The issue of diversity in private equity has come to the fore this year in the aftermath of the death of George Floyd and ongoing discussions about racial and gender equality in wider society.
Private equity giants Blackstone, TPG, KKR and Carlyle Group are among firms that have said they have zero tolerance for racism of any kind and have pledged to promote inclusion at their firms as well as foster critical conversations on these issues.
One long-standing investor that knows a lot about encouraging diversity of all types is the Los Angeles Fire and Police Pension System.
The Californian pension has committed over $620 million to 63 diverse and emerging managers since the inception of its specialised manager programme in 2007, pension documents from August show.
For public pensions that are bullish in backing diverse and inclusive managers, it all comes down to the nature of the board that controls the systems, chief investment officer Tom Lopez told sister publication Private Equity International.
“In the US, lots of board members of the retirement systems had been appointed by local politicians, so there’s some reflection of the local community,” Lopez says. Other institutions such as foundations and endowments tend to be more focused on running themselves rather than trying to improve things in other parts of the world, he added.
Three diverse-led firms that have received commitments from the programme are tech and communications-focused Astra Capital Management, venture and growth equity firm Oak HC/FT and Defy Partners, a female-dominated early stage VC firm, documents from the pension’s consultant show.
The pension system’s emerging manager programme began in 1987, investing in stocks and bonds managers that did not have access to institutional investors because of their size or experience as a firm. It commits to first, second or third-time institutional funds with a stated maximum size of approximately $500 million.
It was in 2007 that LAFPP’s board came up with the idea for a formal programme for private equity – the specialised manager programme – with an allocation attached to it. The pension hired StepStone Group to run the programme, Lopez said.
In 2016, LAFPP extended its manager criteria to include firms owned at the GP level by one or more people who identify as minorities, women, disabled veterans and/or lesbian, gay, bisexual, transgender or queer. It was one of the first pension systems in the US to provide this access to the LGBTQ community, according to its 2016 annual report.
The programme also invests in funds that target companies which offer demographically focused products and services to minorities and/or invest in companies located in Los Angeles or California.
LAFPP, which does not have a yearly allocation for the programme, has a soft target of approximately 10 percent of its annual PE commitment pace for specialised managers, according to documents from Portfolio Advisors – the fund of funds manager which also runs its specialised programme. For its 2020 programme, staff recommended $100 million each to Portfolio Advisors and Fairview Capital Partners to invest, and the board opted to raise this to $150 million each to the fund of funds managers, having decided to put more assets into the programme.
Commitment sizes have ranged between $5 million and $15 million. With LAFPP’s assets growing over the years – $25 billion as of August compared with $18.5 billion in mid-2016 – there is more of an emphasis on the plan to grow its exposure to emerging and diverse-owned managers, said Todd Hughes, a managing director at Portfolio Advisors.
LAFPP began investing in PE with a 3 percent target exposure in 1996, committing $18.1 million to the asset class that year. Fast forward to 2020 and the fund has a 12 percent exposure target which stood at 10.28 percent or $2.56 billion of commitments as at end-July, according to pension documents. That figure is set to increase as LAFPP’s board voted in mid-August to boost its target allocation to 14 percent.
The programme has been “very successful”, according to Lopez. Other public pensions that have tried these programmes have been disappointed with the results, as the returns of the emerging manager partnerships they invested in were lower than those of the core funds in their portfolios, he added.
A look at the domestic emerging manager PE programme from the California Public Employees’ Retirement System, for example, shows its performance is lower than its core portfolio. Its two funds of funds managed by GCM Grosvenor – 2012 and 2014-vintage programmes which manage $350 million in total – delivered an 8.5 percent net internal rate of return and 1.2x investment multiple and a 7.7 percent net IRR and 1.1x multiple respectively as of 31 March. This compares with the since inception net IRR of 10.4 percent and 1.4x net multiple as of end-March this year of its overall PE portfolio.
“Going back to the inception of the specialised PE programme in 2007, it’s pretty much tracking the core PE portfolio. Historically, on a quarterly basis, the multiple on investment and the internal rate of return are extraordinarily close to the performance of the core PE portfolio, usually three-tenths of a percent,” Lopez explained.
Hughes told PEI that LAFPP’s specialised manager PE programme, which Portfolio Advisors has been managing since 2010 and which Fairview has co-managed since 2017, has delivered from inception until year end-2019 a net IRR of 11.6 percent and a 1.59x net multiple. The programme’s strong returns have “added value” to LAFPP’s long-term assumed rate of return of 7 percent, he added.
“This is a very important area of focus for LAFPP’s board. In general, there is a heightened interest in investing in diversity and inclusion,” said Hughes.
Portfolio Advisors, which also manages the fund’s core PE portfolio, began informally tracking information on the ethnic composition of LAFPP’s GPs in 2015. In 2018 the firm created a modified diversity matrix that they ask all GPs to voluntarily complete. The form breaks down the sponsor’s workforce by occupation, gender identity, and ethnic background and includes disabled and veteran employees. The firm has compiled diversity information on approximately 40 to 45 private equity funds, according to pension documents.
Challenges to manager selection
Hughes noted that one of the biggest challenges the firm faces when sourcing managers is identifying groups that are LGBTQ-owned.
“You have got to have senior investment professionals in organisations that have declared their sexual orientation and are willing to be public. Returns are first and foremost on the board’s mind and anything we do during due diligence is always focused on returns. But finding managers who are LGBTQ-owned has been more difficult.”
Portfolio Advisors sources such GPs through its global GP and LP networks, placement firms, as well as via cold calling efforts and actual meetings with managers where firm diversity is discussed, Hughes said.
The push to prioritise diversity in private equity comes at an opportune time. US-based firms owned by women and minorities managed just 1.3 percent of assets in the $69 trillion global asset management industry, according to a study from Bella Research Group and the John S and James L Knight Foundation published last year. Only 5.2 percent of such PE firms are women-owned, and they manage approximately 3.4 percent of industry assets. Meanwhile, minority-owned firms represent 3.9 percent of all PE firms and manage 3.8 percent of industry assets, the report revealed.
For Lopez, LAFPP’s specialised programme has built on itself over the years.
“What surprised me a little bit was that over the years, people got to know about the programme,” he said. “We started to get referrals of other funds from GPs that we had invested in.”