Morgan Stanley
  • Investment Management
  • Oct 20, 2021

Pension Funds Lead the Way in Prioritizing Diversity in Investing

Our new survey finds that while many institutional investors believe that seeking out women and multicultural investment managers is a worthy goal, pension fund asset owners practice what they preach.

Over the past several years, various social justice movements have put the spotlight on gender and racial discrimination and inequality, forcing corporate America to reevaluate the ways in which they promote diversity, equity and inclusion, from recruitment to business practices.

One subset within financial services that  could stand to benefit from this sort of assessment:institutional investors. A new survey commissioned by Morgan Stanley finds that asset owners—defined as investment decision makers at large U.S. pension funds, endowments, foundations and insurance companies—may identify prioritizing diversity in investing as a worthy goal, however, they don’t necessarily pursue that goal in meaningful and tangible ways. “As we found in our previous surveys of VCs, asset owners may say they value diversity and that identifying and investing in more multicultural managers is a priority, but the reality is that they have not always followed though,” says Carla Harris, Vice Chairman, Global Wealth Management and Senior Client Advisor.

A deeper dive finds that, despite acknowledging the importance of incorporating diversity into their investment decisions, a majority of asset owners (56%) say that doing so comes at the expense of returns. But is that fear justified?

Source: Asset Owners and Investing in Diversity: Intention versus Action © 2021 Morgan Stanley Smith Barney LLC

Pension Funds’ Commitment to Diversity

For answers, we looked to public pension funds, which are leading the way when it comes to environmental, social and governance (ESG) investing, and building more diverse investment teams. One reason may be their accountability to government regulations on diversity. For example, state laws and local ordinances may emphasize the need to include minority- and women-owned business enterprises in contractual dealings with government entities.1 No such external accountability around diversity exists for private sector funds, which may be why they fall into familiar, “safer” patterns of investing in the same types of investment managers who have a longer track record or have more assets under management—which means that they often overlook shorter-tenure yet promising external management firms that offer greater diversity among their asset managers.

Public pension funds have proven the exception to that private-sector rule, setting an example whereby seeking out diverse managers is ingrained in their culture. “[Diversifying our investment teams] is a major priority for us,” said a senior member of a state public pension fund we interviewed. “The regulatory requirements have been in place for a while, but our D&I priorities have moved past just what is required of us. We do the systematic work across every asset class, manager and transaction. This takes concerted time and effort. You're not going to have all the answers right away; you have to continue to prioritize it and be willing to evolve over time.”

Source: Asset Owners and Investing in Diversity: Intention versus Action © 2021 Morgan Stanley Smith Barney LLC

The Tradeoff Myth and How to Dispel It

Those efforts have produced a body of evidence that runs counter to the fear many asset owners have about a tradeoff in returns if they invest in diversity. Three-quarters of public pension fund asset owners (75%) say that investment teams with sufficient women representation significantly improve the performance of their investments, compared to 15% of other asset owners. Similarly, 63% of public pension fund asset owners say the same of investment teams with sufficient multicultural representation, compared to 13% of other asset owners. 

“Continuing to share such data-backed evidence of the financial benefits of a diversity-based approach with the broader asset owner industry will help to dispel inaccurate beliefs about investing with a D&I mindset and motivate progress,” says Seema Hingorani, Managing Director, Morgan Stanley Investment Management.

Given the trail blazed by pension fund asset owners, how can other asset owners take the necessary steps to follow their lead? Our survey offers six key recommendations:

  1. Publish industrywide data highlighting returns from diverse external managers.
  2. Showcase real-world financial benefits of using Emerging Manager Programs to identify opportunities with newer, smaller and more diverse investment management firms.
  3. Establish standardized practices to formally track external managers’ progress on meeting diversity targets, and to hold them accountable for failing to reach said targets.
  4. Encourage asset owners to instill additional transparency measures around how much of their own organization’s assets under management are invested with diverse external managers.
  5. Elevate leaders who have shown a commitment to investing the time, resources and effort into creating meaningful change around diversity within the organization, including instituting formal policies.
  6. Require consultants to maintain a list of diverse managers for consideration, much in the same way that corporations require recruiting agencies to present diverse candidates for senior positions.  

 

1 http://www.wcasi.com/wp-content/uploads/2016/02/2016-Nationwide-Investment-Diversity.pdf

Want to learn more about our findings and recommendations?

Read the full survey

RISK CONSIDERATIONS

There is no assurance that a portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline and that the value of portfolio shares may therefore be less than what you paid for them. Market values can change daily due to economic and other events (e.g. natural disasters, health crises, terrorism, conflicts and social unrest) that affect markets, countries, companies or governments. It is difficult to predict the timing, duration, and potential adverse effects (e.g. portfolio liquidity) of events.

ESG strategies that incorporate impact investing and/or environmental, social and governance (ESG) factors could result in relative investment performance deviating from other strategies or broad market benchmarks, depending on whether such sectors or investments are in or out of favor in the market. As a result, there is no assurance ESG strategies could result in more favorable investment performance.

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