ESG: Who Cares Wins


To many readers of the financial press it might appear that ESG (Environmental, Social, Governance) is a trending phenomenon. It might have attracted a lot of attention recently, but in fact ESG was introduced almost 15 years ago, in 2006 by the UN PRI (Principles for Responsible Investment). For most of the time since then ESG has been a sideshow. However, during 2020, starting with Greta Thunberg taking on President Trump in Davos, ESG and climate change in particular has been the main show.  Indeed, sometimes it feels as if the investment world has been hit by an ESG tsunami.

The current narrative is that hedge funds and ESG are not necessarily natural bedfellows. ESG is about long term investing: the “E” for example is concerned about how the global economy transitions to a low carbon economy over the next 10 to 30 years and the risks surrounding that transition. Meanwhile, hedge funds are perceived to have, and in many cases do have a much shorter investment time horizon.

I would present an alternative view: that ESG enables an opportunity for the hedge fund industry, not only to improve its public perception; but to also help turn the tide of negative net hedge fund flows, amounting to about $100bn in 2019.

The general perception is that hedge funds are behind the curve and this is certainly supported by my own experience through discussion with many managers. As it stands, the long only world has been grappling with ESG for many years now and in a few exceptional cases since before 2006, when the PRI introduced the concept.

There are reasons that hedge funds have remained behind the curve. First of all, there is confusion around terminology and language which has not helped. Apart from questions regarding terminology, including differences between ethical investing, responsible investing, socially responsible investing, impact investing and ESG, the ESG world is literally littered with acronyms. The PRI and ESG acronyms are just for starters. At a recent conference I was asked what I thought about the TCFD, the CPD, the GRI and SASB. You need an “acronym bible” to negotiate your way through an ESG conference these days.

As well as confusion, there is also cynicism with regards to ESG ratings. A whole industry has grown up around ESG ratings, a simple answer to a complex problem, which tries to address how good companies are according to a variety of ESG factors. But it’s not clear how meaningful these corporate ratings are.  Ultimately it is a subjective view which tries to aggregate apples, oranges and bananas.  It is no surprise therefore that there can be little correlation between ESG data providers.

And yet ESG provides the active fund management world and hedge funds an incredible opportunity to fight back against the inexorable rise of indexation.

From an investment perspective, hedge funds have an opportunity to short those companies failing to properly adapt to climate change.  Shorting is no longer a dirty word, partly responsible for the financial crisis in 2008; instead it can be seen as a smart strategy, helping to accelerate the transition to a low carbon economy. Equity hedge funds have the opportunity to create carbon neutral, even carbon negative portfolios.  For those pension funds and insurance companies looking to reduce their carbon footprint, this could be an interesting additional source of diversification.

And for once hedge funds have had a positive portrayal in the general media. Reporting on Hedge Fund Manager, Sir Christopher Hohn, Founder of the TCI, the Children’s Investment Fund, who came out publicly with details of TCI’s ESG policy, and its focus on climate risk. Mr Hohn recommended that all investment managers should engage with the companies that they are invested with on climate risk and, more controversially, he suggested that asset owners should fire any investment managers who aren’t doing so. Therefore, ESG can help to reverse the negative image of hedge funds in the general media.

Looking now into the crystal ball, what does 2020 have in store? Well, firstly the rising tide of enthusiasm for ESG is not going to slow down. 2020 will be the year when ESG continues to dominate the news. Culminating with the UN COP 26 meeting in Glasgow in November, the most important meeting on climate change since Paris in 2015.

A lot of the coverage around ESG investing has so far focused on millennials and rightly so. In 2020, however, I believe that the big story will be how the UK pension fund industry adapts to the ESG revolution.  The interpretation of fiduciary duty has been turned upside down in the ESG space. And now there is over a trillion dollars of assets which need to consider ESG and provide evidence of how this is done.

A couple of examples: the Brunel Partnership, which manages assets of around £30 billion for local authority pension funds, has announced their intention to remove non-ESG compliant fund managers from their portfolios. NEST, the largest UK Defined Contribution pension fund, with 8.9m members, wants its investment managers to be aware of ESG risks and opportunities; and, furthermore, that ESG is part of the culture of the firm and that this should start right from the top.

So, with this in mind I suggest a simple “ESG action plan” which can apply to both hedge fund managers and service providers: to become carbon neutral in 2020.  The UK has set a target of becoming carbon neutral by 2050; BP recently hit the headlines when it set the same target of becoming carbon neutral by 2050.  If the hedge fund industry becomes carbon neutral in 2020, then it would be 30 years ahead of the ESG curve.

3 things are required:

  • Firstly, calculate your company carbon footprint, which comes mainly from air travel
  • Secondly, get your calculation approved and there are several certification agents; and
  • Finally, offset your carbon footprint. In this respect there are various offset programs, including those supplied by the certification agents.

There are various parties who do care: employees; families; and perhaps most important, investors. 2020 will be the year when “Who cares wins”.