One would imagine that investing is one of those decisions that will be based upon clear and rational criteria, but that often doesn’t appear to be the case when investing in startups. Previous research has shown that gender can play a role, with female entrepreneurs less likely to receive investment than their male peers, and now new research from Stanford highlights how race can also play a part in the way investments are made.
The research examined how ‘asset allocators’ deploy capital and make investments, especially when dealing with third party fund managers, of whom less than 1.3% are women or people of color.
“Identifying the root of racial disparities in investing is challenging because there are so few people of color in this space to begin with,” the researchers explain. “Are investors biased against racially diverse teams, or is there just not enough diversity in the pipeline? We decided our first step should be to design a controlled experiment that could tell us whether, all qualifications equal, racially diverse teams face more scrutiny than their racially homogeneous counterparts.”
Biased investing
The team tested three distinct theories, with the first being there is no bias against funds managed by people of color, the second that such a bias only exists at weaker levels of performance, and the final theory that it exists predominantly at higher levels of performance.
The researchers were able to explore differences in judgement among asset allocators when all aspects of the fund’s track record were the same, with the only distinguishing feature being the race of the fund manager.
The results show that asset allocators had distinct difficulty in gauging the competence of racially diverse teams, with this bias especially pronounced at stronger performance levels, where funds led by white fund managers were rated more favorably, whether in terms of investment skills, competence or social fit.
“Controlling assets of nearly $100 trillion, the influence that these beneficial institutional investors have on the entire chain of financial intermediation, capitalism and even society cannot be overstated,” the researchers say. “It is of the highest importance that they invest and operate without bias. This paper and its findings hopefully raise awareness of the types of biases that remain. Racial bias is still alive and well in our country and its system of capitalism, and the investment community needs to do more to counter it in order to live up to their fiduciary obligations.”
The team believe their results highlight that this issue is not simply a problem of under-representation in the talent pipeline, as people of color appear to face the biggest barriers as they establish themselves as strong performers. They plan to further explore the issue to examine potential solutions, but in the mean time urge the industry to begin addressing these worrying findings.
