A study led by psychology professor Jennifer Eberhardt found that venture capital (VC) funds led by accomplished black individuals are viewed less favorably by investors than similarly accomplished white-led firms. This is a result of racial bias among asset allocators, who manage monetary decisions for firms and could therefore contribute to “stark racial disparities in institutional investing,” according to the authors of the paper.
“Since the founding, America has grappled with issues of race and prejudice,” said Daryn Dodson, a co-author of the paper and the managing director of Illumen Capital, a private investment firm focused on reducing implicit bias. “The financial sector is not exempt. Many investors may not seem to harbor conscious prejudices or even notice their biased behavior, yet there exist persistent racial disparities across the institutional investor landscape. As a sector, we have to become more aware of how bias shows up in our decision-making and be intentional about reducing that bias.”
The group’s findings were published in “Proceedings of the National Academy of Sciences,” and have recently gained traction due to their insight into the world of investment and racial disparity.
The research found that firms led by people of color are typically more harshly judged by professional investors, reflecting the fact that diverse fund managers comprise a small portion of the market. Fewer than 1.3% of the $96.1 trillion in global assets are being managed by people of color or women, as cited in the study.
“While it’s important to continue to continue work on populating the pipeline with diverse teams, those looking to reduce disparities in this space need to also focus on amplifying the work of well-qualified diverse teams. Bias enters decision-making whenever there’s too much ambiguity in the process,” said Sarah Lyons-Padilla, another co-author of the paper and a research scientist at Stanford’s Social Psychological Answers to Real-World Questions (SPARQ) “do-tank.”
In order to conduct the study, researchers asked 180 asset allocators to evaluate four different venture capital funds: two led by a black male leading a strong or weak team, and the two others led by a white male directing a strong or weak team. They were given summaries of performance history and credentials, and then asked to rate each firm’s performance and potential. Additionally, they were asked how likely they were to begin the investment process for each team.
Researchers concluded that the investors gave higher ratings to the strong white-led team than the strong black-led team. Neither of the weaker terms were likely to be invested in across the board, however, regardless of race.
The investors also perceived less of a gap between the black-led teams than the white-led teams. Whereas the strong white-led team earned much higher ratings than the weak white-led team, the black-led teams earned relatively similar ratings to each other.
“People of color have faced discrimination in various aspects of life over the course of America’s history,” said Michela Martin, a business student at Howard University, a historically black college in Washington D.C. “As [people of cover] break into the business world and start taking on larger roles they’ve historically been overlooked for, I believe it’ll take some time for the industry to adjust and normalize them in these positions of power.”
The researchers concluded that teams led by people of color are more likely to encounter negative bias when confronting investors, leading to the undervaluation of several high-performing funds. The researchers suggested that investment criteria should be tightened in conjunction with a more transparent decision-making process.
“The research shows that asset allocators are actually leaving money on the table by underestimating the value of funds owned by people of color,” Dodson said. “Even beyond that, when companies doubt or underestimate diverse fund managers, they are also limiting their firm’s growth and reach to new audiences. Today, as our world becomes increasingly globalized, diversity and inclusion must be an intentional part of how we do business, and while it starts with who we hire, it is also just as important to provide opportunities for that talent to grow and thrive.”
According to Padilla, it would be a win-win for investors to eliminate the racial bias observed in the study.
“There are certainly barriers to improvement,” Padilla said. “Asset allocators are legally obligated to deliver the highest financial returns possible. Deviating from what’s believed to be a tried-and-true strategy for generating high returns might be considered too risky. We hope our study makes [clear] that not investing in diverse funds is what’s risky.”
Contact Arushi Saxena at 21ArushiS ‘at’ students.harker.org.