Sanan Pillay, head of Alternatives Research at Sanlam Investments Multi-manager
The hedge fund industry, historically shielded from intense scrutiny and enjoying greater investment flexibility, is facing mounting pressure to align with environmental, social and governance (ESG) considerations. Investors have become accustomed to ESG integration in their long-only portfolios and are increasingly inquiring about the actions and improvements hedge fund managers are undertaking in this area.
According to a Barclays Corporate and Investment Bank survey, interest in making hedge fund allocations based on ESG preferences has soared among investors, from 8% in 2018 to 30% in 2022.
Sanan Pillay, Head of Alternatives Research at Sanlam Investments Multi-Manager, says, “It is clear investors are looking to invest in funds with strong ESG strategies and the urgency of addressing environmental, social and governance challenges calls for immediate action. However, it is crucial to acknowledge that harnessing the hedge fund industry’s potential to positively influence the world will be a complex and lengthy endeavour.”
The firm’s Alternatives Research team has begun a process of actively engaging with hedge fund managers to understand their current ESG practices and plans for enhancement. “By fostering open and honest discussions and leveraging industry knowledge, our team is committed to driving ESG integration within hedge fund strategies and general operations.”
However, the diverse range of hedge fund strategies and industry intricacies create significant challenges when integrating ESG into these funds. “For instance, hedge funds that rely on macroeconomic analysis and express their views through futures contracts may not have straightforward avenues for integrating ESG actions into their portfolio management. Similarly, managers engaged in short-term trading with limited security holdings may struggle to effect positive change in the ESG standing of invested businesses,” says Pillay.
Hedge fund managers with direct investments in securities and longer holding periods, similar to traditional long-only asset managers, have greater opportunities to implement ESG initiatives. These managers have the time and ability to engage with company management, thereby influencing positive change.
Conversely, managers who invest in derivatives face hurdles in implementing ESG initiatives. Derivatives lack rights related to attending shareholder meetings or voting on company decisions, while short holding periods limit their capacity to engage management effectively on ESG considerations.
“This raises the question of whether it is fair to impose uniform ESG expectations on all hedge fund managers or if a more contextual approach is necessary,” He explains, “While it is important to not give any fund managers special treatment, it is also important not to penalise managers for something that is genuinely outside the scope of their operations.”
Pillay believes one possible solution would be to temporarily distinguish hedge funds for which ESG initiatives may currently be challenging, while considering their specific circumstances when evaluating ESG performance. “This approach provides the industry and fund managers with time to develop the necessary databases, systems, and processes required for broader ESG integration across hedge funds.”
The complexity of implementing ESG actions within hedge fund strategies prompts the consideration of a broader perspective beyond individual funds. While some managers may have limitations in influencing companies and governments on ESG factors, they can still make a positive impact through private initiatives, such as bursary programmes and sponsorship of socially impactful endeavours. Expanding ESG evaluations to encompass the firm level, rather than solely focusing on individual funds, would unlock opportunities for the industry to contribute positively to the world. Additionally, it would encourage all hedge fund managers to consider their broader environment and their potential for positive impact.
Pillay says, “We have only just begun the process and we know the journey ahead holds promising opportunities for progress.”