Race influences professional investors' financial judgments

According to research in the Proceedings of the National Academy of Sciences, race influences the investment judgments of asset allocators. Experts believe this may contribute to the stark racial disparities in the world of institutional investing.

What the researchers say: “We’re living in a society where we’re absorbing images and ideas all the time that influence who we are and how we see the world, even when we’re not aware of it,” said the lead author. “This study takes a necessary and critical look at how bias impacts the investing space through the lens of those in power and provides insight into how decision-makers can better resolve those challenges going forward.”

As the report highlights, “asset allocators” operate via pension funds, endowments, foundations, and sovereign funds, performing two key functions for society and their sponsors: providing high rates of return for the organizations they represent and acting as the base of the global capitalist system, allocating their funds to countless investment opportunities around the world, often through for-profit financial intermediaries (venture capitalists, hedge funds, private equity funds) managed by professional fund managers who attempt to generate a high investment return.

Given their power and influence, it is critical to understand how these asset allocators deploy capital and make investment judgements, particularly across third party fund managers. If asset allocators set incorrect or biased incentives, the entire capitalist system will reflect and reinforce these biases.

Furthermore, while there are $69.1 trillion of global financial assets under management across mutual funds, hedge funds, real estate and private equity, fewer than 1.3 percent are managed by women and people of color. And there has been no systematic investigation of the factors that cause those disparities in investment decision-making until now.

“I’ve observed investors leaving money on the table because they underestimate the value of funds managed by people of color and women,” said another of the authors. “But many of these investors did not seem to harbor conscious prejudices or even notice their biased behavior. This leads me to believe that the problem can be addressed, but we must first clearly define why these issues exist.”

“Identifying the root of racial disparities in investing is challenging because there are so few people of color in this space to begin with,” the researchers said. “Are investors biased against racially diverse teams, or is there just not enough diversity in the pipeline? We decided our first step should be to design a controlled experiment that could tell us whether, all qualifications equal, racially diverse teams face more scrutiny than their racially homogeneous counterparts.”

The research team explored three distinct theories that could explain disparities in investing: 1) there is no investor bias against funds owned by people of color, suggesting that the issue is primarily a talent pipeline problem; 2) bias exists predominantly at weaker levels of performance; and 3) bias exists predominantly at stronger levels of performance.

The study examined differences in judgment among asset allocators when all details about a fund’s track record and qualifications were kept constant except race. Through an online experiment with actual asset allocators, the research team sought to determine whether there are biases in their evaluations of funds owned by black men, and, if so, how these biases manifest.

What the researchers found:

• Asset allocators have trouble gauging the competence of racially diverse teams. Asset allocators’ judgments of the team’s competence were more strongly correlated with predictions about future performance (e.g., money raised) for racially homogenous teams than for racially diverse teams.
• Racially diverse teams face bias at the top. At stronger performance levels, asset allocators rated white-led funds more favorably than they did black-led funds when evaluating investment skills, competence, and social fit.
• Racially diverse teams get the benefit of the doubt at the bottom, but not more funding. At weaker performance levels, asset allocators actually rated black-led teams more favorably than white-led teams in terms of overall performance, investment skills, and ability to raise money. However, understandably they expressed little interest in investing in weaker funds, diverse or otherwise.

So, what? The results suggest first, that underrepresentation of people of color in the realm of investing is not only a talent pipeline problem, and second, that funds led by people of color might paradoxically face the most barriers to advancement after they have established themselves as strong performers.

You see something of the same bias in science where papers written by non-white researchers or papers emanating from Asia or South America, or even Spain and Italy are not regarded as being as worthwhile as those from white researchers, Northern Europe, the US (top-flight institutions only) or Australia.

This is one of the reasons that in TR I only rarely mention the name of the author or the country/institution a study comes from (if you’re really interested you can follow the link and read the original study including authorship and universities the authors are attached to).