Friday, June 01, 2018

Study: More hedge fund investors want responsible investment

By Amanda Maine, J.D.

A report published by the Alternative Investment Management Association (AIMA) has found that investors in hedge funds are increasingly embracing “responsible investment” strategies and that this demand has driven growth in responsible investment by hedge funds. The report, From Niche to Mainstream: Responsible Investing and Hedge Funds, which was commissioned by the AIMA and the Cayman Alternative Investment Summit, surveyed 80 asset managers with $550 billion in hedge fund assets under management (AUM).

Responsible investment. The study cites the United Nations Principles for Responsible Investment (UN PRI), which are six investment principles aimed at ensuring that asset management is socially responsible and environmentally sustainable. The UN PRI calls for signatories to incorporate environmental, social and governance (ESG) issues into their investment analysis and decision-making processes and to seek appropriate disclosure on ESG issues.

Investor demand. According to the report, investor demand for responsible investment is becoming mainstream, where in the past it had been largely limited to religious organizations and Scandinavian countries. AIMA’s study revealed that slightly over half of survey respondents had experienced an increase in interest of their firm’s responsible investment strategies, with the strongest interest coming from investors in North America and Europe. The study also found that investor interest was strongest among the largest hedge funds. The report noted that larger hedge funds do tend to have a greater variety of investors who can express interest in responsible investing. However, the report added that responsible investment is not limited to the largest hedge funds.

More and more investors are demanding that their capital be put towards responsible investing, partly due to changing risk perceptions, according to the report. Long-term risks such as environmental damage have become more of a concern to investors than in the past. There is also a generational shift occurring where millennial investors are actively thinking about ESG factors when investing, the report noted.

Hedge funds and responsible investment. The report states that 36 percent of survey respondents have either signed or plan to sign the UN PRI, with larger hedge funds of more than $1 billion in AUM to be the most likely signatories. Geographically, U.K.-based hedge fund firms are far more likely than those in North America to sign the UN PRI or to fill out the Responsible Investment Due Diligence Questionnaire (RI DDQ). The report observes that “since North American firms dominate the overall hedge fund industry assets under management, it will be interesting to see whether this gap closes in the coming years.”

While smaller hedge fund firms with less than $100 million in total firm AUM are less likely to engage in responsible investment on an absolute basis, the report found that they are far more likely to commit a significant portion of their assets to responsible investing. This suggests, according to the report, that these are specialized firms that have committed to responsible investing. In contrast, the report found that for the larger hedge fund firms, while more likely to have capital invested in responsible investment strategies, the level of commitment can vary, reflecting the challenge of integrating these strategies into an existing investment philosophy.

Approaches and challenges to responsible investment. The report notes that a relative lack of data regarding responsible investment opportunities can make it difficult to build an algorithm to evaluate responsible investment opportunities. However, the report forecasts that this will likely change in the near future, given increased computing power and the wider accessibility of data.

Two challenges go “hand-in-hand” for firms looking to incorporate responsible investment into their investment strategy: inadequate methodologies for the calculation of sustainability risks and the lack of relevant disclosures from companies. Without companies publicly disclosing ESG data performance, firms will find it difficult to evaluate the environmental and social impact of potential investments, the report advises.

The report notes, however, that there are several initiatives aimed at encouraging companies to report on issues such as carbon emissions, gender diversity, and employee compensation, including the GRI Standards, the Sustainability Accounting Standards Board, and the Carbon Disclosure Project. Even companies like ExxonMobil are facing pressure from investors to study the impact of their business on issues like climate change.

While improving measurement capabilities was cited as one of the biggest challenges to integrating responsible investing, the report notes that a third of the respondents to the survey were skeptical about such investments being able to generate double-digit returns, and a quarter said responsible investment presented a lack of attractive investment opportunities. These barriers were fairly consistent across firms of different sizes in the survey.

The report also finds that hedge fund managers are looking to expand their responsible investment expertise. Hiring responsible investment experts has increased, and several hedge funds surveyed have announced additions to their responsible investment teams. The report observes that these experts do more than just evaluate potential investment opportunities—they also talk to investors and explain how the impact of responsible investing is measured. Such expertise is likely to become even more important in the future, according to the report.