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A Longtime Excuse for Not Investing in Diverse Fund Managers No Longer Works


Institutional investors have long said the reason they don’t allocate more money to diverse or minority-led alternative funds and firms is that there are too few of them. That’s no longer an excuse, according to research by StepStone Group, the $150 billion alternative investment firm.

The number of diverse funds has grown significantly, at a 21 percent CAGR since 2010, and they account for more than 8 percent of private equity funds.

StepStone, which now tracks more than 530 firms and 1,000 funds that qualify as diverse in its proprietary private markets library, estimates there were 80 diverse funds in the market seeking to raise about $57 billion in capital commitments in 2023.

The firm acknowledges that its research has some limitations for a conclusive study, including the recency that new businesses were formed and sample size. But despite that, minority-owned firms “undoubtedly raise far less capital than non-diverse firms and face a higher bar when raising subsequent funds,” the report says.

“We wanted to just explore the vast opportunity set in diverse managed funds and really highlight not only the potential outperformance but also how large and unallocated to the universe” investors are, Natalie Zar Walker, a partner at StepStone, told Institutional Investor.

Small private equity funds, especially those with a narrow focus on a sector or subsector, meaningfully outperform larger ones, and nearly all private equity funds that qualify as diverse are small. Nearly all (96 percent) of those analyzed by StepStone are raising less than $2 billion and the majority are only raising the first, second or third fund, Walker said.

In fairness to institutional investors, some of them are managing enormous pools of capital and investing at a scale that makes allocating to small managers challenging. Even some of the largest public pension funds might not have the staff and resources to dedicate to finding, doing due diligence on, and investing in the volume of small managers they would need or like to.

But StepStone argues that where there’s a will, there’s a way, and there are examples of big institutions figuring out ways to invest in diverse managers. In recent years, the Alaska Permanent Fund Corporation rethought its $15 billion private equity allocation and — although not necessarily seeking diverse managers — it started making a higher volume of smaller investments.

StepStone works with smaller diverse managers on getting in front of big institutional investors, Walker said, but limited partners are the ones that need to change, or risk missing out on opportunities.

The bar for diverse fund managers is much higher. StepStone’s research suggests that minority managers are less likely to meet first-time fundraising goals for first-time funds — they raise about 40 percent less capital compared to peers. And when they raise follow-on funds, fundraising success is three times more sensitive to past performance.

Last year and this year have been especially tough, as investors turn to other asset classes and tilt toward larger asset managers during a new market regime. Over the past 24 months, commitments to diverse funds have declined by 85 percent, resulting in a 71 percent decrease in the percentage of total commitments going to diverse managers, StepStone found.

“It kind of ebbs and flows year to year, with 2021 being the high watermark. Not surprising because across the private equity industry that was the peak of the market when the most funds were getting raised and the most capital,” Walker said.

“But today, even though we’ve seen short term pullback in overall allocations and investing, we wanted to highlight that the opportunity that still exists is still a large opportunity, and that you have to be intentional about going out and finding those funds that are in the market.”

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