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Increasing Number of Hedge Funds Integrating ESG Factors, BNP Paribas reports

Investors and asset owners urged to encourage more ESG integration in hedge funds.

A total of 40% of major hedge funds claim to take ESG considerations into account throughout their investment processes, but one in five admit to not doing so due to a “lack of data”, suggesting the industry still has some way to go to match progress made in other investment sectors.

This is according to the ‘Hedge Funds and ESG: Finding their place on the ESG Spectrum’ report released by international banking giant BNP Paribas. Findings were gathered from 53 hedge funds (representing a range of manager styles, sizes and geographies) with US$0.5 trillion in combined assets under management (AUM) – around 20% of total industry AUM.

The survey showed that pressure to speed up ESG adoption is largely coming from clients, with 61% of investors strongly advocating for ESG integration. Senior management buy-in is an increasingly important factor.

“Many institutional investors are looking to their investment managers to help drive positive outcomes in this area,” the report added. “For hedge funds, the path to integration has started in some areas but has yet to find wholesale adoption.”

In a webinar in which BNP Paribas experts surmised their survey findings, it was confirmed that hedge funds incorporating ESG factors are “late on the uptake”, with 67% incorporating ESG factors from 2018 onwards and 28% of non-ESG funds “planning to begin incorporating ESG within the next two years”.

BNP Paribas believes hedge funds will reach their “tipping point” by mid-2022, with an anticipated 57% of funds integrating ESG into their investment process, thanks to ever-increasing client demand.

“This is a personal opinion, but the pressure asset managers felt from their investors and asset owners to involve ESG in their investment processes over the last few years will gradually be pushed on to the hedge fund world,” said Peter McGleughlin, Managing Director, Hedge Funds, Financial Institutions, BNP Paribas.

Although hedge funds are typically more focused on generating absolute returns – compared to asset managers working with situational returns – areas where ESG is proving “cost competitive” are sparking interest. Almost half (48%) of funds are “driven by the belief that it will improve their risk-return profile”.

As a result, areas of the ESG market such as renewable energies and electric vehicles are proving popular amongst hedge funds.

“Hedge funds are going where the pivot points are,” Sustainability Research Analyst at BNP Paribas Markets 360 Trevor Allen explained. “They see the value there and are beginning to incorporate their focus on alpha generation with sustainable factors.”

According to Alexandra Basirov – Global Head of Sustainable Finance, Financial Institutions – “the ‘S’ is the biggest problem area of the ESG factors for hedge funds”, with 67% of respondents to the survey citing how social scores are much harder to measure across regions.

The largest institutional clients in the hedge fund space are the primary drivers behind ESG adoption and, as the survey revealed, “tend to favour bigger, more institutionalised hedge funds that can better meet requirements around longevity, transparency, reporting and operational risk management.”

Even among the larger funds, the relatively recent integration of ESG factors into the investment process appears to be a work in progress, with dedicated resources the exception rather than the rule. Currently, 81% of hedge funds do not have internal teams, instead relying of external research vendors. Only 10% of hedge funds can claim to have any in-house ESG analysts at all.

Despite signs of progress across the hedge fund sector, the BNP Paribas report warns that ESG integration needs to be happening at an increased rate – particularly in the US and Asian regions.

“Hedge funds are increasingly creating ESG products, not only because they can drive positive change, but because it makes business sense to do so,” concluded the report.

“Investors too, whether principled or not, invest in ESG products without expecting weaker returns. These shifts are changing the hedge fund landscape, and show no signs of slowing. They may end up representing a fundamental investment trend of this decade.”

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