Hedge funds off the pace on ESG integration, new bfinance investor poll finds

Staying ahead

Hedge funds are falling behind other sectors such as private equity and real estate when it comes to integrating ESG factors into their portfolios.

But that tardiness may prove beneficial in avoiding other sectors’ earlier mistakes, as managers slowly adopt sustainability principles in the future, according to a new bfinance study.

The survey of 256 investors – including pension funds, insurance companies, foundations, endowments, and family offices – explored their priorities and practices, as well as the challenges faced, when it comes to ESG (environmental, social and governance) and sustainable investing.

Among other things, bfinance’s ‘ESG Asset Owner Survey’ also looked at the importance of ESG in manager selection, and how sustainability factors may shape fund performance in years to come.

Only 7 per cent of investors quizzed said their hedge fund and liquid alternative managers offer “high integration” of ESG principles in their investment processes. Among larger investors – defined as those with more USD25 billion in assets – that number rose to 13 per cent. Roughly 30 per cent of investors said their hedge fund investments offer “partial” ESG integration, while two-thirds said there was little-to-no ESG integration.

By comparison, some 30 per cent of respondents said their real estate allocations have a high integration of ESG principles, with 24 per cent for private equity.

Investors in hedge funds are split when it comes to the prospect of ESG factors helping to deliver returns. Asked whether they believe that ESG integration will be associated with outperformance over the next three years, some 45 per cent of hedge fund investors said they either “strongly” or “somewhat” agree, while 55 per cent said they either “strongly” or “somewhat” disagree.

However, longer term, some 64 per cent of asset owners expect ESG integration will be positively associated with hedge fund outperformance in the next 20 years. But that remains behind the 88 per cent for equities, 85 per cent in private equity and real estate, and 80 per cent in bonds.

bfinance said many hedge funds remain reluctant to make ESG integral to their investment processes, pointing to additional monitoring and reporting requirements, questions over the applicability of ESG to short trades, and the issue of crowded positions and reduced investment universes.

But Chris Stevens, director, diversifying strategies at bfinance, said that while hedge funds may be arriving “late to the revolution”, their “tardiness does confer a singular advantage.”

“Managers can look to see where mistakes have already been made by some mainstream asset management houses and avoid those missteps,” Stevens said.

“When hedge fund firms, as an industry, decide to embrace ESG integration and move to meet investor demand, we expect the transition to happen swiftly. The Covid-19 crisis will not stall that progress – if anything, the crisis highlights the need for managers to think anew about future risks and opportunities in a changed world.”

Of the asset owners surveyed by bfinance, close to two-thirds – 60 per cent – indicated ESG issues now play a major role in manager selection, a sharp rise from the 41 per cent recorded in 2018.

The study also acknowledged varying degrees of ESG integration according to asset class and hedge fund strategy type. Micro assets – such as individual equity or credit names – are typically more ESG-relevant than macro assets such as index futures, forwards, ETFs and options. As a result, fund strategies like equity and credit long-short are much more adaptable to ESG screening compared to CTAs and discretionary global macro.