ESG and responsible investing have garnered lots of positive buzz around the hedge fund industry for years now, but finally managers have a guidebook on how to effectively put their shared principles with investors to work.
The United Nations Principles for Responsible Investment (UN PRI) recently issued more practical guidance for the hedge fund industry with broad input from top investors and asset managers. The group began in 2006 with some of the world’s largest pension funds as signatories.
The number of signatories reporting on the hedge fund module in PRI Reporting and Assessment has increased over the last two years.
Since the 2008 financial crisis, “hedge fund managers have strengthened their governance structures considerably, the regulatory scrutiny they face has increased, and they have played an important role providing liquidity, particularly in times of market stress, with strategies focused on private or distressed debt or event-driven and special situations helping to restructure and rescue companies, including those in the cleantech and renewable sectors,” Marisol Hernandez, who is head of asset owners at PRI, wrote in a recent blog post.
“The time has come for the hedge fund industry to think about responsible investment beyond new products, increasing AUM or identifying new investment opportunities and risks,” said Fiona Reynolds, chief executive officer of the PRI. “Market participants must now widen their perspective to consider their role and responsibility as stewards of assets.”
In considering issues of portfolio construction with ESG in mind, managers are encouraged to break the process down into integration, screening and thematic strategies.
Integration is including ESG considerations within the investment analysis and decision making. Screening is the obvious activity in that managers are able to apply filters to potential investments. And lastly with thematic focus, hedge fund managers are able to combine attractive risk-return profiles with an intention to contribute to a specific environmental or social outcome. This also includes impact investing, which has been rising in popularity over the years.
Hedge fund managers can also use the principles to drive performance, according to PRI. They point to engagement and proxy voting initiatives, whereby hedge funds can adapt activist strategies in order to positively influence management strategy.
PRI approach to ESG is four-faceted – policy, governance, investment process and monitoring/reporting.
Policy includes the drafting of a set investment policy that may include specific information on how responsible investment policy is disclose to current and prospective investors as well as how screens are use and details on what constitutes a breach and how it would be remedied.
Governance structures and frameworks for hedge funds often include both the investment managers’ governance and fund governance. Investment manager governance looks at how responsible investment guidelines are applied at the fund level, while the fund governance focuses on oversight and specifically on what responsible investment guidelines are used by the fund and how breaches are handled.
The investment process is all encompassing of identifying ESG factors and portfolio construction. According to the PRI integration of these processes and stewardship practices may be driven by client values, regulation or evidence that ESG factors are correlated to financial returns as some academic studies have suggested.
The PRI breaks down the investment process further based on investment strategy and how it has seen hedge funds implement ESG into the portfolio.
Lastly comes the monitoring and reporting module, which includes the creation of detailed reports on action taken the outcomes of those investments.
Officials said that hedge fund managers may want to report things such as net long exposure to enable comparison against ESG metrics or separate reports on impact measurement or quantitative approaches to issues such as carbon footprinting.
The full set of guidelines can be found online along with due diligence measurement tools for hedge fund investors.