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Financial decision makers are increasingly making hedge fund allocations based on their ESG preferences. Their interest has soared from 8% to 30% since 2018, based on our survey of circa 200 investors through 3rd quarter 2022.
Among funds of hedge funds (FoHFs), 41% factor ESG into their allocation choices. Among advisors and consultants, 55% do.
On a relative basis, EMEA investors are more driven by ESG considerations, but investors in the Americas have been catching up recently.
Source: Barclays Strategic Consulting
ESG Hedge Fund products offer myriad features, including differing emphases on pillar focus, scoring mechanisms, portfolio construction, and levels of interaction with underlying companies.
From a pillar focus perspective, there are two existing ESG product types: ‘generalists’, which address all three ESG pillars, and ‘specialists’ that mostly focus on just one. Among specialists, which represent about 60% of our ESG product sample, all focus on the environmental pillar. Some specific themes emerge among those that focused on “E”, with products aimed at climate change, clean energy, and/or carbon emissions.
For ESG HF products, portfolio construction begins by establishing scores for companies within their investable universe. Most managers create their own scoring systems, but some utilize 3rd party vendor solutions. Once the scores are established, there are many options as to how to build out their portfolios. For instance, managers may choose to invest in companies with the highest scores, select those with lower scores with the hopes of capitalising on potential improvements over time, or they may do a combination of the two.
Among those looking to benefit from improved ESG scores over time, some managers choose to engage with companies to encourage ESG improvements in an effort to potentially maximise returns. On a relative basis over the last three years, these managers have outperformed their counterparts that do not engage across both alpha and return metrics.
Over the past three years, data show that ESG funds in our sample delivered 8% returns with 5.7% alpha while Discretionary Equity funds came in with 7.2% returns and 2.8% alpha.*
The Strategic Consulting team tracks 52 ESG funds, of which roughly 75% of are Discretionary Equity funds, which explains why that benchmark was chosen.
*Source: HFR, HFM, Capital Solutions
Source: HFR, HFM, Capital Solutions, Jensen’s alpha is calculated as follows: Returns – LIBOR - beta to MSCI*(MSCI returns-LIBOR).
Our survey shows that ESG is continuing to gain traction in the hedge fund universe. These products are taking on many new forms, flexing to meet increasing and varied demand, while demonstrating the potential to outperform their relative benchmarks.
About the experts
Ermanno Dal Pont
Managing Director, EMEA Head of Capital Solutions
Kate Holleran
Managing Director, US Head of Capital Solutions
Roark Stahler
Director, US Head of Strategic Consulting
R. Hazan Sucu
Assistant Vice President
Daniel Bergelson
Assistant Vice President
Laura McBryan
Analyst