A couple of weeks ago, at Australia’s private equity and venture capital industry conference in Melbourne, the message was clear.
Private equity and venture capital has a diversity problem.
To those in the industry, the observation that the industry is over-indexed with men is hardly news. In fact, this observation was raised or commented on by several key note speakers including CEO of MYOB, Tim Reed, who spontaneously noted the fact that despite being backed by two different private equity firms throughout MYOB’s life, he had never worked with a female private equity professional.
He also commented on how he believed that diversity of backgrounds and perspectives at the board of directors-level was likely beneficial for optimal commercial performance.
Private equity investors take board of directors roles within their portfolio companies, and studies now fairly unanimously support the concept that diverse boards and management not just correlate with, but are a direct cause of, superior fiscal performance.
It therefore begs the natural question: is gender disparity holding the private equity sector back from optimal financial performance?
While the observation is indeed not new, it was perhaps the scale of the diversity issue for private equity that has come as a shock to many.
The Australian private equity industry has a staggering 5% gender diversity. In fact current Australian of the Year, David Morrison AO, who closed the conference speaking specifically to the issue of gender diversity and equality in private equity, joked that the only organisation with a poorer diversity metric was the Catholic Church.
Is private equity hostile to women, or is there simply a “pipeline problem”?
As managing director of an Australian venture capital fund manager, Blue Sky Venture Capital, and one of the few but increasing number of female investment professionals in the private equity sector, I have a first person perspective of this sector’s attitude toward diversity.
The data doesn’t lie, women are woefully underrepresented, but my personal experience certainly doesn’t gel with the concept that private equity is hostile to women.
Throughout my decade in the sector, I have genuinely and overwhelmingly felt welcomed, supported and encouraged by men and women within the sector, across all demographics.
To be sure, there has been the odd occasion when a man struggles with the protocol at greeting (hot tip: just shake my hand, firmly and warmly like you would a man in my role) or I’ve sat across the negotiating table from a male in a one on one scenario, who shuffles uncomfortably in his seat simply from being in a room alone with a woman.
I’ve also had the odd occasion when, among a group in a pitch, men will direct their answers to the other men in room, even if I’ve asked the question.
I’m not excusing that behaviour by any means, but that happens in many, many industries and sectors, private equity certainly doesn’t have a monopoly. My personal experience has been that I have been generously mentored, warmly included and equally treated by (almost exclusively) men I’ve worked alongside or with.
Private equity fund managers are rewarded for performance, and indeed there are many factors that influence fund manager performance, not the least of which includes the collective expertise of the team, the sum of their networks collected over their careers spanning decades.
The data now unanimously supports the fact that diversity, particularly at a board level contributes to (not just correlates with) superior financial performance. Catalyst’s 2007 study showed that gender diverse boards reported a 53% higher return on equity and 63% higher returns on invested capital and the IMF concluded that firms with a larger share of women in senior positions yielded between 8–13 basis point increase in return on assets.
The Peterson institute of International Economics concluded that organisations with 30% female leaders can add up to 6 points to its net margin and Smith, Smith and Verner demonstrated a direct causal effect (rather than simple correlation) between gender diverse boards and profitability.
Indeed, many reasons for this effect have been hypothesised (although not proven) including a lower tendency to group think, better corporate governance, a female consumer perspective and a greater tendency towards long term objectives.
While I certainly would not presume to speak for all women in private equity, if one accepts my experience that private equity is not hostile to women, and increasing diversity improves financial performance and fund managers get rewarded for performance, why is the industry not proactively addressing its 5% diversity metric and recruiting more women?
I believe the real reason private equity has one of the lowest diversity track records of all sectors, is actually quite simple: it’s fat and lazy.
I have been an active party to the sector’s challenges in hiring and promoting a more diverse workplace.
I often hear (and may have even uttered this a few times myself) that there is a “pipeline issue”. The funnels for candidates into private equity have traditionally been management consulting and investment banking, where female representation is also low, so in this way the pipeline is an issue.
But I did not come from either of these backgrounds (in fact, I am a trained biochemist) and the board of Blue Sky Alternative Investments, in particular my colleagues Tim Wilson, managing director of private equity and Mark Sowerby, the founder and CEO, took what was perceived to be a great risk in choosing someone from a non-traditional background to build our venture capital business.
However, the DNA of private equity, is ultimately risk management. Private equity managers are paid to identify, assess and manage risk in parallel with, and often leading to, optimising profitability.
I am certain that we are casting our net too narrowly when recruiting new candidates because we, as an industry, are too risk averse and too lazy to test and manage alternative strategies.
For many established, successful private equity managers, their scale, reputation and experienced team contributes significantly to their fund performance and they are doing just fine, thank you.
For fund managers with large scale funds under management and consistent IRRs of 25–40%, against the backdrop of the ever debated two and 20 fee regime, what is their incentive to change what ain’t broke?
They are too fat.
For the newer, or smaller fund managers, still trying to establish their track record, who are competing in the early to mid market sector, any advantage that might yield a few basis point improvement in their portfolio companies will make a material impact in their performance and the returns to investors.
Yet, astonishingly, they are not finding a way to change the pipeline issue and recruit more women. Given how competitive the sector is, the only reason that makes sense is that they are lazy — no-one has yet disrupted the industry adequately yet to force them to change behaviour.
LPs should be asking fund managers (big or small, established or new) if adding more women to the team would likely increase their net of fees returns by a few extra percent, why are they not they doing it?
Raphael Arndt, CIO of the future fund, spoke at the AVCAL conference of the comprehensive diligence process they apply to fund managers to ensure they are only paying for value, skill and real performance (not free kicks).
Raphael Arndt also spoke of the lengths he goes to ensure diversity in his own investment team, insisting recruiters bring a balanced candidate pool or he doesn’t mandate them.
Given the proven effect of diversity on company performance, I would suggest LPs more broadly might include diversity as a bona-fide talent metric when evaluating GPs to ensure their returns, even from high performing fund managers are optimised.
To be clear, I’m not a supporter of quotas. Im a staunch believer in mertiocracy, but I also acknoweldge that individuals and organisations measure of merit can be narrow, unimaginative and often biased.
As a venture capitalist, I’ve seen the ethos of “innovate or be disrupted” play out too many times to be ignorant to it.
Private equity has remained the same for decades and is ripe for disruption.
Excellent private equity teams take a long time to build, and the nature of the sector is that it takes a long time to bear fruit and build a track record with that team.
The private equity fund managers who will be most influential in the Australian market in 10 and 20 years time will be the ones who are innovative now, who are focused on developing any advantage that will deliver improved returns to their investors.
While we at Blue Sky still have not optimised diversity across our business, we recognise that fund managers who build diversity into their teams now, knowing that in the ensuing decades their networks, expertise, diversity of perspective and likely non-traditional skill set, will materially benefit portfolio companies and maximise the returns to investors and possibly even grow the contribution of private equity to Australia’s GDP from 4% now to double digits within 10 years, will remain competitive.
Those who don’t will be disrupted.
This article was first published on Medium.