The UN-backed Principles of Responsible Investment (PRI) Initiative has issued a discussion paper on hedge funds to help its asset owner signatories better understand the risks associated with particular hedge fund strategies and instruments and the implications these may have for the performance of their portfolios and the broader market.

It also outlines some actions that investors can take to improve the governance of hedge funds.
 
The paper has been produced in response to growing interest from PRI signatories about how responsible investment relates to alternative investment strategies and instruments, including high frequency trading, leverage, shorting and the use of derivatives by hedge fund managers.

According to PRI’s 2011 Reporting and Assessment survey, 137 signatories have some exposure to hedge fund investments, including 74 asset owners. As the paper notes, some funds have already made public commitments to responsible investment, however very few hedge fund managers have published a policy that includes specific wording to drive the implementation of responsible investment into investment decision making.
 
“Many signatories have significant allocations to hedge funds and the PRI has a growing number of hedge fund manager signatories. However, there is currently no clear consensus on what being a responsible investor in hedge funds actually entails,” said Rob Lake, director of responsible investment at PRI. “During the financial crisis and in its aftermath, hedge fund performance has varied widely and the extent to which particular strategies and instruments have the potential to contribute to market-wide risk has been the subject of unprecedented scrutiny by investors and policymakers. This paper marks a first step in stimulating debate among PRI signatories and supporting asset owners to understand the implications of their hedge fund investments  Our aim is to  equip them with the information they need to reach their own conclusions about whether their approach is consistent with their commitments to responsible investment.”
 
The paper identifies actions investors can take to improve the fund governance of hedge funds. It provides an overview of the responsible investment considerations for different types of hedge fund strategies and argues there are many opportunities for investors to evaluate environmental, social and governance (ESG) risks and opportunities associated with a manager’s strategy. It offers guidance on how the relationship between asset owners and hedge fund managers may be improved to ensure interests between both parties are aligned. It also identifies several actions that asset owners can take to ensure that ESG issues and wider responsible investment concerns are appropriately addressed by hedge fund managers when investments are made.
 
The paper was prepared by the PRI Hedge Funds Working Group, with input from representatives from the following organisations: Albourne Partners, APG, BT Pension Scheme, Church of England National Investing Bodies, The Environmental Investment Partnership, Harcourt Investment Consulting, Hedge Fund Standards Board, Hermes EOS and Highland Good Steward Management. Universities Superannuation Scheme provided input for the fund governance sections.