u.s. foundations diverse am - final draft 1.3 · commissioned by abfe & the prudential...

Commissioned by ABFE & The Prudential Foundation

Sept 2016

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U.S. Foundations: Investing with

Diverse Asset Managers

ExecutiveSummaryItiswellknownthatcharitableFoundationsfundabroadarrayofprogramsthataddressproblemsassociatedwithstructuralinequalityforwomenandminorities.Asidefromthese philanthropic endeavors, most people do not realize these grant-making organizations arealso investment powerhouses with significant influence in the finance industry. A Foundation’sinvestmentdivisionischargedwithpreservingandgrowingtheFoundation’scapital,whichinturnfundsitsmission-drivenprogramming.Thefunctionoftheinvestmentdivision–toprudentlyinvestcapital for the benefit of the Foundation – is an integral part of its success. In most cases, theimportanceoftheinvestmentmanagementfunctionisreflectedinpersonnelstatus,compensation,andreportinglines.To date, only a few Foundations have publicly championed allocating to diverse assetmanagerswithintheirinvestmentportfolio,andtheyhavedonesothroughintentional,structuraladjustmentstobemoreinclusiveinthemanagerselectionprocess.WeembarkedonthisstudyinordertohelpFoundationsshare ideas,beself-critical, andultimatelywork toward thedevelopmentof thebestpracticesthatensuretheyareappropriatelyinclusivewhenselectingassetmanagers.WhilemanyFoundationshave remainedon the sidelines, either skepticalorunawareofmissedopportunitieswith diverse investment managers, this study was a collaborative effort between 18 U.S.Foundationswhoaremindfulabout continued inequality, andareeager toencourageefforts thatexpandpossibilitiesfordiversemanagers.

Table of Contents: Maintaining High Standards (pg 2)

Collaboration is Foundational (pg 2)

Best-In-Class Diverse Asset Managers (pg 3)

Support & Sponsorship from the Board (pg 4)

Hiring Practices & CIO Compensation (pg 5)

Investment Policy Evaluation (pg 6)

Resources (pg 7)

Collaborative Partners in this Study (pg 8)

About Lenox Park (pg 8)

LENOX PARK | U.S. Foundations: Investing with Diverse Asset Managers

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MaintainingHighStandardsWhileRemovingBarrierstoEntry

The investment staff responsible formanaging the capital of a Foundation iswellawareofitsresponsibility,whichistobeagoodstewardofthefundswithwhich it is entrusted. Understandably,Chief InvestmentOfficers (“CIOs”) andtheirstaffmaybewaryofanydirectivethattheyperceiveasimplyingthatthehighstandardstheyholdfortheirassetmanagersshouldbecompromised.Asan organization evolves to be more inclusive, it is imperative to

communicate clearly that maintaining a high performance standard

ensures the best chance of success. It is never the case that making theuniverseofassetmanagersmoreinclusiverequireslessstringentstandardsfordiverseassetmanagers. Rather,whenwetalkaboutbeingmoreinclusive,wemeanmakingsurethosemanagerswhomaynotbenaturallynetworkedarenotunintentionallyexcludedfrommanagingtheFoundation’sassets.Thisinitiativedoes not require weakening performance standards, and there is ampleresearch confirming that diverse asset managers are competitive acrossindustriesandassetclasses.Ofnote,threeofthetop-performingprivateequityfirmstodayareminority-owned.CollaborationisFoundationalWe found that the single most important thing Foundations can do to beinclusiveintheirassetmanagerselectionistoextendtheimpressivecultureofcollaboration thatexistson thegrant-makingsideof theorganization into theinvestmentdivision.MostoftheFoundation’sstaffareunderthegrant-makingumbrella, and are by definition and intent closely aligned with the mission.However,theinvestmentstaffisofteninasiloorganizationally,focusedsolelyonassetmanagement.Byprioritizingcollaborationacrosstheorganization,the CIO and his/her staff can learn from their colleagues outside of the

investment division, which expands their own understanding of what it

meanstobeinclusivewithrespecttomanagerselection.

Informed Revisions for Investment Policies to be

more Inclusive

Greater Awareness of Best-in-Class Diverse

Asset Managers

Sustained Support from Governing Board

& Chief Investment Officer

Collaboration

Q&A Bert Feuss

Sr, Investment Officer, Silicon

Valley Community Foundation

1. How have you maintained high performance standards as you have included diverse asset managers? Equal treatment. We instructed our investment consultant not to change their due diligence standards, but rather do a better job of identifying top-performing diverse managers across all asset classes. Our consultant is expected to apply the same due diligence process to all managers. Staff and the investment committee apply the same vetting rigor when reviewing recommendations from our consultant. The fact that the manager is diverse is not really relevant in the due diligence write-up, recommendation and committee discussion. Diversity data is presented at the end of the analysis as an attribute of the fund. When a manager is underperforming, they are scrutinized like any other manager.

2. Have you found that your diverse

asset managers have performed as well as your more traditional asset managers? So far so good, no differences. Yet, still early days. Five of the eight diverse managers were added in the past two calendar years. Until we have at least 3 years of history with a public securities manager, it’s very hard to say. Even harder to say on private equity funds until at least year 5 or longer. One manager has had disappointing returns relative to the benchmark, however, the manager’s strategy is benchmark agnostic and we have not lost conviction in their approach. It helps to have the consultant’s review and perspective to remain patient if performance is a function of style out of favor as opposed to poor investment decisions, changing strategy, lost focus/conviction, or staff and organizational changes. That said, I would expect to see the same patterns of performance and periodic replacement as with any other managers who evolve over time.

LENOX PARK | U.S. Foundations: Investing in Diverse Asset Managers

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Youwouldbehardpressedto finda21stcenturyorganizationofanykindthatdoesnottoutthebenefitsof“collaboration”.Whileonemightthinkofthiswordto describe a general harmony amongworking groups, what wemean in thiscontext is much more specific. Collaboration is the intentional sharing ofideas,experiencesandstrategieswithotherFoundationsandacrossyourFoundation. While Foundations should prioritize collaborating with theirindustry peers, equally important is the increase of collaboration internally—across the organization. This is a pivotal aspect of growing the diverse assetmanager space, as this internal collaboration creates the conditions necessaryforbestpracticestomaterializeintosuccessfuloutcomes.Thebenefitsofdoingthisareplenty,butthefollowing3outcomesarealmostcertain:

§ Greaterawarenessofbest-inclassdiverseassetmanagers§ SustainedsupportfromtheBoardandCIO§ Informedrevisionsforinvestmentpoliciestobemoreinclusive

AwarenessofBest-In-ClassDiverseAssetManagers

Oneofthebiggestpracticalbarrierstoutilizingdiverseassetmanagersis,quitesimply, lackofawareness. It isnosecretthattheuniverseofassetmanagers ispredominantly white and male. So, in many ways it makes sense thatFoundations are not presented oftenwith diverse choices.However,we foundthat by collaborating with other Foundations and industry experts, Boardmembers and investment staff can be made aware of the rich pool of talentamong diverse asset managers. Ideas are shared and recommendations aremade at industry conferences, networking events, and other collaborativeforums. For example, we talked to one Foundationwhich sponsors an annualevent to highlight diverse managers and bring industry participants together.Leadership can be proactive in setting priorities around this issue and raisingawareness of the many opportunities for education and networking in thediversemanagerspace.

Accessing Diverse Asset Managers

Emerging managers, including those that are diverse, have historically set up their businesses in cities that are

considered financial centers, or perhaps more deliberately, near pools

of capital earmarked for “Emerging Managers”. Those state and local legislatures with the most diverse

constituents have responded to the electorate’s desire to see that an

appropriately inclusive process is in place to determine the best

managers for public pension plans. Consequently, Foundations in states other than CA, IL, NY or TX may be

less likely to meet Diverse Managers if their searches are restricted to

local networks. Collaborative forums though which referrals can be made

are even more critical for Foundations outside of these financial centers.

Fostering an inclusive investment strategy is not without its challenges. One practice that seems to be working well for at least two Foundations we interviewed is outsourcing the entire investment function. This growing trend for Endowments & Foundations (“E&Fs”) is driven primarily by sensitivities to cost, but outsourcing may also include benefits for creating a more inclusive stable of investment managers. Bloomberg Business recently surveyed this landscape and reported(1) that as recently as 10 years ago, there were just a handful of boutique firms that focused on this business; now there are close to 80. According to Bloomberg, E&F assets managed by outsourced firms have increased more than two-fold since 2010: from about $42 billion to $100 billion. This model is inherently flexible, in that while some E&Fs choose to outsource their entire investment function, others may outsource just a portion of their portfolio. This outsourcing model can foster inclusivity because once the Foundation becomes a client, the service provider will interact with staff that are likely more mission-aligned than the average investment professional. The Foundation may be able to set more specific expectations for including diverse asset managers.

Outsourcing the Investment Function


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SustainedSupport&SponsorshipfromtheBoard&CIO

Foundations that have been prudent and successful in allocating capital to diverse assetmanagers are those that havestrongsupportfromtheBoardsoftheirorganizations.Byintentionallycollaboratingwithothersinthefieldandeducatingthemselvesaboutdiversemanagers, supportandenthusiasmat the top level grows. While thismayseem intuitive, thedynamicsofthatsupportareimportant.First,wefoundthatfirmsthataresuccessfulinallocatingtodiverseassetmanagershaveCIOsthatprioritizediversityandinclusion.WealsofoundthatCEOsareoftenmorelikelytochampiondiverseassetmanagersthanCIOs.ThismakessenseinthatCEOswouldpresumablybehiredbyaFoundationinlargepartbecauseoftheirtrackrecordandcommitmenttothemissionandvaluesof theorganization.By contrast,CIOsare, rightly,hiredprimarily for their track record in investing.WhilethesupportoftheCEOisparamount,whatbecameclearthroughourresearchistheimportanceofhavingaCIOwhoisactivelyengagedinandsupportiveofdiverseassetmanagers.CIOsoftencametochampionamore inclusivestableofinvestmentmanagersthroughexposuretothediverseassetmanagerspace,or,inatleasttwocasesduringourresearch,averyspecific“aha”momentthatconnectedthemtotheimportanceofdiversity.Second, we discovered that in practice Foundations tend to be structured in a way that can leave the Investment sidedisconnected from the grant-making side of the firm. This disconnection can result in a noticeable detachment of theinvestment staff from themissionofFoundation.Tobe clear, every investmentprofessionalwe interviewedduring thisstudywasacutelyawareofandcommittedtothemissionsoftheFoundationswheretheyworked.Buttherewasoftenaperceptionthatthe‘missions’weretheresponsibilityofthefolksacrossthehallway,intheprogramssideofthefirm,whilepreserving or growing the capitalwas the responsibility of the investments division.We examined the issues thatmaycontribute to this perception, and found two thatwebelieve every Foundation, particularly Community Foundations orFoundationsthatarenewlyformedorarelessmature,shouldaddress:HiringPracticesandCompensation.During the hiring process these firms should consider CIO candidates and investment staff that have a

demonstrated commitment to diversity and inclusion. Significant thought should be given to the compensation

structure. Specifically, firms should ensure that compensationdoesnot foster a perception that the investment

divisionoperatesseparatelyfromtherestoftheorganization.

From the CIO


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InvestmentPolicyEvaluationandOptimizingtheConsultantRelationship

Astheinitiativetoincludediversemanagersgainsmomentum,theBoardmayfinditnecessarytobemorereflectiveofthesystemsinplaceattheFoundationthatarebarrierstosuccessfullysourcingdiversemanagers.Onewaytoassesthisistoconduct a thorough evaluation of the investment policy. Inmany cases this evaluationwill reveal a need to amend thepolicy and prioritize more inclusive sourcing of asset managers. This process will be strengthened considerably if theauthorsof thepolicy are collaboratingwith theirpeers.By sharing ideas and languagearound investmentpolicieswithotherFoundations,Boardscancreatedocumentsthatdonot justgivelipservicetodiversityandinclusion,butsetsomerealbenchmarksfortheinitiative.Indeed,manyFoundationshaveformalizedsomeprioritiesbyinsistingthatcertaincategoriesofinvestmentsbeexcludedfromtheirinvestmentportfolios.Forexample,oneTrusteewespokewithpointedoutthatitdoesnotmakesenseforthegrant-making side of the firm to support anti-violence programs while the investment side was investing in gunmanufacturers. Likewise, many Foundations that support public health initiatives have made the decision to excludetobacco companies from their investments. This same intentionality can and should be applied to ensuring that theuniverseofassetmanagersfromwhichinvestmentsarechosenisappropriatelyinclusive.ManyFoundationswillrelyonexternalconsultantsforsourcingandvettingassetmanagers.Wefoundabroadconsensusaround the importance of this relationship. Without exception, the Foundation staff who worked with the consultantsstressed the necessity of communicating to their consultants the priorities of diversity and inclusion when presentingmanagers for consideration.Without specific, strong encouragement, most consultants have not recommended diverseassetmanagers.Itisimperativethatconsultantsunderstandtheyareexpectedtobeinclusiveintheirsearch.Tothatend,theinvestmentstaffandBoardneedtoholdtheconsultantsaccountableinmeetingthisgoal.Thegoodnewsisthatweheardseveralaccountsofconsultantsbeingwillingandcapableofthismandate.Inthisarea,too,investmentstaff

willbewellservedbycollaboratingwithindustrypeersabouthowtoapplyconcertedpressuretoconsultants.

The board and/or CEO should set the tone for organization expectations during the interview process with investment professionals. The hiring process should explicitly ask applicants about their commitment to inclusiveness as it relates to investing. While most prospective employees of a Foundation will likely articulate a general commitment to its mission, the Board must specifically screen for a desire to carry that enthusiasm over to the investment staff.

Hiring Investment Staff

CIO Compensation

We examined available public filings for the top 100 U.S. Foundations and found that while some Foundations reward their CEOs and CIOs in line with a more traditional corporate compensation scheme (i.e., the CEO is compensated highest, and other C-level executives make less), in many cases the CIO is paid considerably more than the CEO (“CEO” used interchangeably for CEO, President or Executive Director). We also observed that investment divisions at Foundations that reward the CIO more than the CEO tend to be less active in sourcing or allocating to Diverse Managers. They also seem to be less visible at conferences and less accessible for substantive discussion around the topic of a more inclusive investment portfolio. Our examination causes us to ask the following question: How much influence does a CEO have in setting organizational priorities for the investments division if there is a significant compensation imbalance in favor of the CIO, and/or reporting lines directly into the Governing Board?

CIO Compensation Relative to CEO [5]

Hiring Investment Staff


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ConclusionByexpandingtheiruniverseofassetmanagerstobemoreinclusive,Foundations can generate impressive returns, fully align their investmentportfoliowiththeirmissionalimperatives,participateinthe“democratizationofcapital”,andcultivatethepipelineofdiverseassetmanagers.Foundationshavean impressiverecordandzeal forworkingonissuesofdiversityandinclusion.However,theseprioritieshavenotalwaysworkedtheirwayintotheinvestmentdivisionswhich allocate capital. This is perhapsnot surprising, given that theprimary function of a charitable Foundation is grant-making. The leaders ofthese organizations likely have an expertise and personal affinity for theimportantsocialimpactworkthatreflectstheirmission.However,ourresearchconfirmed that many Foundations want to evolve in a way that prioritizesdiversity and opportunity across the organization. We found thatcollaborationisthefoundationonwhichrobustprioritiesofinclusioncan

be built. As the organization fosters that dialogue, the Board, the

investmentstaffandthephilanthropicdivisionwillcometoseethatthey

are all working together towards a common goal. That shared sense of

mission and purpose will create fertile ground for growing an inclusive

stableofmanagers.n

Investment Policy Guidelines

To ensure the success and continuity of any effort to implement or improve diversity in investment manager selection, it is important that Foundations include specific language in the Investment Policy Statement (“IPS”) that governs all investment activity. Being proactive and thoughtful around the implementation not only makes it possible to evaluate success over time, but it encourages support at all levels within the organization. Explicit IPS language also ensures that any effort is memorialized and can withstand some inevitable turnover at the Governing Board and Investment Staff levels. Institutionalizing the effort should provide clear definitions and expectations so that those who champion this effort are assured it will continue beyond their tenure. Setting clear goals and parameters is paramount. The following are some questions the Foundation should contemplate as it plans to institutionalize its efforts for a more diverse, inclusive stable of investment managers: § How does the organization

define ‘Diverse Managers’?

§ Will the effort be implemented across the entire portfolio, or will there be a particular asset class focus?

§ Will this effort be outsourced or managed through an internal investment division?

§ Are the current available resources at the Foundation sufficient to initiate and maintain a sustained effort?

§ What level of accountability for staff and/or external service providers is appropriate?

§ How much of the total portfolio allocation should be included over time?

§ What does a successful program look like to your specific Foundation?

To further explore these topics, please see “Publications” at

www.lenoxparkllc.com

Our investigation turned out a mixed interpretation of what it means to be a ‘fiduciary’ at a Foundation. Many investment officers understand this responsibility as one tied solely to generating the highest risk-adjusted returns possible for the Foundation’s investment portfolio. Through this lens, there is a general discomfort with negative screening or anything that may be perceived to erode returns. On the other hand, some investment officers, trustees and grant-making staff see alignment of the Foundation’s principles and how it allocates its investment capital as inextricably linked. That said, everyone we interviewed agrees that an inclusive, more diverse selection universe for investment managers does not require weakening performance standards or compromising returns. To us, a ‘fiduciary’ is responsible for including segments of a market that are believed to be systematically excluded, and then making the most prudent investment decisions possible.


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Select Resources

1. August 19, 2016: “Wall Street redoubles fight to manage $100 billion at endowments.” Bloomberg. www.bloomberg.com 2. Institutional Capital calculated from P&I Top 1000 for public and corporate funds, as well as Foundations Center Top 100 for Foundations.

§ Pension & Investments:” The P&I 1,000 Largest Retirement Funds.” March 2016. www.pionline.com § Foundation Center: “Fiscal Totals of the 100 Largest Foundations in the U.S. by Total Assets, 2014.” www.foundationcenter.org

3. Institutional Emerging Manager Programs calculated on most recent publicly available data as of June 1, 2016. Only public funds with more than $30m allocated in a dedicated Emerging Manager effort included.

4. Location of Emerging Managers and cumulative Assets Under Management sourced from Lenox Park’s proprietary database of managers. 5. Latest publicly available 990 Forms were reviewed for the Top U.S. 100 Foundations. This study reflects information from the 20 U.S.

Foundations that list both a Chief Executive Officer and a Chief Investment Officer position in the latest Form 990 filing. 6. Council of Foundations. “10 things every new Foundation board member should know. “ www.cof.org

Notes


AboutthisStudy&CollaborativePartnersWewouldliketoexpressourdeepestgratitudetothefollowingorganizationsfordemonstratingasignificantcommitmenttobetterunderstandingtheDiverseManageruniversebyagreeingtocontributetheirtimeandexperiencetothisstudy.Ingatheringandorganizinginformationforthisstudy,LenoxParkinterviewedandcollaboratedwithseveralindividualsatthe following18organizations.Thisstudywas intended toexamine theirapproachesbyconducting in-depth interviewswithExecutiveManagement,GoverningBodies(TrusteesorBoardMembers),InvestmentStaffandothers.The Studywas designed to uncovermajor themes and thenprovide some guidelines for implementing an effective andsustainableefforttoinvestwithDiverseAssetManagers.

www.abfe.org

www.lenoxparkllc.com [email protected]

www.prudential.com

ABFE is a membership-based philanthropic organization that advocates for responsive and transformative investments in Black communities. Partnering with foundations, nonprofits and individuals, ABFE provides members with professional development and technical assistance that further the philanthropic sector’s connection and responsiveness to issues of equality, diversity and inclusion. Established in 1971 as the Association of Black Foundation Executives, the all-volunteer organization was credited with many of philanthropy’s early gains in diversity.

Lenox Park is an independent Advisory and Technology Solutions firm with offices in New York, NY and Austin, TX. The firm’s clients include Pension Funds, Family Offices, Endowments, Foundations and Financial Institutions. Lenox Park was established in 2009 to address a growing need in the Investment Management industry for independent, conflict-free Advisory work. The firm has been retained by some of the largest institutions in the U.S. to assist in Emerging Manager Internal Audit, evaluating Investment Managers & Strategies and Derivatives & Regulatory Exposures.

Through its Corporate Social Responsibility Group, Prudential has had a long history of helping customers achieve financial security and peace of mind. The organization’s collective knowledge and expertise provides them with a unique understanding of the social issues that contribute to economic inequality. For this reason, the leadership feels it has a critical role to play in ensuring that everyone has the opportunity to achieve economic success.

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u.s. foundations diverse am - final draft 1.3 · commissioned by abfe & the prudential...

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