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Hedgeweek Global Outlook 2022

Chapter Four: ESG

31 Jan (Hedgeweek) – Hedgeweek’s Global Outlook 2022 takes an in-depth look at the range of issues impacting equities, credit, macro and more. Below, as part of Chapter Four: ESG, Geordie
Cox, Investment Manager
, comments on hedge funds, impact in private markets and integration of ESG considerations into investment decision-making.

Hedge funds have been slower to demonstrate integration of ESG considerations into investment decision-making. Often citing a lack of relevancy, robust data sets and the costs of reporting. There has also, in our view, been a lack of understanding as to what ESG actually means from an investment perspective. Often, we find managers are considering these factors
in investments (eg governance), but have not historically seen this as “ESG”.

We comprehensively rate over 160 strategies (including equity long only, fixed income, hedge funds and private market funds). Our research shows the above referred to pace of change improving. Ninety-five per cent of the managers we analysed (including hedge funds) demonstrated positive momentum on ESG issues. Positive behaviours included a growing willingness to engage, more robust ESG selection processes, increased use of data analytics and dedicated sustainability resources. But there remains more to be done; in particular, we
would like to see further attention paid to stewardship (where the strategy allows).

We expect this positive momentum to continue. The more advanced hedge funds are already active in this space – increasing commentary/ reporting, as well as incorporating ESG data analytics and signals into their investment models and analysis. We expect this to continue to be driven by: (i) LP sentiment – it will be easier to raise if managers are meeting LP ESG demands; but also (ii) fundamentals – GPs are increasingly seeing markets (pricing/ volatility)
affected by ESG factors.

Our personal approach is asset class specific – for ‘high focus’ strategies where ESG issues can affect the risk-return within the given strategy, we engage with managers to drive better practice. However, we acknowledge that in certain ‘low focus’ strategies (e.g. portfolios with synthetic exposure, low concentration, high position turnover etc.), ESG issues may be less relevant, and we would expect to see sustainability progress to be slower. We classify
most (but not all) hedge funds as low focus, meaning we view ESG factors as having less impact on risk-return in the given strategy than in (for example) a buy and hold equity long only strategy with physical positions.

That said, minimum standards apply to all funds – we do not expect stagnancy within hedge funds. There is plenty of opportunity to advance. Our deputy CIO – Keith Guthrie – is co-chair of the IIGGC Hedge Funds & Derivatives working group, focusing on setting clear ESG targets and clarifying consultants’ expectations for hedge funds. The group is also looking at how hedge funds and derivatives positions can still achieve real-world sustainability impact, which
in our view is an area less well-understood and considered. 

Allocators are focused on improving hedge fund ESG practices. This is not a fad. Managers will need to evolve, regardless of their strategy focus. The best ones are already doing so.

For us the future of ESG investing falls into a few core themes. The first – engagement – will become an intrinsic part of asset management services, as ESG data consistency and availability improves. We expect outsourcing to specialised engagement service providers (aggregating investor positions to maximise engagement agendas on behalf of investors) to be a growing trend. 

Secondly, ESG data (and analytics to process) will become ubiquitous in fundamental company/portfolio analysis. Data providers will continue to grow in importance, but consolidation of data, as well as cross-industry/asset class initiatives such as carbon accounting will increasingly be critical. Thirdly, allocators will begin to look beyond seeing sustainability purely as a risk management tool and increasingly focus on the potential positive
societal or environmental impact their portfolios could have. 

This final bullet is best expressed (albeit by no means exclusively) in our client’s private portfolios, where the increased ability to control and the increased duration that private market strategies offer, provide one of the most powerful toolkits to drive real world impact.

Where public markets lead, private markets tend to follow, so we welcome the extension of TCFD reporting requirements and transition plans to private companies. We also expect to see more attention to sustainability impact disclosures, particularly where private funds are badged sustainable. The FCA is currently consulting on sustainability disclosure requirements and
investment labels. The disclosures are expected to refer to the UK green taxonomy, which is also in progress.