Hedge Funds Drag Their Feet When It Comes To ESG

Few hedge funds are investing based on environmental, social, and governance factors — but AQR just releaseda framework for the strategy.

Brent Lewin/Bloomberg

Brent Lewin/Bloomberg

Hedge fund firms continue to be slower than other alternative investment firms when it comes to embracing environmental, social, and governance-oriented investing strategies, a new report from Preqin shows.

The alternative investment data provider released a report Wednesday that shows 65 percent of hedge fund investors surveyed by Preqin said they think ESG will become more important in the next five years. This is compared with just 37 percent of hedge fund managers who said the same thing.

Hedge fund firms traditionally have bucked ESG investing strategies, according to Preqin. But increasingly, funds like AQR Capital Management — which released a responsible investing framework in partnership with the United Nations Principles for Responsible Investment on Wednesday — are considering the matter.

“Hedge funds exist to generate an absolute return across a range of markets and asset classes, using a variety of instruments to achieve a differentiated return stream,” according to the Preqin report, which stated that for those reasons, constraining portfolios based on ESG considerations may be “anathema” to some hedge funds.

According to Preqin, 29 percent of investors surveyed already have ESG policies in place for their hedge fund investments, while 20 percent are planning to add policies during 2019. Just 20 percent of hedge fund firms surveyed have their own ESG policies in place, while 15 percent plan to put policies in place imminently, according to Preqin.

This is compared with the private equity industry, where 53 percent of firms already have ESG policies in place, while 15 percent told Preqin they plan to put policies in place by the end of the year.

“Hedge funds clearly have some way to go to match other alternative assets when it comes to embracing and adopting ESG,” according to the report. But they may want to start catching up, according to Preqin.

“There is a clear appetite for hedge funds to invest responsibly – and ignoring this may prove foolhardy in a fundraising market that is already incredibly challenging,” the report said.

AQR, for its part, noted that there is confusion surrounding what constitutes responsible investing in the framework it published Wednesday.

According to the quantitative investment firm, there are numerous ways for investment firms to approach ESG investing while adhering to the UN’s PRI principles, a set of standards for responsible investing.

[II Deep Dive: How ESG Can Generate Alpha for Hedge Funds]

AQR’s framework shows that investors can engage in responsible asset selection by either screening their portfolios — a process that involves choosing to exclude certain sectors from their investments — or by engaging in ESG integration, which involves considering how ESG could affect a company’s investment quality, the report showed.

AQR’s framework also included responsible ownership, a hot-button issue in the asset allocation world as of late. According to AQR, responsible investing “requires awareness that there are other ways of interacting with companies to influence their business beyond just the decision to invest or not.”

The firm’s report said that responsible ownership includes activism, voting, engagement, and direct management. A spokesperson for the firm reached via email did not immediately respond to a request for comment on how AQR will be using the framework.