When hiring money managers, U.S. pension funds say they have one thing to make clear: It is their fiduciary duty to prioritize firms that can generate strong returns and mitigate risks.

But there are ways that funds make their selection while promoting diversity, regardless of whether they have formal policies for hiring minority- and women-owned programs.

Aside from encouraging inclusiveness within the asset management industry, considering the identity of a firm’s ownership in hiring practices can help allocators create a broad talent base. That can increase the “likelihood of capitalizing on investment opportunities in an increasingly global and diverse world,” said Joanna Bewick, a managing director, portfolio manager and senior consultant at Wilshire Advisors and leader of its DEI and diverse-owned manager initiative.

“We’ve seen over the past five years is increasing interest in DEI in the asset management industry, so in the time that I’ve worked with this initiative I have seen increasing interest in our client base (and) from the consulting industry,” Bewick added. “Even nondiverse-owned firms have improved their reporting when it comes to their diversity statistics.”

In Pensions & Investments‘ survey of the 1,000 largest U.S. retirement plans, 27 of the top 200 plans reported that they have policies or programs to hire firms owned by women, minorities, people with disabilities and veterans.

The data shows 22 plans, including some that don’t have a formal policy, reported investments with diverse firms. Collectively, diverse-owned firms managed a total of $139.6 billion in defined benefit assets.

One such fund without a formal policy is the New Mexico Public Employees Retirement System.

Michael Shackelford, chief investment officer of the $16.3 billion fund, said not having a formal policy doesn’t necessarily mean that PERA isn’t looking at the diversity of firms it hires. After assessing firms for their capabilities and fees, diversity would be looked at as a “tiebreaker,” he said.

By considering the metric of diversity, “we’re telling the manager ‘why aren’t you more diverse?’ I think the more managers hear that from funds and plans, the more likely they are to bring in that entry-level pipeline of more diverse associates and analysts from the junior level, even at the mid level and sometimes the senior level,” Shackelford added. “The more they hear that from allocators, the more likely they’re going to move in that direction.”

A handful of pension funds also run “emerging manager” programs, some with the goal of hiring managers with owners from diverse backgrounds.

Each pension fund has its own definition for what is considered an emerging manager, and they usually emphasize having a sound target strategy as the first criterion.

In the case of the California State Teachers’ Retirement System, West Sacramento, its definition first describes “emerging and diverse managers” as firms that “generate performance aligned with the risk and return objectives” for its portfolio, as noted in the pension fund’s 2022 report on diversity in the management of its investments.

But to support the program, CalSTRS said it pursues opportunities that “promote diversity in the investment industry,” including participating in programs, initiatives and conferences that allow these managers to connect directly with the fund.

CalSTRS reported $3.6 billion in assets with emerging managers in its 2022 diversity report, with the largest share of assets managed by these firms was in global equity, which totaled $1.8 billion. The fund’s global equity emerging managers program started 15 years ago with Bivium Capital Partners, Leading Edge Investment Advisors and Xponance Asset Management, all of which are minority-owned, the report added.

Aside from generating alpha by investing in early stage funds with “a high potential for success,” the allocator’s goals for the program include gaining access to and cultivating long-term partnerships with the next generation of managers, it noted in the 2022 report.

CalSTRS also used these diverse and emerging managers for private equity, fixed income, real estate and inflation-sensitive asset classes.

As of Sept. 30, CalSTRS had $1.8 billion in assets with minority- and women-owned managers, which is close to 0.6% of the fund’s total $307.9 billion.

Teacher Retirement System of Texas, Austin, does not have a policy for hiring diverse-owned managers, but it has an emerging manager program led by senior director Kirk Sims, who defines these firms as those “at an early stage of their life cycle.”

The program’s focus is on small firms that typically have AUM of less than $3 billion, and have private-market funds with a preferred target size of less than $1 billion and are in their fourth or earlier fund.

While generating alpha is the pension fund’s priority, the program will “engage with diverse managers while doing so,” Sims added. Most of the program’s committed capital has been allocated to diverse-owned managers, which Texas Teachers defines as those with at least 33% ownership held by underrepresented demographic groups.

As of Sept. 30, 53% of the program’s commitments are managed by firms owned by African Americans, Asian Americans, Hispanic Americans, women and veterans. Sims said the program started with private equity in 2005, but it has grown to include public markets, real estate and infrastructure.

As of Sept. 30, minority- and women-owned firms managed $2.9 billion, or close to 1.6%, of the Texas Teachers’ total assets of $181.7 billion, while the fund’s emerging manager program managed $6 billion, or 3.3%.

Instead of a broad emerging managers program, the New York State Teachers’ Retirement System, Albany, seeks to expand opportunities in its fund for minority- and women-owned business enterprises, or MWBEs, in accordance with state law. In its guidelines, the $130.8 billion fund defines “traditional” firms to be at least 51% owned by at least one minority group member or woman, while “substantially owned” firms have at least 25% ownership.

NYSTRS established its MWBE strategy to “codify and replicate the best practices for the inclusion” of managers, investment banks, and service providers in the demographic, according to the fund’s 2022-2023 fiscal year report.

As of Sept. 30, minority- and women-owned managers had close to $6.7 billion, or 11.9%, of NYSTRS’ total $56.3 billion assets under external management. Private equity and private debt commitments made up the largest share. NYSTRS also hired these firms to put assets into real estate equity and debt, as well as domestic, international and global equities.

When assessing managers for diversity, some asset owners employ scoring systems for a firm’s ownership or employee base.

New Mexico PERA’s Shackelford said the fund keeps a scorecard for how committed a manager is to increasing diversity among its staff, emphasizing that “it’s not a disqualifier” but rather a “tiebreaker” for when two managers come really close in the hiring process.

In its 2023 investment consultants survey, P&I recently asked investment consultants a question on incorporating diverse managers in manager “screenings/searches.” The results appeared as an even split with 24 firms saying “no” and 25 firms saying “yes,” but under the surface, many of the “yes” answers were qualified.

Several consultants said they incorporate diverse managers only if “client directed.” One response said: “Upon client request we will include DEI in the screening criteria utilized to evaluate manager candidates,” but “to date this has not been requested very often by clients.”

Innovest Portfolio Solutions said its diversity, equity and inclusion rating system for money managers includes “questions on diversity of ownership, portfolio management team, firm demographics, and policies and initiatives in place regarding DEI.” In the P&I consultant survey, the Denver-headquartered consultant said its goal is to “increase meetings with diverse managers,” believing that it “will translate to a higher percentage of diverse investment managers” the firm recommends to clients.

NEPC employs a proprietary DEI scoring system “to evaluate all investment managers’ commitments to DEI practices, as well as their progress.” The Boston-based firm said it developed its own diverse manager policy “to address a possible unconscious bias and the inequitable representation of diverse-owned firms in client portfolios” and created a committee to support this effort.

Since 2018, Wilshire has included a diverse-owned firm in each public securities manager search it conducts for advisory clients, unless they opt out. Doing so captures different matters and perspectives in managing money, in addition to providing a broad set of talent, Bewick said.

NYSTRS will hold its 14th annual Minority- and Women-Owned Business Enterprises Investments and Professional Services Conference on Feb. 15. The following day, the $246.3 billion New York State Common Retirement Fund — which had the most assets managed by minority- and women-owned firms in P&I‘s survey at $31.5 billion — will host its 17th annual Emerging Manager & MWBE Conference.

The events give attendees a chance to not only to gain knowledge about the two pension funds, but also for managers and service providers to network with allocators in the effort to enhance diversity in its strategies. At NYSTRS’ 2023 conference, it had an opening address delivered by Seema Hingorani, founder and chair of Girls Who Invest as well as the managing director and strategic client and talent engagement lead at Morgan Stanley Investment Management. A keynote was given by Tina Byles Williams, CEO, CIO and founder of Xponance.

This year’s conference will be held on the campus of the State University of New York at Albany and include a first-time attendee preconference networking session. The partnership with the university aims to give students a new career pathway, said Heidi Brennan, manager of communications and outreach at NYSTRS.

While the conference will not be streamed live this year, recordings of the event will be available to registrants who are not able to attend in person.

Along with the $35.6 billion Texas Employees Retirement System, Austin, Texas Teachers hosts an emerging manager conference, drawing managers and allocators across the world, including CalSTRS, as the West Coast fund noted in its diversity report.

Since the TRS/ERS Emerging Manager Conference launched in 2012 with 115 attendees, the event has drawn in more than 2,000 attendees annually since 2021, when the in-person event in Austin moved online due to the COVID-19 pandemic.

The 17th annual conference will be held virtually on Feb. 28, and there are no plans to bring the event back in person. Sims said that holding the conference online benefited attendees by eliminating travel costs as well as enabling more members of a management firm to attend and speak with allocators, as opposed to an individual representing the team.