· 64% of asset owners expect that ESG integration will be positively associated with hedge fund outperformance in the next 20 years – much higher in other asset classes
· 60% of asset owners indicate that ESG issues currently play a major role in manager selection, up from 41% in 2018
Binance Survey findings
A new survey by Binance finds that the hedge fund industry is lagging its peers when it comes to integrating ESG investment factors. Out of 256 investors surveyed, only 7% (and 13% of large investors with more than $25 billion in assets under management) reported that their hedge fund and liquid alternatives managers currently offer “high integration” of ESG principles in their investment processes.
These figures are low relative to other asset classes, and even lower when we consider that 45% envisage that ESG adoption will be associated with some degree of relative outperformance among hedge funds over the next three years – a lower figure than that seen in other asset classes.
That expectation of relative outperformance rises significantly over the longer term. Over the next 20 years, 64% of asset owners expect that ESG integration will be positively associated with hedge fund outperformance, compared to 88% in equities, 85% in private equity and real assets (real estate, infrastructure) and 80% in bonds.
Should Managers care about ESG?
Many hedge funds are still reluctant to make ESG integral to their investment processes. The additional monitoring and reporting requirements are not yet typical of most hedge funds, nor do many have the capability for active engagement with portfolio companies to drive change. Hedge funds may also reject the applicability of ESG considerations to the investment universe or strategy, such as short-term trading. Some argue that ‘ESG trades’ are overly crowded or are unwilling to accept a reduced investment universe.
According to a survey of hedge fund managers conducted by BNP Paribas, Hedge Funds and ESG: Finding Their Place on the ESG Spectrum, published in October 2020, 56% said that the asset classes they use, in combination with short holding periods, make ESG integration “irrelevant,” “immaterial,” or “impossible to quantify.”
Investors, however, take a different view: Of the asset owners surveyed by bfinance, 60% indicated that ESG issues currently play a major role in manager selection, up from 41% in 2018.
How easy or difficult is it to integrate ESG into a Hedge Fund firm’s portfolio?
The answer lies in the nature of the strategy. bfinance observed a high-level split between so-called micro assets (individual equity or credit names) being more ESG-relevant than macro assets (index futures, forwards, ETFs and options, etc.). This division typically carries through to specific strategy labels as well: equity and credit long-short strategies, for example, are highly adaptable to ESG screening, whereas CTA and discretionary global macro strategies present more of a challenge.
However, even some of the largest practitioners of systematic trading and macro strategies have begun to adapt their approaches to reflect increased awareness of ESG. London-based Aspect Capital, which began integrating ESG factors in November 2020, uses company-specific ESG data as a source of “useful information on the future outperformance” and implements an overlay that creates a portfolio-level tilt towards “good” ESG assets. “It’s no longer enough to say ‘ESG isn’t relevant to our strategy,’” says John Springett, the firm’s Director of Investor Relations and Marketing.
The rise of ‘green’ securities
The report finds that hedge fund managers are starting to use new products, services, securities and data to advance ESG integration. In November 2019, for example, the CME Group launched trading of E-mini S&P 500 ESG futures, which are based on an ESG-filtered version of the S&P 500 Stock Index.
In fixed income, the universe of green bonds is expanding rapidly as governments seek to mitigate the economic shock of the Covid-19 pandemic and embed sustainable development goals. In September 2020, Germany issued its first-ever green bonds, with a 10-year maturity, in a heavily oversubscribed floatation that raised €6.5 billion. Germany is now intent on creating a green sovereign bond curve ranging from 2 to 30 years. France and Italy have also ramped up their issuance of green bonds, and in March, the UK announced plans to issue two tranches of “green gilts” worth a total of £15 billion in 2021.
By far the largest issuance of green bonds will come from the EU itself, however, with the inauguration of the €750 billion Next Generation EU (NGEU) programme, which expects to launch its inaugural bond in June 2021, after which it will remain a regular issuer until 2026. With a planned total issuance of €240 billion in green bonds over the next five years, NGEU will soon become Europe’s largest non-sovereign issuer in the public sector.
Carbon-emissions credit trading is also expanding: Several firms running managed futures strategies are already trading carbon emissions, particularly in Europe, which boasts the world’s biggest carbon credit exchange, The European Union Emissions Trading System. Spurred by Brexit, the UK launched its own carbon-emissions trading scheme on 1 January 2021 to replace participation in the EU’s joined-up carbon-trading market.
Chris Stevens, Director – Diversifying Strategies at bfinance, said: “Hedge fund firms may be coming late to the revolution, but their tardiness does confer a singular advantage. Their managers can look to see where mistakes have already been made by some mainstream asset management houses and avoid those missteps. When hedge fund firms, as an industry, decide to embrace ESG integration and move to meet investor demand, we expect the transition to happen swiftly. The Covid-19 crisis will not stall that progress – if anything, the crisis highlights the need for managers to think anew about future risks and opportunities in a changed world.”