Professional investors favor white-led venture capital funds

When a black-led venture capital firm has an impressive track record, it encounters more bias from professional investors, according to new research.

In the new study, researchers report that when venture capital funds are managed by a person of color with strong credentials, professional investors judge them more harshly than their white counterparts with identical credentials.

These findings, which appear in the Proceedings of the National Academy of Sciences, suggest that funds led by people of color might paradoxically encounter more obstacles after they have proved themselves to be strong performers, says study leader Jennifer L. Eberhardt, a psychologist at Stanford University.

“It’s not simply a pipeline problem,” Eberhardt says. “African Americans who are most qualified, those with the best track record, are getting blocked the most.”

Professional investors and their influence

Professional investors—people who manage money for governments, nonprofits, and companies—do not appear to be hiring or investing in professional fund managers with diverse backgrounds, the researchers say, noting previous research that found that women and people of color manage fewer than 1.3% of the $69.1 trillion in global assets under the four major asset classes: mutual funds, hedge funds, real estate, and private equity.

Professional investors “can counter their biases by developing specific investment criteria and establishing a transparent process for making decisions.”

“Given the power and influence of asset allocators—professional investors—it is critical to understand how they deploy capital and make investment decisions,” says coauthor Ashby Monk, executive director of the Stanford Global Projects Center. “In today’s market, investments flow through professional money managers before taking root in companies and projects. As such, if asset allocators set incorrect or biased incentives, the entire capitalist system will reflect and reinforce these biases.”

To identify any potential racial bias beyond a potential pipeline problem, the researchers asked 180 asset allocators to evaluate four venture capital funds that either black or white men led.

The professional investors encountered four one-page summaries of the funds’ credentials and performance history. There were two versions with a black male managing partner leading either a stronger or a weaker team, and two versions with a white male managing partner leading either a stronger or a weaker team.

The researchers then asked the investors to rate each firm’s overall performance, investment skills, competency, social fit, and their expectations of how much the fund could raise. They also asked the investors how likely they were to take a meeting with the team and begin the investment process.

Evaluating venture capital funds

The researchers found that professional investors rated the stronger white-male-led team marginally higher than the stronger-quality black-male-led team. But when a firm’s credentials were weaker, investors favored the black-led, racially diverse team. However, the professional investors expressed that they were not likely to invest in either of the weaker teams, diverse or otherwise, the researchers say.

Another finding to emerge was a disparity between how professional investors judged stronger and the weaker teams. The researchers found that when investors evaluated the white-led teams, they could easily distinguish between the stronger and weaker firms—they assigned the stronger team higher ratings and the weaker team lower ratings.

However, this did not hold up for professional investors’ assessments of either of the black-led teams. When investors were asked to rate the black-led teams, they were unable to distinguish between the stronger and weaker black-led teams.

“Over 98% of the industry is white and male,” Eberhardt says. “One explanation of this finding could be that investors have rarely seen black-led teams. They simply don’t know how to evaluate them.”

Taken together, these findings suggest how black-led teams are likely to encounter more bias when their credentials are stronger, the researchers say.

The results also suggest that racial disparities in investing are not only a pipeline problem.

“While it is important to work on populating the pipeline, we need to think about how to continue supporting diverse teams who have already established themselves as strong performers,” says coauthor Sarah Lyons-Padilla, a research scientist at SPARQ, a psychology department program that Eberhardt and coauthor Hazel Rose Markus co-direct. “Our results suggest these teams may not receive as much consideration as their white-male-led counterparts.”

It’s a competence issue, too

By undervaluing high-performing funds led by people of color or by overvaluing white-male-led funds, investors may not realize they are missing opportunities for higher financial returns, the researchers say.

“In fact, asset allocators might be violating their fiduciary obligations (i.e., to generate the highest possible returns for their investors) by not investing in funds led by people of color that could produce returns as high or higher than white-male-led funds,” the researchers write.

“Investors should be knowledgeable about successful firms led by people of color,” says Markus, a professor of behavioral science. “They can counter their biases by developing specific investment criteria and establishing a transparent process for making decisions.”

Additional coauthors of the paper are from Stanford Angels & Entrepreneurs and Illumen Capital. SPARQ collaborated with Illumen Capital to examine the sources and consequences of gender and racial disparities in investing.

Funding for the work came from Prudential Financial; the partnership between SPARQ has support from the William and Flora Hewlett Foundation.

Source: Stanford University

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