CalPERS has a well-developed plan to encourage diversity on public company boards on its own and as part of industry organizations, but when it comes to private companies, officials at the largest pension plan in the country are choosing to work as part of an industry group rather than go it alone.

Asset owners haven’t tackled the issue of diversity at private companies until relatively recently. But as the number of private companies choosing to stay private longer increases, more investors are asking their managers about it.

In October, California Controller Betty T. Yee, who also is a CalPERS and CalSTRS board member, sent letters to the two public pension funds on Oct. 29 urging greater diversity on private company boards and asking them to put the matter on a future meeting agenda. So far, the in- vestment committee chairmen have not decided whether they will do so, spokeswomen at both pension funds said.

Ms. Yee noted in the letters that just one-third of private companies have a goal to diversify their boards, citing data from the 2019 National Association of Corporate Directors Private Company Governance Survey. According to Preqin, women make up 19.7% of the alternative investment firms’ workforce, an increase of 0.9 percentage points compared with 2017, and less than 12% of senior roles in alternative investment firms. Ms. Yee, citing Preqin, noted that only 5.7% of private equity board members are female.

And in September, private equity investor industry group Institutional Limited Partners Association expanded its due diligence questionnaire, template and codes of conduct for managers, limited partners and portfolio companies aimed at supporting greater diversity and inclusion in the private equity industry.

ILPA is in the process of creating a road map to advance diversity across the alternative investment money management industry that will include research links and other resources. Organization executives expect to release it in the first quarter of 2020.

Promoting diversity

At the Nov. 18 investment committee meeting of the $385.1 billion California Public Employees’ Retirement System, Sacramento, Ms. Yee asked pension staff what they are doing to promote diversity at private companies.

In response, CIO Yu Ben Meng said ILPA represents the entire asset owner community and that that organization can have the most impact on the matter.

Private company board diversity has been a topic of lively debate in the private equity community, said Anne Simpson, CalPERS director, board governance and strategy, in an interview. She added that CalPERS has adopted principles encouraging diversity that apply across its portfolio, including private markets. “It’s a question of control,” she said. Limited partners in funds have no control over portfolio companies including diversity at the executive team and board levels, she said.

The question of control in its relationships with private equity general partners appeared to be a stumbling block for CalPERS on other ESG-related topics, too. Also at the Nov. 18 investment committee meeting, board member Ramon Rubalcava asked what CalPERS was doing regarding human capital issues arising as a result of private equity ownership of companies, such as the mass layoffs at the private equity-backed Toys R Us, which filed for bankruptcy in 2017.

Greg Ruiz, CalPERS managing investment director for private equity, replied that staff considers manager integrity when it is deciding whether to invest with a manager.

“When we assess managers, we assess them across many dimensions. … It’s important to partner with people with integrity so that is kind of first and foremost, and there are many complexities when you get into managing companies,” Mr. Ruiz said. “Once we enter into a partnership we are not in control. We are only one voice but (we are) an active voice.”

Expanding due diligence

Other institutional investors and a growing minority of alternative investment managers are turning their attention to portfolio company-level diversity. Some asset owners are adding questions about diversity at the executive and board level of portfolio companies as part of their due diligence before investing with private equity managers, said Emily Mendell, Washington-based managing director of ILPA.

The aim of the expanded due diligence guidelines and template is to measure employee gender and ethnicity by role, she said.

The association is hearing anecdotally and with consistency that limited partners are asking questions about diversity at the portfolio company level more and more, Ms. Mendell said.

“It’s no longer taboo and uncommon” to ask general partners what they are doing to diversify their investment team and portfolio companies, she said.

Investors are absolutely thinking about diversity, including at the portfolio company level, and CalPERS is at the forefront, Ms. Mendell said.

“GPs are almost expecting the question now,” she said.

But it’s up to the GPs to promote diversity at their portfolio companies and more of them are asking human capital professionals and others for help to get more women and minority executives on their portfolio company boards, she said.

Regulators weighing in

A recent global regulatory push to diversify public company boards is also having an impact on private companies and their private equity backers.

These efforts include the International Organization for Standardization’s December launch of a human capital reporting framework that includes workforce diversity, Congressional bills and the U.S. Securities and Exchange Commission rule under consideration that would require public companies to disclose workforce diversity.

The Human Capital Management Coalition, an institutional investor organization, had proposed the SEC rule in 2017.

Private equity firms are taking notice because portfolio companies that file to go public would have to disclose the diversity of their workforces if the proposed SEC rule is adopted, said Laura K. Queen, Doylestown, Pa.-based founder and CEO of 29Bison, a strategic human capital adviser for middle-market private equity and venture capital firms and their portfolio companies.

Investor action, pending regulations and a desire by many GPs to diversify their executive suites and boards as well as those of their portfolio companies and boards are causing some general partners to take action, she said.

“Boards of portfolio companies tend to mirror the networks and connections of their founders and so are mostly made up of highly educated white males,” Ms. Queen said.

While GPs have a long way to go to diversify portfolio company boards, there has been progress. When Ms. Queen and her team starting bringing up the topic of diversity and inclusion on portfolio company boards and executive teams in 2013, few GPs wanted to discuss it, she said.

Now, some 25% of the private equity firms 29Bison works with are considering populating their boards and portfolio company boards and executive and operations teams with more diverse individuals. The conversation most often comes up in succession planning, she said.

So far, the definition of diversity includes women and people of color.

“I would argue over time, it’s a limiting definition of diversity,” she said. Firms should be looking more broadly to include diverse personnel from groups such as the LBGTQ community, people with disabilities and people from different cultures, Ms. Queen said.

Hugh A. Shields, a co-founder and principal in the Chicago office of Shields Meneley Partners, an executive coaching and consulting firm, said he also sees investors putting more pressure on private equity firms to have better representation of women and minorities on portfolio company boards.

Particularly, the larger private equity firms and larger portfolio companies are trying hard to get better representation of women and minorities on portfolio company boards, he said.

“We are really starting to see more and more … portfolio companies are more open to diverse candidates,” he said.

Source: Pensions & Investments