Hedge funds are going long ESG

For those involved in a corporate action situation, a remuneration vote, or implementing the sustainability policy of a large company there is one audience which you normally have not had to consider: hedge funds. However, there are signs that is changing.

In general, hedge funds are interested in generating alpha, or non-market correlated returns. The typical holding period can be quite short, somewhere between minutes and weeks, and – unless they are engaged in an activist strategy – they don’t usually vote or engage with the company on Environmental, Social and Governance (ESG) issues.

This week, Albourne, a consultancy advising the clients of hedge funds, published a manifesto in which one of the main points is to develop a standardised method of ESG reporting both for corporates and funds. Simon Ruddick, the chairman, is stepping down to promote it.

The Financial Times also carried a piece which claimed about a tenth of hedge fund strategies are now managed according to ESG principles. Half of hedge funds have also signed up to the United Nations’ Principles of Responsible Investment (UNPRI) charter.

Client’s demand

The drive for greater commitment to ESG by hedge funds is coming from their clients. According to a recent survey by the trade association AIMA, some 51% of hedge funds are seeing increased interest in their responsible investment capabilities, with the bulk of it coming from North America.

There have been some notable fund launches in this area. Jana Partners Impact Fund recently took on Apple over the addictive use of smart phones by children. It invests in companies which it, “believes are good bets but could do better for the world.” ValueAct Capital also launched its Spring Fund which invests in companies which, “are emphasising and addressing environmental and societal problems.”

To be fair to hedge funds, there are good reasons why they have not historically taken much of an interest in this area. Not only are their positions frequently of short duration, their primary objective is to generate alpha for their clients and this may in fact conflict with sustainable investing. There may be better returns to be made from a distressed security with a poor reputation. Furthermore, they may actually have a short position or stock on loan, where the votes rest with the legal owner. Or they may invest via Swaps which face the same issue.

Many hedge funds manage systematic strategies which are based on filtering and analysing data. Standardising ESG reporting by corporates, as the UNPRI is moving towards, is likely to enable them to create filters, indices and algorithms to provide ESG signals to adjust their portfolios or their votes accordingly.

Corporates take note

What are the implications for corporates? These are threefold. There is yet more of a requirement to keep the share register up to date and to establish who is the real owner and decision maker of shares out on loan or held via nominee accounts or other synthetic devices. Second, having worked that out, companies need to understand their investment or voting criteria, which may be systematic. And thirdly to engage with the funds and to emit the right signals.

Hedge funds now manage some $3.1 trillion of assets. As we saw in the campaign against the London Stock Exchange led by the TCI fund, they don’t do things by halves and even if they don’t succeed in their demands, they will make their presence felt by boards and companies and will shake things up.

The recent decision by Unilever to pull a vote on its redomicile was a classic example of things going wrong for a corporate. One suspects the company wasn’t clear who owned its shares and what they thought. Most of the names which came out against it were classic long-only funds. In the future, more hedge fund names are likely to be named publicly in such situations.