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ESG Factors Are Becoming Important For Hedge Fund Selection


The ESG (environmental, social, governance) trend continues, with more than half of institutional investors now saying that such factors directly impact their decision to invest with a hedge fund. To determine this statistic, HFM Insights held interviews and surveys with 65 fund selectors during the fourth quarter. It also looked at analysis of its other data and data from the United Nations Principles for Responsible Investment (UNPRI).

ESG becoming important in hedge fund selection

In a recent report, HFM Insights said there's a distinct regional divide by geographical region in the importance of ESG for hedge fund selection. The firm found that 58% of European investors incorporate ESG into their fund selection process, while only 35% of North American investors and 20% of Asia-Pacific investors do.

Additionally, 13% of European investors have a dedicated ESG capital pool, compared to just 8% of North American investors and no Asia-Pacific investors. For now, ESG considerations are still more prevalent among allocators in Europe.

Large hedge funds leading the way

However, HFM added that its analysis of its Billion Dollar Club of larger hedge fund managers and the list of UNPRI signatories suggests North America is catching up to Europe quickly. Of the 15% of North American asset managers with more than a billion dollars under management that are UNPRI signatories, 45% signed up last year. According to HFM, firms in North America are noticing the "growing clamour among investors for action on issues such as climate change and social responsibility."

HFM also said pension funds and family offices are becoming increasingly likely to think about ESG when choosing hedge funds as younger generations and beneficiaries influence investment decisions more often.

Debate over ESG

There's been much debate over whether ESG considerations will reduce returns. Some sources say that they do, while others say they don't. HFM is in the latter camp, saying that ESG policies do not constrain returns or investor inflows. The firm explained that the median amount of capital allocated to firms that became UNPRI signatories grew 32% after managers signed up and 47% for firms with a "heritage" in hedge funds.

HFM explained that adopting an ESG framework is "both an ethical choice and a commercial imperative." Of course, it's the latter of those two factors that will drive continuing growth in the number of firms adopting ESG policies and launching ESG products.

The firm believes President Joe Biden's green policies could cause more allocators in North American to consider ESG policies, possibly pushing the percentage up over 50%.

Institutions more likely to consider ESG than other investor types

HFM Insights also found that institutional investors are more likely than other investors to consider ESG and diversity & inclusion factors. However, they still place the greatest importance on the reputation of the CEO and the fund's corporate culture. While ESG and diversity & inclusion may be desirable, reputation and corporate culture are essential to building trust between the investor and the manager.

The firm also said corporate culture is important as 75% of allocators consider a fund manager's corporate culture and the reputation of its CEO when investing. Private wealth's emphasis on corporate culture could demonstrate the entrepreneurial background of many family offices.

HFM also said that even at current levels of interest, ESG and D&I present "attractive opportunities that are only likely to grow." The firm added that early adopters would have the "most credible ESG offering" than managers that are latecomers.

ESG focus expected to keep growing

The firm found that private wealth investors are the least likely to incorporate ESG into their investment process. However, as younger family members and new entrepreneurs take over family offices, HFM expects the proportion that does think about ESG to jump.

It also said institutions are more likely to integrate ESG into both their general investment process and across individual investments. HFM expects this trend to be accelerated by demographic shifts as younger pension fund beneficiaries become more likely to push for ESG policies.

For now, ESG may not be a focus in conversations with private wealth allocators. However, HFM expects that to change and believes investor relations should lay the foundation now for future conversations with high-net-worth individuals and family offices.

Funds sign onto UNPRI

HFM also found a surge in large hedge funds signing on to the UNPRI. Billion Dollar Club hedge fund UNPRI signatories grew 39% last year. Now 23% of these firms managing $700 billion in hedge fund assets are signatories. More than half of them signed up within the last three years, and more than 25% of them signed up in 2020.

HFM also found record inflows into and strong performance among ESG funds, and hedge funds have noticed. However, it has caused concerns that the momentum of money pouring into ESG assets could be inflating a bubble.

Even though there has been a sharp increase in hedge fund signatories for the UNPRI, most signatories are still traditional asset managers. Signing up demonstrates to investors that managers intend to develop their business beyond its niche.

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