While scrutiny of private equity’s diversity, equity and inclusion credentials has ramped up dramatically over the past few years, private debt has, until recently, slipped under the radar.

But times are changing. LPs are now asking tough questions of their managers, which, in turn, are finally waking up to the impact of diversity on performance.

“Building a diverse debt portfolio involves making judgement calls on large numbers of companies,” says Paul Shea, co-founder of Beechbrook Capital. “You need those different perspectives, experiences and backgrounds around the table to make informed investment decisions.”

“A diverse team, with different thinking styles and visions, will bring deeper discussions and more innovative ideas and solutions,” agrees Coralie De Maesschalck, head of ESG and CSR at Kartesia. “It also allows us to retain our current employees and to attract great new talent, as diversity and inclusivity are important topics for millennials and Generation Z.”

Alona Gornick, managing director at Churchill Asset Management, adds: “DE&I is critical for long-term organisational success. It makes you better at problem solving and allows you to make bigger and bolder decisions. It forces you to think outside the box.”

Debt managers are starting to put words into action. A trio of firms – Ares Management, Apollo Global Management and Oaktree Capital Management – recently launched AltFinance, an initiative intended to provide students at historically Black colleges and universities in the US with clear pathways to careers in the alternative investment industry through a mentored fellowship programme, a tailored virtual institute and a scholarship programme.

Ares, meanwhile, hired its first ever global chief diversity, equity and inclusion officer, Indhira Arrington, in January, in recognition of the growing importance of DE&I.

“ESG in direct lending is progressing from a high-level screening of investments towards a more sophisticated incorporation of potential ESG considerations, including DE&I, throughout the full investment life cycle,” Arrington explains.

She adds that covid has further exposed inequities in the economy and in society, and that this has prompted investors to bring ESG and DE&I issues to the fore.

“There is a greater sense of urgency and accountability up and down the chain,” she says. “This has presented a new dynamic for direct lenders which can, in turn, heed the call to both conduct their businesses with a greater emphasis on sustainable practices, including DE&I recruitment and retention, whilst also seeking to generate attractive risk-adjusted returns through a responsible approach to investing.”

Long road ahead

There is no doubt, however, that private debt is still at the very beginning of its DE&I journey. According to Diversity Review in Corporate Credit, a 2020 paper by specialist credit recruitment company Waterman Stern, just 14 percent of the European private debt industry is female, falling to under 8 percent in senior roles. Black employees, meanwhile, represent just over half a percent of the asset class.

The nascence of the DE&I debate in private debt is problematic. “The main challenge that we encounter today regarding DE&I in private debt is similar to the one we had to overcome with ESG in general – lagging behind the other larger asset classes,” says De Maesschalck.

“Five years ago, we had to use the ESG resources, best practices and tools of the private equity market as we could not find any that were specific to private debt at that time,” De Maesschalck explains, pointing to the UN PRI’s Limited Partner’s Guide to Responsible Investing in Private Equity, published in 2011. “The first paper of the UN PRI specific to private debt was only issued in 2018, seven years later. We are encountering the same challenges today with D&I.”

De Maesschalck believes these challenges are best overcome by being an active UN PRI signatory. Indeed, the UN PRI paper specific to private debt was the result of an increasing number of private debt players engaging on the topic. She also thinks it is important for private debt managers to exchange ideas with their peers and to share best practices.

Arrington agrees that solutions should come from within the asset class: “Direct lenders of scale are in a leadership position to not only embed ESG principles more holistically into their investment processes, but also to contribute to the future progression of those principles within the industry.”

Influence vs control

Although private debt managers have woken up to the necessity of radically improving the DE&I profiles of their own organisations, the role of those managers in tackling DE&I within their portfolio companies is less clear cut. Unlike private equity investors, which typically take a control position, debt investors’ sphere of influence is more nuanced.

“As it relates to the GP, investors absolutely want to see private debt managers taking active steps to build diverse teams because that tends to lead to better decision-making,” says Antje Hensel-Roth, chief people and external affairs officer at Intermediate Capital Group. “But DE&I is less on their radar as it pertains to underlying assets.”

Debt managers are seeking to make a difference among their borrower base where they can, however. For Churchill, for example, which exclusively supports private equity-backed deals, the answer is to exert pressure through the sponsor relationship. This is particularly effective, as the business also has a fund of funds arm.

“We are not making decisions around board composition or management hires, but we have strong relationships with the private equity firms that are,” says Gornick. “In fact, we are often investors with those firms, so we get to ask questions about DE&I practices when we are deciding where to put our dollars.”

DE&I is also part of Churchill’s formal screening when it comes to choosing whether or not to finance a business, while an extensive portfolio of around 200 borrowers provides the means to benchmark and measure improvements.

Nonetheless, access to data can be a challenge. “Our position as a lender may not always allow us to discuss directly with management. This is even more true for our secondary deals,” says De Maesschalck, who adds that data access is particularly challenging in the SME market.

Private debt managers have a role to play in educating and supporting businesses as they too evolve their DE&I capabilities.

“As an industry we need to do more to create the conditions for diversity – it’s something that every GP needs to work on,” says Hensel-Roth. “And I sense there’s now a willingness to tackle this issue, both within standalone debt funds and within multi-asset businesses like ours.”

“We believe promoting DE&I is both the right thing to do and that it will help us create greater, long-term value for our stakeholders,” adds Arrington. “Given our resources and passion, we also believe we can play an important role in advancing the adoption of DE&I ideas across the private debt industry.”

Impact investing and DE&I

Although private equity is not known as a beacon of diversity, the burgeoning impact investment space is very different, according to Nuveen managing director and co-head of impact investing, Rekha Unnithan.

“In fact, impact teams like ours can often be more diverse than the general population,” she says. “That is a function of the experiences and passions that have brought people into the sector.”

Impact strategies typically focus on climate change mitigation or income inequities, and a DE&I component to achieving those goals is increasingly the norm. Nuveen itself is taking a more intentional approach to DE&I by investing in businesses designed to reduce inequality and improve environmental outcomes. “We don’t go out looking for companies run by women or minorities and measure our impact that way,” says Unnithan. “But we see driving a DE&I agenda as one way to improve both the financial performance and impact performance of the businesses we back.”

Nuveen always takes a board seat and because two out of three of the senior private equity impact team are women and women of colour, the investment itself can already have a transformational effect. “We may often be the first women to join that board, so we can bring a different perspective,” says Unnithan. “We then continue to push for improvements around pay equity, skills development and a diverse and inclusive workforce throughout our holding period.”