‘The one thing that doesn’t abide by majority rule is a person’s conscience.’ – To Kill a Mockingbird (Harper Lee)
The new hot trend for hedge funds is ESG investing (Environmental, Social, and Governance). Beyond the socially conscious motivation, there is evidence that investments with higher ESG principles are less risky and deliver higher growth. A recent report stated that 45% of institutional investors base their investments in ESG hedge funds on the view that they offer improved opportunities to generate alpha.
These principles are not new to the market, long before hedge funds, the traditional fund sector had been developing this market, and investors’ appetite is not yet satiated. As the investor community increasingly considers ESG as part of their allocation process, hedge fund managers are adapting their investment processes to meet this demand. In a recent AIMA survey, 72% (up from 40% in 2018) of hedge fund managers surveyed, cited the growing interest among investors as the biggest driver for them to embrace ESG.
‘Social’: Consideration of people & relationships
As we witness increased social unrest in the US, and many other countries, a light is being shone on the ‘S’ in ESG. The factors of ‘social’ responsibility are defined as human rights, gender/diversity, community relations, employee engagement, labour standards, data protection/privacy and customer satisfaction. The first five principles here can all be said to be the main proponents of the protests that we see today.
As the hedge fund industry has matured, many of these factors have been considered part of the business development process. This is demonstrated across a broad spectrum of initiatives, from direct action to charitable endeavours.
There is evidence that hedge fund managers are taking steps to improve the diversity and to foster an inclusive culture. This is further encouraged by external influencers, such as regulators and investors, who are focusing on businesses that adopt this philosophy in their own day-to-day operations.
Though identifying analysis to support the application of ESG principles at a manger level has proven difficult, one indicator, that support the broader assumption that it is beneficial, is the HFRI’s Women’s Index (hedge funds managed by women), which has substantially outperformed the broader industry index since its inception in 2007.
As with all industries, hedge fund managers still have some way to go to fully integrate the ESG. The industry, in the US and Europe, is clearly dominated by white male managers, though it has been said that attracting diverse candidates who want to work for a hedge fund has been challenging. Investors too need to reflect further, research from Stanford University and Illumen Capital Management LLC found that investors tend to devalue firms with black ownership and leadership, even with high-performing funds.
Walking the walk
Since inception, Quay Partners has embraced the ESG principles in our business development and we continue to seek opportunities for improvement. As the industry pivots towards this new paradigm, I am optimistic that we can, together, deliver a better future for investors and the broader community.
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Quay Partners Group delivers bespoke investment management solutions to independent hedge fund managers and family offices.
Thomas Underwood, the Founder, has over 20 years’ experience in managing and operating hedge funds.