Diverse Private Equity Firms Outshine Benchmarks, Raising Questions About Underinvestment

A recent report by the National Association of Investment Companies (NAIC) has reignited the conversation surrounding diverse-owned private equity firms and their consistent outperformance of industry benchmarks.

Titled “Examining the Returns 2023: Further Evidence of Diverse-Owned Private Equity Firm Outperformance,” the report paints a compelling picture of the expertise and potential within this often-overlooked segment of the investment world.

The report arrives against a backdrop of evolving demographics in the United States. While recent news cycles may paint a picture of heightened public discourse around diversity, the actual landscape is far more nuanced. Based on the 2020 Census, the U.S. population is diversifying rapidly, particularly among younger generations.

The Brookings Institute, analyzing early Census data, found that while 40% of the total population is now considered diverse (up from 30% two decades ago), this figure rises to near parity among those under 16. Similarly, the Census Bureau’s Diversity Index, indicating the probability of two random individuals belonging to different racial or ethnic groups, jumped to 61.1% in 2020, a significant increase from 2010.

This demographic shift underscores the increasing relevance of diverse perspectives in various sectors, including private equity. The NAIC report highlights the superior performance of diverse-owned PE firms:

Superior Returns

From 1998 to September 2022, diverse PE funds (represented by the NAIC Private Equity Index) generated a net Internal Rate of Return (IRR) of 17.23%, a net Total Value to Paid-In (TVPI) of 1.68x, and a Distribution to Paid-In Capital (DPI) of 0.66x. These figures significantly surpass the industry benchmarks established by The BURGISS Group.

Outperforming the Median

The NAIC Private Equity Index consistently outperformed the median BURGISS fund across various metrics. For instance, when comparing IRR by vintage year, diverse PE funds outperformed the BURGISS Median Quartile in 66% of the years studied.

Top Quartile Performance

Notably, the NAIC Private Equity Index performed in the top two quartiles (first or second) 72.2% of the time, with 31% of the funds even achieving top quartile net IRRs during the entire period.

These findings challenge the long-held notion that investing in diverse-owned firms comes at the cost of sacrificing returns. In fact, the data suggests the opposite. By allocating capital to diverse PE firms, institutional investors have the potential to not only enhance their returns but also fulfill their fiduciary duty by considering a wider range of investment opportunities.

Despite the clear evidence, the report also highlights a concerning reality: diverse managers manage less than 2% of the industry’s total assets. This underinvestment persists despite the consistent track record of superior performance documented in the NAIC report and previous studies.

As the financial services industry evolves, the call for inclusivity extends beyond moral considerations. The evidence presented in the NAIC report suggests that embracing diversity is not just the right thing to do, but also a strategic and financially sound decision.

By recognizing the talent and potential within diverse-owned firms, investors can unlock significant value for themselves and contribute to a more equitable and prosperous investment landscape.

by Tony O. Lawson

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