HFs researching ESG weigh demand, returns

As growing numbers of investors get serious about ESG investing, more hedge fund managers are adopting the approach with an eye to securing additional inflows. According to Jim Neumann, chief investment officer at global hedge fund advisory firm Sussex Partners, more managers are launching ESG strategies or reconfiguring existing strategies to be as ESG compliant as possible, allowing managers to raise more assets from public and private pensions that are under pressure to go green and be more aware of social governance. Hedge fund managers have been slow to adopt ESG strategies, largely due to inconsistent data and a lack of expertise in sustainability and socially responsible investing. It is also unclear what it means exactly to be ESG compliant. “Many managers have had difficulty with the lack of standardization of what ESG is,” Neumann said. And because of that ambiguity, managers have had to try to come up with their own definition and design a compliant program around that, he added. While there is still a lot of ambiguity about what exactly makes an ESG program or measure its success, Neumann noted that a few organizations are putting forth some guidelines and trying to develop rating systems and criteria in this area to make it easier for managers to invest and measure its effectiveness. “If you’re going to launch an ESG fund then you need to figure out how to measure it in terms of environmental, social and governance return. One way this is being done is through the development of indices so there is a tangible way to measure IRR and Impact IRR,” Neumann explained. Clearly some strategies will lend themselves to an ESG lens more easily than others; most notably longer-term investment strategies. For managers looking to get in on the ESG trend right now, Neumann said it would be better to launch a new fund focused on socially responsible investing rather than taking an existing product and trying to meld it into ESG. Managers also need to be prepared for difficulties with ESG programs. First, Neuman said research on investment companies is much more in-depth and time-consuming, particularly with global companies that have multiple business lines in different industries. Another issue with ESG is that managers may have to sacrifice returns to invest in compliant companies. And this lack of performance may have turned some investors from ESG-focused hedge funds. “I think some of the investors that got into ESG hedge funds early were likely disappointed with returns,” Neumann stated. “But I think better products are coming out now from managers that will help investors achieve both their returns goals and their ESG compliance goals.” However, Neumann stressed that as more managers start adopting similar ESG mandates and there is a clearer definition of what constitutes ESG, there could be fewer opportunities or fewer securities to choose from. “That will make it harder to differentiate funds and returns,” he added in his forward-looking analysis. “I also think you may end up getting a more generic return stream out of ESG, so there is also that to consider if you’re looking to get into the space.”

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