Demystifying Racial Justice Investing

There is a groundswell of interest in racial justice among institutional investors as beneficiaries, clients, board members, and staff advocate for investors to take anti-racist action. Myriad investor efforts are underway to promote racial justice.

Some institutional investors are signing racial justice pledges and making public statements. Others are increasing racial diversity and inclusion internally and promoting supplier diversity. Within their portfolios, institutional investor actions span from promoting board diversity to making investments that support job and wealth creation for underrepresented minorities.

This article attempts to provide investors who are interested in racial justice with a range of options.

Investor Racial Justice Pledges and Public Statements

Institutional investors are primarily focused on three racial justice pledges: Confluence Philanthropy’s 2020 Belonging Pledge – A Commitment to Advance Racial Equity; Racial Justice Investing’s Investor Statement of Solidarity to Address Systemic Racism and Call to Action ; and the Responsible Asset Allocator Initiative at New America’s Asset Allocator Racial Equity Pledge. 79 signatories and partner networks representing $572 billion have signed the 2020 Belonging Pledge. The Investor Statement of Solidarity to Address Systemic Racism has endorsements from 210 institutional investors. Meanwhile, the Asset Allocator Racial Equity Pledge is at an earlier stage of development.

Asset managers are also making standalone pledges to advance racial equity, as well as their own public statements of support for the Black community. BlackRock is a case in point. Pledges and public statements are a good start, and the remainder of this article will focus on the actions that are needed.

Institutional Investor Organizational Anti-Racist Initiatives

Institutional investors are focused on diversity and inclusion in recruiting, promotion, and compensation. Sponsors for Educational Opportunity, Robert Toigo Foundation, and John Rogers, Jr. Internship Program in Finance are among several excellent organizations that help talented young people of color enter investment roles. Association of Asian American Investment Managers (AAAIM) is an example of a professional association of people of color in investing.

Institutional investors are also participating in unconscious bias training and hiring diverse investment consultants and other vendors.

Fostering Racial Justice through Portfolio Construction and Strategic Engagement

Advancing racial equity through investment portfolios is multi-layered. Let’s explore select layers below.

Manager selection. Manager diversity is correlated with outperformance: a 2019 study led by Harvard Business School Professor Josh Lerner found that funds managed by diverse-owned firms were overrepresented in the top-performing quartile of mutual funds, hedge funds, and private equity. Similarly, National Association of Investment Companies (NAIC) analysis of the returns of diverse private equity managers found that diverse private equity funds outperformed median US PE funds in nearly 80% of vintage years. As NYC Comptroller Scott Stringer explains, “in addition to fiduciary arguments for selecting diverse managers, breaking down barriers for institutional access to diverse managers requires proactive initiatives with clear goals, an articulated strategy to achieve or exceed those goals, and accountability at the most senior levels of the organization.”

Institutional investors with such goals may wish to hire minority-owned managers or managers with both diverse teams and policies that foster diversity. NAIC, Diverse Asset Managers Initiative (DAMI), New America Alliance (NAA), National Association of Securities Professionals (NASP), and AAAIM are organizations focused on diverse-owned managers.

Strategic engagement with companies. Diversity on corporate boards can drive outperformance: the Carlyle Group finds that within its portfolio each diverse board member is associated with a 5% increase in annualized earnings growth. As a result, numerous institutional investors promote corporate board diversity. Investors can also encourage companies in their portfolios to administer anti-racist training; heighten the focus on diversity in recruiting and retention; and develop and implement pay equity, living wage, and supplier diversity policies. To illustrate, Harvard Business Review research suggests that mandating at least two minorities or women in the pool of finalists is critical and that closing the racial gaps in income could increase US GDP by 14%. Harvard Business School Lecturer Mark Kramer goes further to suggest that companies eliminate the box on job application forms for felony conviction, which disproportionately excludes people of color.

Impact investing. Impact investing advisory firm Cornerstone Capital Group highlights investment approaches that drive solutions to three key components of racial disparity: income inequality; access to affordable housing; and access to capital. Specifically , with respect to income inequality, investors could target companies with strong diversity hiring and supply chain practices. To promote affordable housing, investors might consider affordable housing real estate investment trusts (REITs), affordable housing private equity funds, or affordable mortgage-backed securities (MBS). Regarding access to capital, Kresge Foundation Managing Director Aaron Seybert suggests that “investors may opt to invest in businesses serving vulnerable demographics or make deposits in Black-owned banks or community banks in communities of color.”

Impact investing can mitigate portfolio risk. Anecdotally, affordable housing funds are reporting lower delinquency rates than market rate housing during the pandemic. Similarly, during the Global Financial Crisis, Heron Foundation’s mission-aligned decision to buy only mortgage-backed securities indexed as affordable for the full 30-year life of the underlying loans shielded it from losses from adjustable-rate mortgages during the Global Financial Crisis.

Lists of Black-owned banks and community banks in communities of color abound on the internet. New York-headquartered examples include publicly traded Black-owned Carver Federal Savings Bank in Harlem and FDIC-insured community bank Spring Bank in the South Bronx.

Negative screens. Other investors seek to exclude or engage with investees that exacerbate racial injustice. For example, underprivileged minorities with comparable credit scores were more than three times more likely than white borrowers to receive subprime mortgages between 2004 and 2008 and were more than 75% more likely to have negative equity in 2010 (up from similar likelihood of negative equity in 2005). In addition, guns and private prisons disproportionately harm underprivileged minorities. Accordingly, investors may opt to exclude financial institutions with predatory lending practices, a subset of the prison industrial complex, or gun manufacturers from their portfolios. For example, Black-owned investment firm Robasciotti & Philipson published a racial justice screen for publicly traded companies that excludes prison involvement, money bail involvement, immigrant detention, surveillance, for-profit colleges, and occupied territories.

A Long Walk to Freedom and Racial Justice

According to the Economic Policy Institute, despite progress in other areas, Black unemployment and incarceration rates worsened, while Black homeownership remained the same during the 50 years following the Civil Rights Act of 1968. With today’s heightened focus on racial inequities, racial justice investing initiatives are likely to continue to proliferate. As policymakers and other stakeholders work to advance racial equity in the decades ahead, racial justice investing remains an area to watch.

By Bhakti Mirchandani, Contributor