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Discussing the state of diversity in global private markets

Nov 12, 2023 | Public | 0 comments

Since 2020, diversity, equity, and inclusion (DEI) in the workplace has become an important yet polarizing topic for many industries. Findings from McKinsey’s recent The state of diversity in global private markets: 2023 report show the strides the private equity (PE) sector has made to improve gender and ethnic diversity, but they also show the lengths the sector must go to truly achieve parity. In this episode of Deal Volume, McKinsey’s podcast on private markets, McKinsey partner and host Brian Vickery speaks with Alexandra Nee, a partner in McKinsey’s Private Equity & Principal Investors Practice. They discuss noteworthy statistics from the report, DEI trends they are seeing in the sector, and how PE firms can move forward. An edited version of their conversation follows.

Discussing the state of diversity in global private markets

Brian Vickery: It seems, on one hand, DEI in PE is getting better year over year. On the other hand, it doesn’t seem like progress is happening quickly enough. How do you perceive progress today?

Alexandra Nee: There has been incremental progress, and the industry is slowly but steadily bringing in more diverse talent, particularly on the investing side. At the same time, data show that progress is moving slowly at higher levels, specifically senior and managing director levels. So there’s more work to be done.

Brian Vickery: Do more diverse firms produce better investment results?

Alexandra Nee: The reason firms and, in particular, PE investors care about or should care about DEI is because data show correlation between more diverse management teams and financial outperformance. McKinsey data show that companies that have more ethnically or racially diverse leadership teams are 36 percent more likely to financially outperform companies with less diverse management. The same correlation exists for companies with gender diversity on leadership teams, which has a 25 percent higher likelihood of financial outperformance.

Brian Vickery: Why are general partners interested in this topic?

Alexandra Nee: I have the privilege of seeing a lot of PE firms and talking with them about how they are thinking about DEI. Firms can be separated into three buckets. There’s one tranche of companies that are investing in DEI because institutional investors are asking for the metrics. It’s a bit of a check-the-box exercise for them. The second group—which is the majority—has seen the data on financial outperformance and are looking to do what they can to get an edge. So they believe it’s a good thing to do, but they also want to outperform their peers. Finally, the third category consists of true believers who mostly think it’s the right thing to do, and the financial component is an added benefit.

How data can connect DEI to performance

Brian Vickery: Right now, there is not a clear data set that shows that being diverse in certain ways will point to better financial outcomes. How are leading firms balancing the lack of data with pressure from stakeholders to do better?

Alexandra Nee: In 2020, after the killing of George Floyd and during the Black Lives Matter movement, some firms on the leading edge came out with ambitious DEI goals and aspirations. Today, with additional scrutiny, and lawsuits in some cases, firms are being more cautious. A lot of PE firms are now showing their portfolio companies why they believe investing in DEI matters, and they are grounding this belief in numbers. Institutional investors care about this topic and are increasingly asking for data from PE firms, meaning general partners [GPs] are paying more attention to it so they can continue fundraising.

Brian Vickery: The report mentions that limited partners [LPs] are asking for more data about DEI topics from GPs. One anecdote in the report mentions an LP that’s making decisions based on that data—but that’s one investor. What are other LPs doing with all this information?

Alexandra Nee: There is an increasing divide in how we see LPs using this information. Some LPs are using DEI data as a threshold when deciding to allocate their funds, and they will consider companies ineligible for their pool of money if the levels of diverse talent do not meet their thresholds. There are other LPs that are now doing the opposite: one quite public recent example is Kansas’ state pension, which, because of the state’s anti-ESG [environmental, social, and governance] measures, will not invest with firms that have ESG or DEI considerations. However, the majority of LPs, because of the fiduciary duty to stakeholders, look at a company’s track record of performance and expected returns first and foremost, with DEI as a secondary metric.

Brian Vickery: I served a small management team composed entirely of white men. They mentioned that when they see certain institutional investors, they’re getting feedback like, “It’s been hard for us to invest with you based on the constituency of your team.” It’s a conversation that they weren’t having five or six years ago and are having today.

Building promotion-rate parity

Brian Vickery: One striking finding in the report was the difference in promotion rates among genders and ethnicities. Are firms acknowledging their own inconsistencies in promotions?

Alexandra Nee: The lack of gender parity in promotions for investing team members has persisted year after year. Global data shows that, in 2022, men were promoted at higher rates at every level than their female colleagues in investing. When we looked at promotions into the principal level—the level just below managing director in our analyses—men were being promoted at a rate 2.8 times higher than women were. This analysis factors in the pool of available men or women in the level below. So, given that those senior levels already have a narrowed funnel of women, it will be hard to improve the numbers quickly when a promotion gap persists between genders.

Brian Vickery: The parity analysis shows how long it will take us to reach parity, and for some areas, it’s six decades away at the current pace, which is both fascinating and troubling. At the same time, managing director is a difficult role to reach. Most of the folks that we work with were at their firms for a decade or longer before they made managing director. It seems difficult to move faster. How can we accelerate that pace?

Alexandra Nee: The other day, I spoke to a PE client about how gender parity in PE would take more than 60 years, given the current rate of progress the industry is making. They shared that they had just left an ESG climate change summit and learned about the pace glaciers were melting—unfortunately, we can’t even say we’re moving at a glacial pace in PE, because glaciers are disappearing faster than our progress to reach gender parity at the investing managing-director level is moving.

That said, there are things we can do to accelerate progress, and data show that some actions have become even more important today. Some firms are diversifying senior investing talent by looking at professions in industries outside PE to find suitable candidates with comparable skill sets they could hire laterally. So there are ways to broaden the investing team funnel at the middle levels, but primarily, firms are working with a base of entry-level analysts and associates that they want to develop.

Retaining and sponsoring women is one way to help improve the rate of promotion parity. Understanding unconscious bias and conscious inclusion are important aspects of improvement. Without training or capability building for the people who conduct these talent assessments, it’s harder for all colleagues to have an equal chance at being promoted. If a company historically has only one type of person as its example of what makes a good PE managing director—how they look, sound, or carry themselves—it’s hard to envision professionals with other characteristics also being successful in that role. So many firms today need to make quite intentional efforts to grow the types of voices in the room.

Achieving promotion parity isn’t simply about debiasing the promotion process, though; it requires additional attention and focus on the people that are in the pipeline to make sure they’re getting the same opportunities to learn and prove themselves in their day-to-day work, ahead of the promotion conversation. Only by first getting selected to work on the same big or complex deals can diverse talent have an equal track record and chance in the promotion process as their male or white colleagues.

Finally, the 2022 data show that attrition rates for women and people of color from their PE firms were higher than that of their male or white colleagues. Interestingly, they’re not leaving the industry; many are leaving to take a promotion by moving to another firm. That fact emphasizes the importance of understanding, proactively sponsoring, and improving communications to talent that firms hope to retain.

Brian Vickery: Interestingly, entry-level positions are at parity. If firms can keep people in the same ratios they bring them in, they can reach parity faster. Firms put a lot of effort and money into attraction, and keeping those people and developing them over time is valuable for any apprenticeship-based firm. We started by talking about investment returns, but there’s also the business side of running a firm, where protecting talent investments matters.

Alexandra Nee: That also comes back to the business case for why firms want more diversity in their investing teams. PE firms are realizing that they can source and win more types of deals by having a more diverse investment team.

A client told me about a portfolio company in the hair care industry that was in discussions with a few PE management teams that wanted to buy said company. In the end, the portfolio company went with one PE firm over another because the other PE firm brought all men to the management meeting, and two of the three—who were talking about understanding their market and business—were bald. They were trying to convince the company that they understood the product and liked their hairbrushes and products, but it was laughable. This may be an extreme example, but it’s illustrative of the fact that having a more diverse set of folks on your management team enables PE firms to spot more deals than they otherwise would and appeal to a broader set of potential targets.

How PE firms can improve DEI in the short term

Brian Vickery: What are the top things you’re telling firms that they should do for DEI?

Alexandra Nee: Progress today on growing diverse talent at senior levels within PE firms is, interestingly, less about focusing on the numbers and more about focusing on the culture, which means improving inclusion and equity. Some inclusion and equity efforts are quite tactical, such as creating HR policies and benefits. For example, studies have shown that increasing or providing equal parental leave for men and women helps the whole firm become better at ramping deal team members on and off, which, in turn, improves parity of deal opportunities to women and men over time.

Firms are at a juncture where if they are not attracting diversity well, they can pull back from a lot of their goals and statements and use examples of lawsuits as a reason. One stat our study shows is that diversity begets diversity. For example, among top-performing PE firms, the average percentage of women at the managing-director level was 15 percent. But 10 percent of all firms have 44 percent women at the managing-director level. Firms that lead in gender diversity are leading in other areas across the board as well.

I think the political climate now will cause disparate takes on how much DEI matters in the coming years, and that will play into whether the 60 years [to get to parity] gets dramatically shortened or if things just continue as they are.

The post "Discussing the state of diversity in global private markets" appeared first on McKinsey Insights


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