Organisations running diversity programs that seek to expand recruitment practices to underrepresented demographics, hold anti-discrimination training, or even roll out accessibility measures to people with disabilities, are in the firing line for not being inclusive or open to all.

Although existing or settled law hasn’t changed, US President Trump’s sweeping executive orders to scrap diversity equity and inclusion have introduced risk to diversity, equity and inclusion (DEI) programs, ushering in a new level of uncertainty on what constitutes an illegal DEI policy and raised the spectre of enforcement by the federal government. The situation is most visibly affecting universities, but private companies are increasingly in view. Meanwhile, investment organisations from BlackRock to Citigroup have rolled back DEI to comply with the new regulatory landscape, scrapping workforce representation goals and the need to interview a diverse slate of candidates for open positions.

Some asset owners interviewed by Top1000funds.com welcome the axe-wielding. They say DEI has grown into an industry (estimated at $9.4 billion) of advisors and trainers which, like ESG, is in danger of breaching fiduciary duty in its quest to use other people’s money to engineer social change. Moreover, DEI in its current guise isn’t working because diversity in the investment industry remains poor.

Others worry that scrapping DEI initiatives will impact their ability to hire and retain the diverse talent that they believe is essential for financial outperformance. They say it is already endangering successful emerging manager programs and jeopardising their ability to engage with corporates on diversity – and other issues – that  impact returns.

Undaunted by the new political landscape, the chief investment officer of the Illinois Municipal Retirement Fund (IMRF), Angela Miller-May, has little patience for asset managers that have rushed to review their internal diversity programs or external commitment to the cause because they are worried about compliance with the President’s executive orders.

“For us, this raises the question of whether an asset manager is going to continue to attract talent and have diverse teams, and if we want to continue to invest with them going forward. Most asset managers know this is something we care about but there is a subset that have always wanted to say they cannot think about DEI, or ESG, because they are fiduciaries. They’ve just never equated the two yet having diverse teams that lead to better decision making and positive financial outcomes is being a good fiduciary.”

Still, as IMRF puts pressure on its external managers to maintain their DEI programs, asset owners like the Missouri State Treasury are dragging their managers in the opposite direction.

In February, State Treasurer Vivek Malek who oversees an $18 billion portfolio of state assets mostly invested in fixed income – and whose Indian heritage makes him a less obvious advocate for dismantling DEI among his fellow red-state treasurers – led opposition to a slate of nominees to Vanguard’s board of trustees due to concerns about their approach to DEI and ESG.

“We’ve made it clear to our investment partners that our office will not support practices that prioritise DEI or ESG criteria over fiduciary duty,” he says. “Encouragingly, we’ve seen firms begin pulling back from such strategies as public scrutiny grows and states like Missouri push for a return to core investment principles.”

Diversity within asset owner organisations helps attract talent

Practising what it preaches, IMFR has nurtured diversity internally to the extent that seven of the 16-person investment team are women. Other asset owners have also made it a priority. CalSTRS boasts 50/50 gender diversity within the investment branch and hiring practices at MassPRIM, which is a signatory of the CFA’s DEI Inclusion Code, include “a focus on intentional diversity in each step of [the] recruitment process”, partnerships with “affinity groups” and “regular pay equity studies,” according to its website.

Sociologist Frank Dobbin, the Henry Ford II Professor at Harvard University, is convinced asset owners will struggle to attract skilled and talented staff in today’s competitive market if they drop these supportive initiatives and policies.

“We know from research that when employers send a signal that they are open to diverse candidates, they get more people applying and more people stay on,” he says. Moreover, he believes the threat of the Trump administration prosecuting reverse discrimination cases will have a long-term and chilling effect on all kinds of policies from parental leave to disability support which have helped investors recruit and retain talent.

“Trump is not just telling agencies not to enforce these regulations and employers that the regulations won’t exist. He’s telling employers that he will use government agencies to prosecute them for discriminating against white people, particularly men,” Dobbin says.

Again, it’s an outlook Missouri Treasurer Malek is quick to rebuff. He argues that the American system successfully rewards talent and determination, regardless of race or background, without the need for DEI policies: his rise to become the first person of colour to head Missouri’s State Treasury is testimony to the fact.

The notion that success is only possible with DEI policies is both patronising and false

“The notion that success is only possible with DEI policies is both patronising and false. Across this country, including in my own life story, there are countless examples of people from all backgrounds succeeding through hard work, education, and perseverance. We should be encouraging individuals to see their identity not as a barrier but as a source of strength. Victimhood mentalities limit potential; merit-based systems unleash it.”

 Does diversity pay?

CFA Institute argues that data from firms that have committed to its DEI Inclusion Code – which champions positive systemic change in the investment industry by addressing challenges that come with demographic, cultural, and societal variations across markets – shows they are more successful at hiring and retaining the diverse talent that supports better outcomes.

“DEI policies help companies attract and retain the best talent and create an environment to achieve optimised outcomes,” says Sarah Maynard, global senior head, inclusion at the CFA.

Other investors espouse the value of cognitive diversity in their own investment teams.

John D. Skjervem, chief investment officer at Utah Retirement Systems, argues the productive power of cognitive diversity was well documented almost two decades ago by University of Michigan professor Scott E. Page in his landmark book, The Difference. Page’s endorsement of the value of collective wisdom particularly struck a chord when Skjervem joined the $140 billion Oregon State Treasury as investment division director and CIO in 2012 and found the investment staff exhibited no meaningful diversity and suffered, in his opinion, from latent unconscious bias.

“It was a very real phenomenon,” he recalls, “where the ‘right fit’ would often manifest as an outdoorsy, middle-aged white guy who enjoyed fishing and hunting.”

With support from the administration of then-Treasurer Ted Wheeler, Skjervem says Oregon began the intentional and at times forceful pursuit of better cognitive diversity after which “the dam burst, and our physical diversity profile started to improve significantly.”

Some are convinced that DEI actively harms the investment process.

“DEI prioritises social engineering over fiduciary duty, undermining the responsibility to maximise returns and manage risk for taxpayers,” says South Carolina’s State Treasurer Loftis Curtis who oversees the state’s $75 billion of public funds. “President Trump is right to dismantle DEI because it injects politics into investing, weakens accountability, and shifts focus from performance to ideology. This threatens sound governance and risks long-term financial harm.”

DEI prioritises social engineering over fiduciary duty, undermining the responsibility to maximise returns

In truth, there is little hard data on either the extent to which a diverse investment team outperforms its benchmarks and peers or the return premium earned from investing in companies with diverse managements and boards.

An easier place to unearth hard numbers linking returns and DEI lies in emerging manager programs where many US pension funds including the $209 billion Teacher Retirement System of Texas, the $109 billion MassPRIM and the $533 billion CalPERS purposefully mandate to diverse and emerging external managers in search of higher returns.

The $284.27 billion NYC retirement systems has a $23 billion allocation to diverse managers which has grown $6.3 billion since 2022. Private market mandates to women and minority-owned firms have outperformed their respective benchmarks by an average public markets equivalent (PME) spread of 5 per cent. In public markets, emerging managers are expected to outperform standard benchmarks (Barclays Aggregate, Russell 2000 and MSCI EAFE) net of fees.

Last year, New York’s five pension funds achieved a combined net return of 10 per cent surpassing their actuarial target rate of 7 per cent. Taffi Ayodele, director of DEI and emerging manager strategy at the New York Bureau of Asset Management, which manages assets for the city, says diverse managers contributed to that success.

“When we look at the data, in aggregate, diverse managers are helping drive outperformance in the portfolio,” she says.

It’s a similar story at IMRF where diverse managers currently invest around $14 billion of the $55 billion portfolio backed by an aspirational target to invest 20 per cent of AUM with minority managers enshrined in the Illinois Pension Code.

IMRF doesn’t distinguish diverse manager returns from the returns of its wider manager cohort, but CIO Miller-May says these managers are central to IMRF consistently hitting its target return of 7.25 per cent. They add value, mitigate the risk of group think, and demonstrate alignment by allowing IMRF to tap fee benefits in exchange for providing seed capital.

In private markets IMRF also expects mid-market diverse managers to see more exits and distributions than others in the current environment because they can exit to larger GPs.

The worrying outlook for diverse managers

But these programs face jeopardy. Top1000funds.com interviewees say it’s possible that allocating to emerging manager programs could face legal challenges if the issue reaches the Supreme Court. The June 2023 ruling that barred race-based affirmative action in college admissions shows the potential for broader legal shifts.

The NYC retirement systems’ strategy has firm support from NYC’s Comptroller and other state and city policymakers. However right now, Ayodele believes the pension fund’s ability to allocate to emerging managers is really a question of “wait and see” and says the current climate is already damaging the outlook for emerging managers. She’s heard that emerging managers are struggling to get in front of enough LPs, and other stories like female founders sending male colleagues to pitch to LPs in red states.

Ayodele now touts the performance and team expertise of some of these emerging managers to peer funds to help them find new audiences.

“Where we are overweight in certain sectors, like private equity, we support a firm’s work with other pension funds. It is about information sharing and helping managers fast track closure,” she says. “Many of these GPs simply won’t be able to come back in a year. It’s important to remember that these emerging managers start with less assets under management which limits their ability to sustain their firms through market downturns.”

Policies that make it harder for the investment industry to hire, promote and retain diverse talent may also shrink the pool of diverse founders and professionals spinning out in the future. “You don’t just wake up one morning and think ‘I’m going to run my own hedge fund or private equity firm’,” says Miller-May. “It takes years to build up experience and a track record of investing.”

It’s one of many reasons why DEI in the majority-owned asset management community is a key focus of stewardship at IMRF.

Proxy voting under attack

It’s not just the asset owners’ ability to nurture diversity internally or engage with their asset managers on DEI that has got more complicated.

A climate of uncertainty has settled over investors’ ability to exert influence on board diversity, gender pay gaps and wider ESG issues, in the companies they own. In a sign of the times, State Street’s asset management unit has dropped proxy voting policies that required company board nomination slates feature a certain percentage of women directors. Elsewhere, US communications group Verizon recently abandoned its DEI program for approval from the Federal Communications Commission (FCC) on an acquisition.

Doubts about the reach of active ownership is also starting to wash-up on European shores. The US administration has asked European firms to comply with DEI or risk disqualification from US federal contracts potentially impacting sectors like defence, aviation and infrastructure.

Tim Manuel, head of responsible investment at the United Kingdom’s £64 billion Border to Coast which engages on DEI with portfolio companies both internally and via its external managers articulates the new uncertainty.

“Asset managers tasked with engagement are in a difficult situation because a lot of the change that is happening has legal ramifications. We don’t want to rush into a situation and pump our fist in a way that is not feasible because of the environment they are working in.”

“Depending on where you are coming from or what sector you’re in, making public statements about ideas related to ESG has got more difficult, but I haven’t seen any changes yet in the way investors engage via the boardroom about the things they find important. Climate problems are not gone, and companies are aware of that,” reflects Ronald Wuijster, chief executive of APG Asset Management which invests on behalf of €552 billion Stichting Pensioenfonds ABP.

“For us, investments are made according to four elements comprising return, risk, cost and sustainability, and that hasn’t changed.”

Others are also determined to press ahead with corporate engagement. Back in January during a presentation to the CalSTRS’ board, portfolio manager Lynn Paquin said the team will continue to engage with corporates regarding diverse director representation on boards and disclosure of basic workforce metrics.

“The goal of our outreach is simple: to have an open dialogue to better understand why companies have made this decision and to reiterate our conviction that robust DEI programs and disclosures can be a positive indicator of an inclusive workplace culture to attract and retain staff, drive productivity, and reduce reputational risk.”

Paquin observed that “the vast majority” of companies pushing back on DEI are not dropping their training and inclusion programs, or workforce reporting. Instead, most of the roll back is focused on public facing programs and changing the language around social policies.

Time for a reset

Other themes are emerging amid the confusion and disruption of dismantling DEI.

Even diversity advocates see the current situation as a chance to reframe the issue and articulate what DEI means in the same way sustainable investors have been challenged on ESG.

It’s an opportunity to re-evaluate if mandatory diversity training, job tests, and grievance procedures really work and Harvard’s Dobbin, for one, doubts they do.

“Targeted internships for minorities don’t affect the workforce very much and diversity training is not a substitute for changing behaviour. It also often backfires because it seeks to convince people they are biased and guilty of sexism and racism which typically angers them,” he reflects, arguing high performance management practices like mentorship are more effective at moving the diversity needle, as well as employee work/life benefits.

John Skjervem, now chief investment officer of the Utah Retirement Systems, goes further still.

“Despite good intentions, DEI programs are exacerbating the problem by subordinating the holy grail of cognitive diversity to quota-based goals” prioritising gender, race, ethnicity and sexual orientation. The result, he says, “is ever greater divisiveness and a further balkanisation of society, not the world I want to live in.”

“DEI and other preference-based approaches are simply the other side of the discrimination coin, violating the civil rights of those who don’t enjoy politically defined preference,” he continues. “My mother taught me at an early age that two wrongs cannot make a right so instead of DEI, we should keep our focus and aspirations on improved cognitive diversity from which a more representative and better integrated meritocracy will emerge.”

DEI and other preference-based approaches are simply the other side of the discrimination coin

In an uncertain environment, heightened by the risk of litigation, the CFA’s common-sense messaging like the importance of shaping a recruitment program with broad selection criteria because programs that don’t target an identity are more successful is a useful guide.

Although the value of diversity – and by extension cognitive diversity – is engrained in investment more than other professions, the industry remains divided and now thwarted on the means to get there.

“It’s going to be a long four years,” concludes Illinois’ CIO Miller-May.