The asset management industry isn’t exactly known for diversity in its ownership ranks, and neither are the outsourced service providers firms often engage. Katie Twomey of Illumen Capital argues for diversity across the board, even in organizations without traditional supply chains.
Diverse-owned firms represent just 1.4% of the $82 trillion in assets under management within the asset management industry. While we can deduce that the outsourced service providers engaged by these asset management firms might follow the same trend, the statistics proving that pattern are hard to find. What we do know is that, due to a wide variety of reasons, such as limited partner (LP) and regulatory pressure, the use of outsourced service providers within the asset management industry has continuously increased.
A recent McKinsey report shares that corporations spend 58 cents of every dollar on payments to suppliers. Further, 83% of small businesses aim to maintain or increase their spending on outsourced services in 2023 in order to reduce expenses and bring industry expertise to their team. Globally, there’s been a push for companies to diversify their supply chains to tackle racial injustice and create more inclusive markets. In 2019, 90% of companies on the S&P 500 index published corporate social responsibility (CSR) reports, many of which cover a company’s impact spanning from internal practices to their supply chain.
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But this same attention hasn’t yet been applied to asset managers. In fact, evaluating asset managers’ outsourced suppliers from an impact and DEI standpoint is a fairly new concept. Corporations have a microscope on their supply chains, so why are we not held to the same standard when it comes to who we choose to engage with?
We are familiar with the importance of including DEI in every aspect of our firms. Now is the time to bring that same DEI lens to our entire sphere of influence.
More optimal performance
A study by Stanford SPARQ found that asset allocators have trouble gauging the competence of racially diverse teams. While this certainly affects investment decisions, the same bias intervenes with who we decide to outsource our work to. A McKinsey analysis found that of the 350 largest M&A transactions closed in 2021, none of the financial advisers or law firms used were minority-owned.
However, there are tens of thousands of ready-to-engage businesses owned by minorities, women, LGBTQ+ people, veterans and people with disabilities. Further, studies have shown that partnering with minority- and women-owned business enterprises (MWBEs) can lead to considerable cost savings.
These MWBEs are also more likely to hire minority talent at a significantly higher rate than the U.S. average. For many asset managers, outsourced service providers engage with the team just as much as internal team members. There is evidence that homogenous teams have worse investment outcomes and that diverse teams correlate with better returns. Engaging diverse outsourced providers can attract underrepresented talent, increase employee satisfaction, positively impact brand reputation and fulfill regulatory and investor needs.
Increased LP focus on DEI in due diligence
From their research with over 2,000 asset owners, Coalition Greenwich found that more than 50% request information related to DEI from their prospective fund managers, having conviction that increased performance is correlated with having a diverse and inclusive workspace. When coming up with questions to ask during the due diligence process, nearly 600 member institutions representing 7,000 investment professionals look to The Institutional Limited Partners Association (ILPA) for guidance. ILPA’s current due diligence questionnaire template now includes questions about suppliers, specifically as it relates to processes and goals related to evaluating diversity among such vendors. Additionally, ILPA provides a DEI roadmap resource to support LPs in implementing and advancing DEI efforts.
As services become more specialized, firms are using a smaller set of service providers, leading to increased risk, especially during times of economic uncertainty. In October 2022, the SEC proposed new oversight requirements relating to outsourcing services and functions to service providers.
While not yet approved, many investment advisers are taking appropriate preparations. One reason cited for the new rule is concentration risk. In the event that a widely used service provider fails, the failure can negatively impact global markets. After what happened with Silicon Valley Bank, this risk is more apparent than ever. With the stress of this type of situation, we are more likely to rely on our biases and habits when choosing the next steps, leading to engaging providers similar to those we’ve worked with in the past, and ultimately compounding the concentration risk.
Set targets and expand networks to meet them
When conducting vendor due diligence, set specific targets, and don’t enter the next phase of diligence until you’ve reached those targets. For example, a target could be that you want at least one out of three providers that you research to be minority-owned. One fund manager shared that while they may not engage only minority-owned providers, they have an internal rule that the provider’s team that they directly work with must have at least one woman of color. If you are having trouble meeting those targets, build relationships with diverse networks. Go out and find diverse providers as opposed to waiting for them to find you.
Remove barriers for underrepresented providers to compete for your business
Without knowing it, we may be removing great service providers from our opportunity set due to our own internal biases, the comfort we get from choosing a provider who was recommended to us or who is well-known or has already saturated the industry, as well as including unnecessary or ultra-specific requirements in our searches. Do we really need a provider that has been around for generations? Or one that has hundreds or thousands of clients that they have retained for decades? Do the onboarding or diligence processes and timeline create resource challenges for the provider? Instead, focus on services, qualifications and technologies required to support your needs as well as the company culture and retention rate. Even better, are there tactics we can employ to make our diligence and onboarding process less burdensome?
Embed your commitment to service provider DEI efforts in internal policies
Efforts codified into internal policy lead to accountability from all stakeholders, as well as budget or firmwide goals attributed to implementing that policy. For example, Popular Bank includes a section on service providers within its diversity policy. The policy prescribes that the company promote and foster relationships with diverse service providers, assess their procurement practices, provide fair and equal opportunity to service providers, build networks to identify diverse service providers and regularly evaluate their use of diverse service providers through qualitative and quantitative metrics.
For our industry to reach its full potential, our DEI efforts should not stop within the confines of our firms. Instead, we must practice what we preach across our entire sphere of influence. Only then will the asset management ecosystem be one that can optimally thrive.