Diverse managers will bear the brunt of a flight to familiarity

Diversity has been a recurring topic in the private equity industry, and the pandemic and racial justice movement in the US this year have added urgency to the issue.

Against this backdrop, PEI fundraising data for the first nine months of the year show that capital is concentrating on ever fewer managers. The Institutional Limited Partners Association’s Jennifer Choi said at an investment summit in September that this flight to familiarity – LPs focusing on re-ups with managers they already had relationships with before the crisis – was the latest risk investors would face, and that opportunities could be overlooked.

At PEI’s Women in Private Equity Forum this week, panellists noted that a pandemic-altered environment makes it doubly hard for diverse managers to attract new investors. Anamica Broetz, head of investor relations at DWS, said LPs would seek safer options that would be easier to get past their internal investment committees and boards.

Paradoxically, blue-chip GPs upping their game on diversity could make it even harder for diverse managers to attract new relationships. Carlyle Group has set a goal of achieving 30 percent board diversity in its companies by 2023. In June, KKR co-chief executive Henry Kravis said 80 percent of its companies had at least two board directors with diverse backgrounds, a goal it had set several years ago.

An LP that needs to meet its diversity targets will have a choice. It could go with a fledgling GP – albeit one led by people with diverse backgrounds – on which it has yet to perform diligence and whose team it has yet to meet in-person. Alternatively, it could choose an established manager that is already focusing on creating diverse leadership, deal teams and operating teams. The latter option can often appear the safer financial choice.

“That thought sends shivers down my spine,” says the head of Europe, private equity, at an investment consultancy. “As an LP you shouldn’t be taking the easy route. We are paid to choose the best funds for our clients and the onus is on the investor to make the best possible return, not the easiest return.”

All this leads to a potentially troubling state of affairs for diverse managers. Research has shown that investing in diverse or women-owned managers pays off. In a 2019 study, diverse PE funds GCM Grosvenor tracked for the period between 1994 and 2018 performed better than industry benchmarks in 78.6 percent of the vintage years studied.

The pandemic is clearly forcing LPs to double down on managers they know well. But ignoring new and diverse managers at a time like this could be a costly decision down the road.