During fundraising, past performance metrics have a greater impact on Black- and Latino-owned private capital funds than on white-owned funds. 

In fact, minority-owned venture capital and private equity buyout funds are more likely to be punished for past performance when fundraising for a second fund, according to a paper titled “Racial Diversity in Private Capital Fundraising” by Johan Cassel, an assistant professor of finance at Vanderbilt University, Josh Lerner, a professor at Harvard Business School, and Emmanuel Yimfor, an assistant professor of finance at the University of Michigan. This dynamic is indicative of larger investor biases toward minority-owned funds. 

The asset management industry has little diversity. According to one of Lerner’s previous papers, in 2021 only about 1.4 percent of the total share of assets under management were managed by firms owned by minorities in the U.S., even though they represented 40 percent of the population last year. While the homogeneity of the asset management industry is widely known, the reasons for the lack of diversity are less clear. In the report, Cassel, Lener, and Yimfor explore possible explanations, focusing on venture capital, buyout, and growth investment firms. The report also notes that past research has found that investors have a tendency to fund entrepreneurs with which they share characteristics. As a result, minorities may face significant obstacles when starting a business, a significant source of wealth creation. 

Using information from Burgiss, PitchBook, filings with the Securities and Exchange Commission, LinkedIn, news articles, commercial data sets, and private communications between investors and consultants, the authors created what they say is the most comprehensive database of minority ownership of private capital groups. 

The authors made three initial conclusions from the new data that they used as the basis of the report: First, similar to earlier research, they found that minority-owned funds in the U.S. are three-to-four times more likely to back minority entrepreneurs. Second, Black- and Latino-owned funds make up only a “modest” portion of the capital raised by U.S. funds. Third, the authors found that it is often more difficult for minorities to get into the market by fundraising for their first fund. According to their analysis of Form D filings, the authors found that Black- and Hispanic-owned funds are less likely than white-owned funds to meet their fundraising goals for their first funds.  

Cassel, Lerner, and Yimfor then explored the potential explanations for these discrepancies based on the economics of discrimination. They started with two hypothetical explanations: “If there were many more minority-owned groups with low expected returns, even after controlling for observable characteristics, we would also observe that the success rate in first-time fundraising is lower for minority-owned groups,” Cassel, Lener, and Yimfor wrote. “Alternatively, the differences may be driven by preferences on the part of the limited partners (taste-based discrimination).”  

The authors first tested the “sensitivity” of inflows from investors to performance for diversely- and non-diversely-owned funds. The study looked at fund performance of both minority- and white-owned funds during a fundraising period and calculated the intermediate fund performance of each fund. 

According to the paper, performance sensitivity is about three times higher for Black- and Hispanic-owned funds. All funds were more likely to raise a follow-up fund if they had high performance during the fundraising period. But the authors found it "striking" that minority-owned funds were far more impacted by their past performance than white-owned funds when it comes to fundraising for a second fund.  

This effect is particularly strong on the “down-side,” the report said. When funds saw weak performance during their first fundraising period, investors were less likely to bankroll their second pursuit.  

“We interpret this with being consistent with the idea that investors have less of a tolerance for failure [at minority-owned funds],” Cassel told Institutional Investor. “So when they are performing well, then minority funds are as likely as non-minority funds to raise funds, but if the performance deteriorates, investors are much less forgiving.”  

For a non-minority fund, poor past performance would also reduce the likelihood of raising a second fund, but at a much lower rate than it would for minority-owned funds. This means that minority-owned funds are “punished more harshly” for poor performance, the authors wrote.  

Another potential explanation for the underrepresentation of minority-owned funds in private capital is the fluctuation in investor demand for these funds. For example, Cassel, Lener, and Yimfor found that minority-owned funds were more successful during fundraising periods that coincided with periods of “high racial awareness.” Although they considered using other approaches, the authors defined high racial awareness as a period of time during which there is an outsized number of news reports about fatal encounters between unarmed citizens and police. The authors calculated this “racial sensitivity” weight for each state and year. In states and years where and when racial sensitivity was high, minority-owned funds had more fundraising success and their likelihood of raising a second fund was greater.  


“That would suggest that perhaps investor attitudes matter for whether or not minorities are able to raise follow-on funds,” Cassel said.  

Next, Cassel, Lener, and Yimfor looked at how the race of chief investment officers at local public pension funds and endowments — institutional investors that often invest in private capital groups — affected the fundraising success of minority-owned funds. In line with their previous findings, the authors concluded that when a minority was appointed as a CIO, diverse-owned funds in the state were more likely to both get an investment from that limited partner and to raise a larger fund.  

The authors concluded the paper with a call for deeper exploration into the decision-making processes in private capital.