BankThink

Don't overlook diversity as a source of alpha

A decade ago, any discussion of doing good in deploying capital was seen as philanthropy. But today conducting business for profit and impact is recognized as both an investment opportunity and the best tool for addressing the world's most pressing problems.

This is an interesting time where both demand and supply dynamics within the financial sector are providing tail winds for this topic.

On the demand side — with the investors — big changes are happening. There will be a $60 trillion wealth transfer over the next few decades and much of this wealth will be controlled by women and millennials. Studies show that these groups want their investments to have a higher level of positive impact.

EY's annual review of the global wealth and asset management sector listed impact investing as one of the 10 drivers of disruption, alongside fintech, cybersecurity and liquidity risk. EY states that wealth management firms must step up their offerings due to the rising influence of millennials and women and their affinity to these investments. Just a few years ago, no one would have predicted that impact investing would be sharing center stage with cybersecurity and liquidity risk. Wealth management firms are starting to see a specialty in investments that make positive social and environmental change as a competitive advantage.

On the supply side — with investment opportunities — there are changes as well. Let's focus on venture capital as an example, since it is the firestarter in our economy. How is diversity a competitive advantage in venture capital?

Multicolored ropes configured to show an arrow going forward.
Success arrow connection and central network achievement as a business concept with a group of diverse ropes connected to a center as a metaphor for connectivity growth and succeeding in linking to a centralized support structure.

Mitch Kapor at Kapor Capital and Darren Walker at the Ford Foundation have articulated this potential the best. It can be summed up in the quote, "Talent is equally distributed, but opportunity is not." Ability and intelligence cut across race, sex and gender orientation, but opportunity (and you can fill in access to capital) does not. This is an arbitrage play for those who identify talent that the majority of the VC community has discounted and overlooked.

We have a bias in the system that keeps a large segment of our economy on the sidelines. Untapped genius — namely nonwhite, nonmale entrepreneurs — doesn't have access to the fuel needed to bring about untold innovation. The VC community traditionally asks what great company has not been created. We are asking what great entrepreneur has not been funded. What loss to society are we suffering accepting this deficiency in our system?

Let me share a few interesting stats that bring this opportunity into focus. The venture capital industry is dominated by men — it is 89% men and 76% white men. Just 7% of the people in this industry are women, only 1% identify as African-American and less than 1% identify as Latino. Now keep in mind who is making the allocations.

Arbitrage Opportunity No. 1: Out of the $60 billion that VCs invested last year, $1.5 billion went to women-run companies. That is roughly 2%.

But studies show female chief executives in the Fortune 1000 drive three times the returns as S&P 500 enterprises run predominantly by men.

Arbitrage Opportunity No. 2: Of the thousands of venture deals done between 2012 and 2014, so few black female founders raised money that, statistically speaking, they registered as zero. (The exact number is 24 out of 10,238, or just 0.2%.) The few who have raised money averaged $36,000 in funding. In contrast, the typical startup, usually founded by a white male, raised an average of $1.3 million in venture funding — even though most of them fail.

But black women constitute the fastest-growing group of entrepreneurs in the country today. They have over 1.5 million businesses — a 322% increase since 1997. These businesses generate more than $44 billion a year in revenue.

Again, talent is equally distributed, but opportunity is not.

As an investment community, we have to realize that any system with 90% homogeneity is vulnerable, while diversity makes the system more resilient. And it is resilient organizations and investments that will outlast and outperform peers.

For reprint and licensing requests for this article, click here.
Diversity and equality Wealth management Women in Banking
MORE FROM AMERICAN BANKER