Ahead of our Impact Investing 101 session, we sat down with Illumen Capital’s Daryn Dodson for a chat about how to reduce racial and gender bias in investments, which can unlock both financial returns and deep impact. Catch Dodson on June 6th as he leads our virtual workshop on the fundamentals of this rapidly evolving space. No prior experience or in-depth knowledge of impact investing is needed to attend!
Keep reading to learn more about Daryn and the work being done at Illumen Capital.
YOUR FIRM SPECIALIZES IN REDUCING IMPLICIT BIAS IN THE INVESTING PROCESS. HOW DOES IMPLICIT BIAS SHOW UP IN THE IMPACT INVESTING SPACE AND WHAT ARE SOME OF THE UNINTENTIONAL EFFECTS?
When we speak about implicit bias within investing and asset management, it’s important to begin by establishing that this is a structural challenge – as a field, we don’t accidentally end up with a mere 1.4% of the over $82 trillion in assets managed by firms owned by women and/or people of color. And that’s even after decades of research establishing that diverse-owned private equity firms match the performance figures of less diverse firms.
So, once we see the systemic nature of racial and gender bias, we can’t unsee it. We see it in hiring processes that rely on often homogenous personal and professional networks that exclude diverse talent. We see it in the trickle of venture funding going to Black, Latinx and Women founders (Black and Latinx founders secured just 2.4 percent of venture funding from 2015-2020, and all-Women founded companies received less than 2 percent of US venture dollars invested in 2022). And we see it, counterintuitively, when Black managers face more bias the higher their performance, as our research with Stanford SPARQ indicates.
All of these dynamics suggest to us that even well-intentioned people within impact investing struggle to allocate to diverse managers and entrepreneurs due to unconscious bias.
HOW CAN MINIMIZING RACIAL AND GENDER BIAS BE A WIN-WIN FOR BOTH INVESTMENT PERFORMANCE AND SOCIAL IMPACT GOALS?
This question leads to the core of Illumen Capital’s thesis. We firmly believe that if you reduce racial and gender bias in the investment process, capital will begin to flow to founders from underrepresented backgrounds. And by driving resources to entrepreneurs who have historically been overlooked and underestimated, you’re creating deep impact.
We are also a research-driven firm. And the evidence suggests that diversity can lead to outperformance, whether it’s a return on investment up to 7 percent higher for firms that reduce the effect of bias in their decision-making process, gender diverse fund management teams delivering stronger net IRR numbers compared to non-gender diverse teams, or companies with more racial diversity experiencing a 33 percent increase in likelihood of out-performance on operating margin.
So yes, we believe reducing racial and gender bias can unlock financial returns as well as impact.
CAN YOU GIVE US AN EXAMPLE OF AN INVESTMENT BLINDSPOT AND HOW YOUR APPROACH COUNTERED IT?
One blind spot we often see is the belief that diverse teams will automatically allocate to diverse founders. Yet unless you reduce bias throughout the investment process, diverse teams are still subject to the structural barriers that limit the flow of capital to overlooked and underrepresented entrepreneurs.
That’s why it’s important to slow down and properly evaluate your entire investment process in order to identify and address bias. For example, is your firm’s in-take process open, transparent, and accessible, allowing entrepreneurs to submit a cold inquiry that is given equal weight to other opportunities? During pitches, do you ask the same types of questions of all founders, knowing that evidence suggests male founders more often receive questions about the potential for gains while women get asked more about potential for losses? And during the selection process, does your team employ a scorecard using a standardized set of criteria to create a more equitable playing field?
Building a diverse investment team is key to driving capital to entrepreneurs of color, but systems and processes must also be developed in an equitable and inclusive way. These are a handful of the questions we ask our managers as we begin working with them to reduce bias.
WHAT IS A COMMON MISPERCEPTION YOU ENCOUNTER ABOUT IMPLICIT BIAS IN INVESTING?
One widespread misperception we addressed in our research is the so-called “pipeline problem.” We often hear from investors that they’d invest in diverse managers and companies if only they had the opportunity – that the pipeline of deals led by women and people of color is limited.
While more work can certainly be done to build a more robust field of underrepresented managers and founders, there’s no shortage of compelling opportunities. In our view, the real issue is structural racial and gender bias that discounts funds and founders that don’t align with the predominant White male norms that pervade asset management. We see it in our research, in which White-led managers were rated higher by professional investors than Black-led managers, all else being equal. We see it in how challenging it can be for first-time diverse managers to gain an attributable track record. And we see it when women founders get dramatically less venture funding despite greater valuation growth at the early stage when compared to their male peers.
WHAT CURRENT DEVELOPMENTS IN THIS SPACE ARE MOST EXCITED ABOUT?
I’m sensing a growing belief in the concept of a “diversity dividend” that is really inspiring – the idea that more diverse and inclusive firms will outperform more homogenous firms. With this, I think we’ll see a number of exciting developments within our field: more capital flowing to firms and founders that have historically been locked out of the capital markets, clearer and more accessible pathways for diverse talent to secure meaningful positions within asset management, and more robust wealth creation for under resourced communities. I am convinced that organizations of all types will increasingly build workplaces where diversity of backgrounds, lived experiences, and cultures is valued and prioritized.