403(b) Curriculum Library

Minority and Women-Owned Asset Managers in Retirement Plans

Investor interest in funds managed by minority and women-owned business enterprises (MWBE) is rising. Several states have enacted legislation either mandating that a minimum percentage of public pension assets be allocated to such enterprises or encouraging that such firms be considered in the allocation process. 

One of the primary factors driving institutions to consider including MWBE managers is the desire to ensure that the composition of firms managing pension and other retirement assets mirrors the employee or customer base.  Another argument in favor of choosing MWBE managers is to cultivate a more diverse talent pool and provide opportunities to managers that have been historically underrepresented in the investment management arena. 

Additionally, MWBE asset managers have the ability to avoid bureaucratic policies associated with larger firms.  Large firms often have operating procedures that place constraints on portfolio managers and investment teams.  For example, large asset managers may place a great deal of focus on risk metrics, such as tracking error, to gauge their portfolios.  On one hand, controlling for risk relative to a benchmark provides a guidepost and assures investors that the fund will not have outsized returns (positive or negative) relative to the benchmark.  On the other hand, constraining portfolio managers may reduce their ability to outperform the benchmark.  This presents an opportunity for nimbler MWBE managers to add value.
Despite the various reasons to invest with MWBE managers, many challenges still exist.  First and foremost, ERISA mandates that selecting the most appropriate investment on behalf of plan participants is the top priority for retirement plan fiduciaries.  This means that an investment option cannot be considered simply because the fund company is owned or run by a woman or a minority. 

A lack in the sheer quantity of MWBE managers presents another obstacle.  While the number of MWBE managers is growing, the absolute number of eligible MWBE managers is still small. Significant barriers to entry exist in the asset management industry.  In order to start a fund, a manager must raise seed capital, commit significant resources, and assume the risk of starting the fund.  Beyond that, upstart managers often have the support of a legacy network, which may put MWBE managers at a disadvantage.  

Short performance track records prevent many MWBE managers from accumulating assets and being placed in retirement plans, as most institutional investors have a three-year performance history requirement.  The vast majority of the MWBE managers have less than $250 million in assets under management.  Size becomes important since many institutions cannot let their own investment represent more than 20% of a manager’s total assets.  Finally, the limited asset bases of MWBE managers may lead to insufficient institutional infrastructure (risk, compliance, research and trading systems) as compared to larger, more established firms. 

Separately managed accounts (SMAs) and sub-advisory relationships will likely remain the largest channel for asset placement with MWBE managers.  SMAs are investment accounts that are not subject to the requirements of the 1940 Investment Company Act, which stipulates the operating and regulatory requirements of mutual funds.  SMAs allow MWBE and other asset managers to operate without bearing the compliance costs associated with being a mutual fund. 

The scope and ability of retirement plan fiduciaries to add MWBE managers will be contingent on new legislation allowing, and perhaps even encouraging, plan fiduciaries to consider MWBE criteria in the selection of an investment option.  The case for inclusion of MWBE managers in retirement plans is likely to gain momentum as U.S. demographics continue to become more diverse.

Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.

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