Editor’s Letter – Issue 122

April | May 2017

Originally published in the April | May 2017 issue

A higher proportion of long only than hedge fund assets are publicly branded as being run on ESG (Environmental, Social and Governance) criteria, but that might change in future. The UNPRI (Principles for Responsible Investment) has finally unveiled a new due diligence questionnaire (DDQ) covering ESG considerations. AIMA, which has developed a suite of DDQs for over 20 years, belonged to the 17-strong working group as did the Hedge Fund Standards Board (HFSB).

The HSFB addresses some concerns around the G in ESG, through its support for fund and manager governance policies on conflicts of interest and valuation policies; reports such as administrator NAV transparency reports, and risk aggregation formats such as Open Protocol Enabling Risk Aggregation. Beyond this, governance at investee companies, and the E and S, are also attracting more interest.

The impetus for the DDQ comes partly from institutional investors. Albourne Partners started examining ESG more closely in 2011, initially in response to interest from allocators in Northern Europe and Australasia. Albourne now reports growing concern from the US.

Man Group’s GLG was an early mover. The firm has run a sustainability fund since 2008, and has been involved with the UNPRI advisory board. Man GLG’s approach avoids both “black boxes” and potentially simplistic box-ticking. “As managers have different styles the aim is to educate them internally and let them adapt,” says COO Carol Ward. Indeed, no one size may fit all. Many in the industry believe that DIY research is needed to complement various rankings supplied by providers such as Sustainalytics, Trucost or TruValue Labs. Additional research is essential partly because there are gaps in providers’ coverage, particularly in emerging markets and China, where disclosure can also be less extensive.

The new DDQ leaves freedom for managers to explain how ESG factors are embedded in their own investment process. Negatively screening, exclusion of, or divestment from, companies falling short of criteria is one approach. Conversely, building substantial stakes in order to bring about change, via engagement, is another avenue that is pursued by some activists. Technical issues can also give rise to divergent opinions, for instance, carbon footprints can be measured in different ways.

The implementation of ESG policies is also tempered by practical factors. ESG is more easily applied to bottom up, fundamental strategies with longer holding periods. Separately managed accounts may be needed to apply some ESG criteria as it is harder to effect exclusion in comingled vehicles. For instance, Finland’s Varma Mutual Pension Insurance Company has a policy of avoiding nuclear power, but does not apply this to external hedge fund allocations made via comingled vehicles.

Whether ESG impacts performance positively, negatively – or not at all – remains debated. Man GLG’s Simon Pickard laments the lack of data mapping ESG against performance while others claim that ESG can add most value on the short side. As more hedge funds manage ESG mandates, we expect to see more research and data on associated performance.