The confirmation a year ago of the first Hispanic Supreme Court justice, following the election of the first black president, has signaled for many people a growing appreciation of racial diversity and inclusiveness in the United States.
The question remains as to what degree such advances will carry over to the financial services industry. At the National Association of Personal Financial Advisors' national conference in May, John W. Rogers Jr., chairman and chief executive of Ariel Investments LLC, provided two critical reasons for the importance of racial diversity in financial services: the ability to serve the growing minority consumer base and the value of having diverse perspectives when it comes to a firm's planning processes. In light of these compelling claims, what is needed for financial advisory firms to become more diverse?
Given the preponderance of white financial professionals and wealthy white clients in the United States, many advisers presume a lack of incentive to broaden their client base. Cross-cultural business relationships require a concerted effort to move beyond comfort and familiarity. The time investment is often assumed to yield a minimal return.
Most financial professionals advocate diversification in long-term investing, even if they have a different approach to developing their firm's client base.
A basic tenet of investment management under modern portfolio theory is to diversify holdings across asset types with complementary risk and return characteristics for different market environments. By investing in assets screened for low correlation, the expected return and overall risk of the portfolio should be more favorable than investing in an individual security or asset class.
In other words, investors shouldn't put all their eggs in one basket.
What would happen if financial advisers applied the basic intent of MPT to matters of racial diversity in the financial profession? Diversification theory would suggest that a firm's business relationships (portfolio) with intentionally diverse asset classes (racial and ethnic groups) can maximize a firm's return (profits and social equity) and minimize its risk (inability to attract and retain minorities as employees or clients and a loss of economic sustainability).
Perceived risks of hiring and serving minorities raise several questions:
• Will the employee have the professional decorum and resolve to warrant the investment?
• Is the firm's culture sufficiently receptive to cultural differences to attract and retain non-white employees and clients?
• What will be the level of trust among employees and clients in light of their different cultural experiences, expectations and biases?
The firm's reward in expanding its minority representation is a stronger talent pool and client base. The goal is to extend the firm's core competencies beyond its market base while avoiding exploitation based on mere opportunity.
The risk-return trade-off requires careful consideration of the firm's goals and objectives, risk tolerance and time horizon.†
Where does the firm envision itself in the next 10, 20 or even 50 years?†Is diversity central to the firm's mission and objectives?†What level of risk will the firm endure to realize its goals?
The firm must find the right balance between safety and growth throughout its projected time horizon.†Safety, in this model, suggests that the firm will continue the status quo — relying on its position as a majority firm serving majority interests.†
Safer investments can preserve the portfolio's principal value while generating modest income but risk losing purchasing power to inflation over long time horizons. In this analogy, the lack of exposure to minority markets minimizes the firm's ability to keep pace with the expanding purchasing power of historically underserved populations.†
The “safe” approach protects the firm's standing as long as its competitors remain at bay and existing clients and future generations identify with the firm's concentrated “majority” business portfolio.
A growth-oriented firm begins from the realization that future racial and ethnic demographics will change market dynamics and returns on human investment. The growth firm willingly assumes higher exposure to the perceived risks of cross-cultural investing for a greater return on investment and increased firm value.
It invests resources strategically and reviews its portfolio regularly to ensure that its allocation aligns well with its goals and time horizon, and that its internal infrastructure effectively and efficiently serves the growing minority client base.
The optimal “diversity” business portfolio for a financial services firm is determined by its expected return relative to identifiable risks in a dynamic-demographic market.†Not all advisers will accept the business case for diversity in the marketplace or even be positioned to serve a growing minority population.
The pertinent question with all investment portfolios is: Will the strategy sustainably provide sufficient return to meet goals throughout the time horizon?
Advisers beware — past performance is no guarantee of future performance.
Lazetta Rainey Braxton is founder and chief executive of Financial Fountains LLC, a fee-only financial planning and registered investment advisory firm.