So far, investors looking to invest for the common good have had little reason to look at hedge funds. But this could be about to change, as hedge funds slowly start to embrace socially responsible investing.
Hedge funds struggle with SRI for three reasons: the demand for transparency, the strategic restraints and the questionable returns. However, as the idea of SRI gains traction with institutional and private investors, the number of hedge funds with environmental, social and corporate governance-compliant strategies is increasing. This presents new business growth opportunities for both single-strategy hedge funds and funds of hedge funds looking to package new products in a bid to win back sceptical investors.
No match made in heaven
We have had specific requests for SRI hedge funds,” says Ian Morley, alternatives senior adviser at AlllenbridgeEpic Investment Advisers. “Mostly from faith-based funds that have intellectually bought into the argument of using hedge funds for diversification but are bound by restrictions.” Hedge funds do not lend themselves very well to SRI, Morley says, mentioning that pure SRI would prohibit not just buying but also short-selling of tobacco and alcohol producers.
“There is no clear definition of what SRI is. We are still at the early stages of what I believe is a long-term trend,” says R. Scott Arnell, partner at Swiss-based SRI advisory boutique Geneva Capital. “A lot of people talk about it, but few actually do it.” One of the issues, says Arnell, is the reluctance among hedge funds to open up their books to investors. “Hedge funds have a problem with transparency. Some investors will want to mirror the trades, so hedge funds don't want to be transparent. But SRI demands transparency.”
At AllenbridgeEpic there is also more interest than action, but then SRI is hardly the only issue on hedge funds' agendas, says Morley: “At the moment, there are about 20 different sets of regulatory rules coming through, so SRI is not a strong focus for hedge funds.” In terms of returns, Morley advises investors to keep up their due diligence, arguing it could be seen as irresponsible for a pension fund to accept a bad manager just because the fund is SRI-compliant.
Despite the challenges of incorporating ESG principles into hedge funds' strategies, Mirabaud Asset Management took the plunge and launched an SRI global emerging market equity fund of hedge funds in July last year. “Pension funds, particularly in Switzerland, give importance to SRI,” explains Lionel Aeschlimann, head of asset management. Mirabaud is currently exploring the possibility of developing a presence in Scandinavia, where Aeschlimann says schemes also have an appetite for SRI.
Could SRI be trending? Christian Dargnat, chief investment officer of BNP Paribas Investment Partners, thinks so: “In a few years' time, the use of ESG criteria will be mainstream. It is a societal trend that asset managers have to take into account. “ESG criteria will be viewed as an added-value activity,” he says, adding: "We are currently incorporating ESG criteria into the investment decision-making processes of all partner firms.”
Hedging the future
It is the next frontier for hedge funds,” says Mercer's principal and US head of responsible investment Craig Metrick. He insists it is still early days, but that hedge funds are beginning to see opportunities for growth in SRI: “There is the belief that if a company has a good ESG record this could mean good management and there could be a strategy in looking at this.” Keon Holmes of adviser Cambridge Associates explains that being a responsible investor in the US usually implies the portfolio has been screened for non-compliant companies from a list provided by MSCI (ISS).
As more institutions are looking for screened strategies, it is also a question of funding. “Hedge funds are looking to grow, as long as it does not affect their performance,” says Holmes. “SRI is an opportunity for the hedge funds to partner with investors that used to be outside of their universe.”
According to Mercer, only 2.4 perecent of hedge funds currently have a strategy falling within the two top ranks of ESG compliance. This is compared with 9 percent of investment strategies as a whole. No one factor explains this, but high turnover, trading-baseed strategies are notoriously difficult to apply ESG factors to.