Advancing Racial Equity Through Your Investments

Building a truly inclusive society will require concerted action across governments, nonprofits, corporations and investors. We increasingly understand the benefits of advancing racial equity but aren’t necessarily aware of the available tools for investors to pursue this goal. Whether considering reducing exposure to objectionable issues, promoting diverse ownership and representation or delving into shareholder engagement, advancing racial equity through investment capital is a journey of discovery, understanding and action. 

Opportunities to integrate racial-equity criteria across asset classes are growing, with research showing that such approaches can achieve market-rate investment returns—or better. Thoughtful guidance and partnership with your Financial Advisor in navigating these opportunities is essential. 

As outlined in our Racial-Equity Investing Guide, investors can consider five approaches:

1. Supporting diverse-owned or diverse-run asset managers;
2. Seeking investments in companies that are creating products and solutions directly addressing the needs of disadvantaged communities;
3. Looking at the diversity and inclusion records of publicly traded companies across industries;
4. Minimizing or avoiding exposure to companies with lagging racial-equity records or whose products and services disproportionately affect disadvantaged communities;
5. Exercising active shareholder dialogue to seek to improve company outcomes across social criteria.

Impact reporting can help monitor and strengthen the impact of each of these approaches. 

By building your portfolio to support companies that take a stand for diversity and show accountability for their actions, as well as supporting diverse-owned firms and more, investors can play a critical role in helping to right historical imbalances. Here’s a closer look at these investment approaches.

While investors increasingly think about a range of social criteria, including the diversity of corporate boards, employees, and senior leaders, fewer investors intentionally integrate diversity of ownership with how investment managers allocate their assets. Some institutions, such as endowments and foundations, have focused specifically on “emerging managers,” a term which can carry many different definitions but is meant to designate promising, often diverse-owned asset managers with more limited track records and fewer assets under management.

At Morgan Stanley, we have highlighted diverse-owned asset managers since 2015, and we have worked to evolve our own due diligence processes to remove barriers and increase opportunities for these managers.

Research shows that diverse-owned asset managers are responsible for less than 1.5% of assets under professional management in the US.¹ Why are so few assets managed by diverse firms? One possibility is that some investors—individuals, families and institutions, as well as the advisors that serve them—harbor implicit bias when selecting asset managers. This finding was the result of a study led by the investment firm Illumen Capital and Stanford University’s SPARQ, a self-described “do tank” that helps policymakers, educators and nonprofit leaders apply social-psychology insights and methods to their work.²

Of note, the performance of diverse-owned asset management firms isn’t statistically different from the industry as a whole, according to a study conducted by Professor Josh Lerner of Harvard Business School, et al., and published by the Knight Foundation and Bella Research Group.³  This study also found that many strategies managed by diverse-owned firms performed in the top quartile of mutual funds, hedge funds and private equity funds.

In addition to firm ownership, other dimensions of a company’s culture, strategy and values can be measured to better understand its approach and contributions to diversity. To look at diversity data more holistically, Morgan Stanley launched DEI signal to enhance our suite of impact assessment and reporting tools. Investors can use the information it surfaces to help measure progress toward diversity in their own portfolios.

When building a portfolio across asset classes, investors should also consider actively allocating capital to funds that invest in companies providing solutions to alleviate social disparities and help disadvantaged communities. This includes identifying products and services creating positive outcomes for communities of color in sectors such as health care, education, energy, affordable housing and more.

For example, investors can support affordable housing and schools or provide access to lower-cost clean energy in diverse communities through tax-exempt bond funds. In addition, investors may be able to support companies creating products and services related to financial inclusion to help close the wealth gap or improve health-care outcomes for communities of color as part of an equity fund.  

Investment funds that factor a holistic set of environmental, social and corporate governance (ESG) considerations into their investment selection process often include racial-equity criteria. For example, as part of social considerations (the “S” in ESG), companies may be evaluated on whether they have diverse representation across employees, as well as policies that support attracting and retaining diverse employees, which can boost talent retention and drive innovation.

As sustainability investors seek to reward companies with a more diverse workforce, research increasingly shows that this can lead to materially positive financial outcomes. For example, companies in the top quartile for ethnic and cultural diversity on executive teams were, according to a leading consulting firm, 33% more likely to outperform the national industry financial benchmark. What’s more, the study found a persistent penalty for diversity laggards. Companies in the bottom quartile of diversity exhibited a 29% lower chance of beating the benchmark.⁴

Sustainable investors have long acknowledged that most companies, even those performing better than their peers, have work to do in achieving balanced representation across race and ethnicity at all levels of their organizations. Sustainable and impact investment firms can also engage shareholders to foster more dialogue, activate proxy voting and file resolutions directly with the companies they own around racial-equity issues. For investors, shareholder engagement can be an important tool to measure through which managers in your portfolios actively engage with the companies they own to influence behavior over time.

For decades, some investors have been focused on avoiding companies that aren’t advancing racial equity. For example, in the 1980s and 1990s, socially responsible investors, including large religious institutions, used their capital to pressure companies to divest from operations in South Africa to protest apartheid.

Today, investors can seek to avoid companies engaged in sectors and industries that disproportionately impact communities of color—for example, the private prison industry or civilian weapons manufacturers. Many of the approximately 300 investment strategies available on Morgan Stanley’s Investing with Impact platform intentionally avoid these industries, as well as corporate laggards in diverse representation across board membership and employees. Investors can also develop custom, separately managed accounts or apply overlay restriction screens on top of traditional investments to avoid these industries.

Once you establish the elements of a portfolio that closely aligns with your values and financial goals, you can work with your Financial Advisor to incorporate some, or all, of the above approaches. One approach is through our Investing with Impact Diversity Portfolios. These options seek to generate broad-based positive environmental and social impact with an emphasis on diversity, equity and inclusion (DEI). You can also invest in our Impact Solutions basket of stocks that addresses global sustainability themes, such as inclusion, as well as health and wellbeing, resource management, climate change, and safety and security. Finally, you can work with your Financial Advisor to construct a custom portfolio that leverages third-party funds to help achieve your unique social goals.

The final step is measuring your progress. At Morgan Stanley, we leverage our patented impact reporting application—Morgan Stanley Impact Quotient^® (Morgan Stanley IQ^®). With this application, clients can identify their racial equity goals and report on their portfolio’s alignment to these goals. If misalignment is identified, your Financial Advisor can use Morgan Stanley IQ^® to adjust portfolio holdings to help improve alignment.

We believe that investors will increasingly be able to position their portfolios to take advantage of more emerging opportunities for racial-equity investing, along with a better understanding of the business case and its ongoing positive impact. This process is not simple, but it can be rewarding. The most important step is the first one—deciding to take action. Racial equity is a complex global problem, but its effects can be mitigated, and solutions can be achieved. An investment portfolio, no matter the size, can have a positive impact.

This article is based on the Morgan Stanley Investing with Impact team’s Racial-Equity Investing Guide. Ask your Financial Advisor for a copy or find an Advisor.