Industry participants explore the key ESG issues looming large over the next few years.
Industry participants explore the key ESG issues looming large over the next few years.
Digital assets
As hedge funds pour more money into cryptocurrency strategies, the need for managers and investors to balance the shift towards sustainability and responsible investing with crypto’s energy-intensive mining process will become crucial.
In an in-depth commentary last year, Robert Furdak, chief investment officer for ESG at Man Group, suggested that bitcoin and sustainability – two major investment trends looming large over the asset management industry – may be set for a “head-on clash”.
Manuela Cedarmas, head of ESG & impact investing at Investcorp-Tages, notes that beyond the amount and types of energy used in cryptocurrencies, questions also remain over the regulatory, governance, and operational risks stemming from digital assets.
“We have been looking at the differences between cryptocurrencies in terms of the sources of energy that are used for mining, considering also the magnitude of their emissions versus what the impact of the traditional banking industry is, for example,” she says. “All of these concerns are taken into consideration at the same level as operational issues, because those are equally important. We would never want to run unwanted risk in this regard, even if the opportunity is quite attractive.”
Speaking to Hedgeweek earlier this year, Anatoly Crachilov, founding partner and CEO of digital assets fund manager Nickel Digital Asset Management, hinted that ESG and cryptocurrency could work conjointly, pointing to how bitcoin miners have taken the opportunity to switch from coal-based power in China towards greener forms of energy, such as solar, in the US and Kazakhstan.
Salvatore Cordaro, co-CEO of Investcorp-Tages, details: “We haven’t made an investment in crypto yet, precisely because we have several concerns that we’re trying to get more comfortable with. Clearly, environmental issues and governance issues are among those.”
Russia
Russia’s invasion of Ukraine has highlighted a battery of ESG and ethical concerns for investment managers of all stripes and strategies. In an interview with Bloomberg last month, US hedge fund titan Ken Griffin, CEO of Citadel, warned US sanctions on the Putin regime could backfire, forcing Russia to look elsewhere – such as China – for software solutions. Separately, some industry participants believe certain sectors and stocks traditionally considered “ESG negative” – such as missiles companies and weapons manufacturers – could be re-evaluated if they can be shown to be bolstering the Ukrainian resistance.
Edward Lees, co-head of BNP Paribas Asset Management’s Environmental Strategies Group, says the war has highlighted the growing challenge of geopolitical energy security, noting how the UK and Germany have ramped up their renewables targets in response to Russia’s energy dominance. “A whole host of countries have, in the last month, basically gone stratospheric with their 2026 and 2030 targets,” he comments.
“If you are vulnerable to, and exposed to, the up-and-down swings of oil prices and gas prices, and if your existence relies on it, and in a cold winter you need it and you can’t produce it, that’s a big issue.”
He adds: “One of the other things this war has shown, beyond the need for solar and wind to replace oil and gas, is the fragility of global supply chains across a broad range of industries, particularly when those are tied to regimes that aren’t stable or that we don’t have a stable relationship with. It’s not just the gas that comes out of Russia, and some metals like nickel; it’s also China, which dominates a lot of the rare earth, lithium battery, and solar component production. The US and Europe does not produce enough of these things – and you need them for these new industries, for electric vehicles, for solar, for energy storage.”
Even prior to the conflict, Russia had been considered a red light with regards to corruption and political risk, more than a narrow social or governance issue, observes Salvatore Cordaro.
“I see the social and governance issue becoming a micro part of the thinking around Russia, with the political risk being the macro point on being in or not being in Russia,” he says. “I think the issue of how managers will incorporate ESG will re-emerge stronger when markets reopen and assets become investable again.”
Biodiversity
One of the newer, emerging themes within the ESG sphere centres around natural capital and biodiversity, which is driven not only by continued concerns over climate change, but also the systematic risks resulting from global dependence and unsustainable management of ecosystems and other environmental assets.
“The importance of natural capital and biodiversity will gain greater significance,” says My-Linh Ngo, head of ESG investment and portfolio manager at BlueBay. “Expect to see increased attention on marine environments – ‘the blue economy’ – and terrestrial ecosystems, particularly forests. Topics such as the change of land use linked to food and agriculture, extractive and infrastructure activities will be key, alongside a greater emphasis on a circular approach to production and consumption.”
Lees points out: “Ukraine produced a lot of food which the UN bought to help feed many countries in Africa. Food prices have been going up, not just because of the Ukraine war, but also because of things like weather disturbances. There been a lot of crazy weather patterns; we had huge disturbances in Brazil which impacted coffee crops, or instance.
“There is also the magnitude of topsoil loss in many places in the world – if commercial farming keeps going the way it’s going, it’s not going to be able to produce the same amount. Global farming is now facing a challenge. One of the things in our sustainability remit asides from decarbonisation and renewable energy has been the need to deal with biodiversity loss, food security, and a more intelligent food supply – such as the ways technology can be used to limit the use of water, the use of fertilisers and chemical pesticides.”
The next step of the biodiversity COP15 is due to take place in April, Ngo says, which includes the aim of securing government commitment to ‘30×30’, a pledge to protect 30 per cent of lands and oceans by 2030.
Talent
With investors increasingly placing ESG at the heart of their portfolio selection, how is this trend shaping hedge funds’ hiring and staffing policies?
Cordaro identifies two main approaches, with certain managers running some strategies which require dedicated ESG resources – whether that’s hiring a dedicated analyst or even a chief sustainability officer – while others are opting to incorporate ESG as part of their broader overall research and risk framework.
“I think it depends on how much weight you give to ESG today in your investment process and in the success of your strategy,” he observes. “For some it’s incredibly important – one fund we seeded 12 months ago has hired a dedicated chief sustainability officer because their strategy is grounded on engaging with companies that are in distress, and helping them to improve and get out of their distressed state by getting better recognition in the market, which includes strategically improving their environmental footprint.
“Other hedge funds use that as part of their regular assessment – they consider any material risks coming from environmental, social or governance in the same way as the consider risks coming from liquidity or other investment factors.”
My-Linh Ngo says: “We don’t see the wider trend in terms of increasing demand for ESG expertise in the industry being any different in the hedge fund world – particularly when the regulation doesn’t make any distinction as is the case in Europe with its sustainable finance package.
“But clearly the hedge fund world has some unique attributes in terms of approaches to investing which require more technical understanding in order to bring this together with ESG thinking. There needs to be more developed thinking as the asset class brings with it opportunities for ESG as well as challenges.”
Read the full Hedge Funds & ESG: Navigating internal change and responsible investing Insight Report here.
