This article is sponsored by CDC Group
Diversity and inclusion had already moved up the agenda at many organisations in recent years, but the events of 2020 have led many investors to take an even harder look at the composition of their own teams, those of the organisations they back, and beyond. From the issues raised by the Black Lives Matter demonstrations to a recognition that unprecedented and uncertain times call for a variety of views and innovative thinking, there is real momentum building around the need for LPs, GPs and portfolio companies to attract and retain diverse talent, from junior hires right up to senior decision-makers.
To date, D&I headlines have largely focused on developed economies, but what is the situation in emerging markets? And what are firms and their investors doing to create diverse and inclusive teams? The UK’s DFI and impact investor is continuing to build on research around this area to better understand the link between diverse teams and GP returns.
We spoke to Clarisa De Franco, CDC’s managing director for Africa funds, funds and capital partnerships to find out more.
What role do you think DFIs can play in promoting diversity and inclusion?
All investors need to consider diversity and inclusion – evidence shows that diversity in teams has a positive impact on financial performance. If you’re not considering this when you invest, you may be capping your returns potential.
As a DFI we have an important role to play in promoting D&I in the GPs we back and in the portfolio companies they invest in. DFIs represent a significant share of LP capital in emerging markets – in our case Africa and South Asia – and we have a duty to move the needle. While a lot of research has been done on diversity in developed markets, we now have more evidence of the importance of gender balance in emerging markets private equity. A recent International Finance Corporation and Oliver Wyman report found gender-balanced GP teams in emerging markets generated returns that were around 20 percent higher than that of male or female-dominated teams. That’s pretty significant.
So how does CDC view diversity?
We believe it’s important to think about diversity in the round. It’s about gender, race and ethnicity, sexual orientation and social and educational background. We believe that you need a well-balanced team that reflects the society it operates in to be successful; you need diversity of thought and experience to reach the best decisions, identify new opportunities and manage risk effectively. With our mandate of investing in Africa and South Asia, we must ensure that our teams are fully representative of the countries and regions they invest in – otherwise, how can they relate and understand the opportunities in their markets?
This applies to us and to the teams we back – diversity brings different experience and networks, a broader dimension that can grow deal pipelines or bring new perspectives. And you’re not just aiming for better financial performance, diversity can increase the development impact of our investments by helping to build broad, sustainable and inclusive markets and economies.
How can you support GPs in creating more diverse teams?
First, we recognise that you can’t tackle all areas of diversity at once – you have to start somewhere, and you have to be systematic. In our own diversity journey, from a capital allocation point of view, we have decided to prioritise gender. In part this is because we felt there was significant untapped opportunity here – it is estimated that $15 trillion is controlled by female consumers worldwide – and because CDC has dedicated resource and created expertise in this area. We use this to provide advice and tools to our GPs and their portfolio.
To be clear, in addition to prioritising female-led teams, we are working to ensure teams are diverse from a holistic perspective. It’s been great that there is much more data around gender – including that female-led teams invest in twice as many female-led businesses – but there’s little that talks about how you go about creating more balanced teams to drive women’s economic empowerment. We have a gender team that works alongside GPs to implement gender-balancing strategies, hosting teach-ins for funds and their investees. We will be launching, in conjunction with the IFC, a gender smart investing guide providing practical advice to GPs and LPs on how to strengthen gender diversity within their firms, incorporate a gender lens into investment decision-making and support portfolio companies to implement their own gender-based initiatives.
What do you look for in the GPs you back when it comes to diversity?
Diversity in teams is an important part of what we look for – and it is increasingly so for other investors. A IFC/Olivier Wyman survey found that 65 percent of LPs view gender diversity as important when committing capital to GPs.
We look for GPs that are considering how to embed diversity and inclusion strategies into their investing process as well as ensuring they have balanced teams at the fund level.
We also look for evidence that a GP is strengthening racial/ethnic and gender diversity within their investment committee – this is a critical driver of decision-making. If an investment team is already diverse, that may be sufficient for now, but we’d still encourage GPs who are not there yet to look at other ways of addressing the issue by, for example, having IC members that reflect the markets and audiences in which their investments are being made, expanding networks to identify better opportunities that will lead to better financial and developmental performance.
Finally, we like to see that GPs are thinking about the legacy of their investments. At exit, we want them to be asking buyers about how they will maintain diversity and the initiatives they have put in place in their portfolio companies.
How are GPs doing on gender-balance in your markets?
It’s a mixed picture. In Africa, there are various well-known female business leaders and politicians such as Graça Machel and Phuti Mahanyele-Dabengwa who are strong role models for women in senior roles.
However, that hasn’t translated into private equity. Based on analysis of our own portfolio, only a few of GPs had gender-balanced teams (defined as having at least 25 percent females in senior leadership positions). We are a founding member of the 2X Challenge alongside the other G7 DFIs, which has mobilised $4.5 billion to support projects that empower women and enhance their economic participation. Through this initiative, Development Partners International – which was co-founded by Runa Alam – recently qualified its ADP III as the first 2X flagship fund, this means it will apply a gender lens to investing and actively promote women’s economic empowerment.
What about other aspects of D&I?
Beyond gender, it is critical that we focus on race and ethnicity. This is more challenging to work on in some respects because there is currently little research and data available. We are encouraged to see Carlyle’s report on the importance of diversity based on their own experience. They found that average earnings growth of portfolio companies with at least two diverse board directors were 12 percent greater than those without diversity. Consequently, Carlyle has committed to ensuring 30 percent of all investee board directors are ethnically diverse.
We also analyse our own investments with this lens. Unless you measure where you are, you can’t adjust what you’re doing and you can’t track progress. We have started with a small sample, it will inform us about racial and ethnic diversity in our GPs and how this is reflected in their portfolio companies.
From preliminary analysis we’ve found that GPs with racially diverse senior teams are more likely to invest in racially diverse portfolio companies. That’s important. It helps promote growth of the private sector, creates a pool of knowledge and skills within our markets that will support economic development. Obviously, other external factors affect the investment opportunities – such as the depth of the market (whether there are enough mature businesses), deal size (where it may be easier for smaller funds to back black-owned businesses because there are few above a certain size) and market-based racial and ethnic nuances that stem from the different histories in each country.
In our top quartile African managers, 93 percent have local offices in Africa, 70 percent have black representation at senior leadership (principal and above) level, whilst only 46 percent have black representation at GP ownership level. This partly supports the theory that local teams tend to perform better. In terms of how/who these managers invest in, nearly half had portfolios consisting of 75 percent to 100 percent locally owned or indigenous businesses (defined by nationality), although only 23 percent of these were black-owned businesses.
As such, given the demographic make-up of Africa, more emphasis must be placed on more representative allocation of capital on the continent. We aim to build on this analysis, collect data, share learnings and provide guidance in the future.
How do you think D&I will develop in your markets over the next five years or so?
My hope is that it will be where ESG is today. Investing and managing according to ESG factors used to be the exception and was often seen as a burden; now these processes are far more deeply integrated and if you are not considering them, you’re behind the curve.
D&I may be more challenging to address in some ways because some people can feel threatened initially and there can sometimes be pushback. If you can get past this, it becomes much more apparent that if you don’t have colleagues from all communities, finding common ground when you’re investing is that much harder and you may not obtain access to all the available pipeline opportunities.
Encouragingly, the issue of gender is starting to progress. I first started talking about this with GPs a couple of years ago and now managers raise it before I even ask. It has also moved from being an explanation of what the senior team looks like to something far more natural – some GPs now talk about complementary skill sets and bringing in individuals who add value in different ways to open new opportunities. This is some progress. We will continue to support this, find ways of moving the industry forward so that we are helping to create diverse and inclusive economies across Africa and Asia.