Sustainable Hedge Funds: Oxymoron or Possibility?

What if you could increase profitability by improving sustainability? Businesses are now finding that this is not just a utopian fantasy but an achievable goal where one does not come at the cost of the other. But would this work for hedge funds and change their myopic thinking? 

Traditional views of business emphasize maximizing returns and focusing on the bottom line, but now companies are expected to be a positive force in their communities by considering how their operations affect the people involved and the natural environment. 

This idea establishes the contemporary concept of Environmental, Social, and Governance (ESG) investing, a main theme covered by the Desautels Business Conference on Sustainability (DBSC) last month. Companies that follow the ESG guidelines not only hedge reputation risk, they claim to boost returns by streamlining inefficiencies, improving employee morale, and ensuring long-term solvency.  

Examples of sustainable factors include use of natural resources, emissions, employee satisfaction, and ethical governance. Resource intensive industries such as energy and agriculture are often highlighted due to their capacity to directly affect sustainability, but the indirect impact of the financial industry is enormous due to its ability to either promote healthy practices or enable unsustainable habits.  

Firms at the DBCS such as Addenda Capital and Fondaction presented their investment strategies that followed ESG and claimed they reduced risk. Long-term firms like these are adapting well, but Hedge funds, on the other hand, are still notorious for their short-term strategy and focusing solely on the bottom line to generate that precious alpha. Since it is already so difficult to beat the market, Hedge funds do not want to restrict themselves by following ESG strategy.  

 Being unconstrained leads to practices such as shorting sustainable companies or investing in unethical firms. Managers try to appear concerned, with 80 percent of large funds ($1B aum) claiming on improvements in sustainability, but research found that only about 10 percent of assets are currently in ESG approved companies. There is a large disparity between what is said and what is done and with Hedge funds coming under scrutiny for charging high fees while underperforming, they may want to consider changing their practices. 

A solution several firms are using is offering sustainable portfolios as an alternate option to clients so that investors have the choice to invest responsibly. With a 50 percent increase in sustainability-minded clients since last year, the rapid growth of demand could make this a very attractive option. As more and more people are becoming aware, ESG funds would grow over time and Hedge funds would continue to become greener. 

 This may change the nature of these firms, but this may be a good thing since the short-term strategy does not seem to be generating additional returns anyways and it is why these are some of the most disliked companies in the financial industry. Managers would be forced to lengthen holding periods, but this would reduce risk and potentially improve long-term results.  

Sustainable Hedge funds can be a reality, but this would require influence from the power behind them; the investors. Since managers are adaptable to client needs, the only way to improve responsibility is to have the majority of investors caring about sustainability. Significant progress has been made but the world is still far from its target and increasing investor awareness is the best way to reach sustainability goals. With a changing business landscape, Hedge funds will be forced to adapt to new ideology or risk further deterioration.