This launched late in 2021, and over its first year supported more than 12 funds.