Hedge Fund Industry Pivots towards ESG Investing, according to KPMG report
Hedge Fund Industry Pivots towards ESG Investing
An increasing number of institutional investors are requiring that their hedge fund managers incorporate environmental, social and governance (ESG) factors in the course of their investment activities, with 72 percent of hedge fund managers citing growing interest among investors as the biggest driver for them to embrace ESG principles.
These are among the key findings of a new report, Sustainable investing: fast forwarding its evolution, published by KPMG, the Alternative Investment Management Association (AIMA), Chartered Alternative Investment Analyst Association (CAIA) and CREATE-Research.
“Sustainability is set to reshape the ecosystem of capital markets and the behaviours of their participants. It requires a mindset shift from the way investing has been done historically,” says Andrew Weir, Global Head of Asset Management and Vice Chairman of KPMG China. "It will become the ‘new normal’ in investing."
Involving 135 institutional investors, hedge fund and long-only managers with total assets of US$6.25 trillion in 13 countries/territories, including Hong Kong SAR, the survey shows that increasingly, investors now expect their asset managers to deliver attractive financial returns while considering the environmental and social risks associated with their investments.
“Institutional investors — and their consultants — have for many years been demanding that their portfolios not be exposed to the so-called ‘sin’ industries like fossil fuels or weapons manufacturing, a growing number of them are now seeking to use their capital to generate positive social and environmental outcomes on top of the financial ones,” says Bonn Liu, Partner, Head of Asset Management in ASPAC and China, KPMG China.
Some 45 percent of institutional investors now base their investments in ESG hedge funds on the view that they offer opportunities to generate alpha, while also offering a more defensive portfolio that looks beyond the blind spots in markets that are slow to price in ESG risks. Evidence suggests that this early generation of investors are satisfied with their returns so far, but there are questions around whether sustainability is a risk factor. Currently, it appears only to be a compensated factor in Europe and much less so in the US and Asia Pacific although this is expected to change over time.
Hedge fund managers have duly responded by advancing their integration of ESG principles. Currently, 15 percent of the surveyed hedge fund managers define themselves as being at the 'mature' stage, where ESG is implemented across the firm via appropriate policies, committees, research and data. A further 44 percent are at the 'in progress' stage, while 31 percent are still at 'awareness raising' stage; leaving the remaining 10 percent as 'no implementation to date'.
In moving to a more ESG-aware world, three avenues have been principally used by the surveyed hedge fund managers; incorporating ESG factors into investment process (52 percent), excluding securities that sit uncomfortably with the personal values of investors (50 percent) and shareholder engagement (31 percent).
Currently, however, only 29 percent of hedge fund managers and 11 percent of institutional investors report positive outcomes. The scale of adoption and the outcomes so far have been hampered by the difficulties in creating a direct line of sight between ESG factors and their investment outcomes. “Creating the necessary infrastructure of data, skills and technology is proving challenging,” adds Amin Rajan, CEO, CREATE-Research and the report's co-author. “Progress may not be enough, but it remains exponential. Investors and their managers are having to climb a steep learning curve via learning-by-doing.”
On the upside, however, the price anomalies resulting from the different levels of ESG adoption offer potential opportunities to generate alpha. Markets usually price in progress only when it is in the rear-view mirror.
The ESG landscape is evolving rapidly, according to the report. Data vendors are experiencing rapid consolidation. The rise of big data and machine learning is improving the quality and timeliness of information. Above all though, stronger engagement with investee companies is also serving two essential aims: bolstering the available data with a better picture of the reality on the ground and providing an information edge.
Under pressure from institutional investors, asset managers of every hue are now increasingly expected to act as agents of change by taking their stewardship role more seriously. Indeed, a ‘carrot and stick’ approach to corporate engagement is emerging. Under it, investors and managers are increasingly collaborating with their peers and external advocacy groups in promoting ESG-related goals at target companies.
Neil Macdonald, Head of Wealth and Asset Management Centre of Excellence (CoE), KPMG China, says: “Asset managers are rediscovering the power of engagement — advancing the sustainability agenda will likely require an injection of resources and talent into a more formalised stewardship function.”
Such a pragmatic activist approach is part of a broad thrust that aims to minimise greenwashing by demanding better data, complying with industry codes of practices, improving reporting and enhancing transparency. At present, 41 percent of institutional investors report a significant amount of greenwashing.
The survey report concludes that ESG investing across the broader financial services is poised to gain further traction in the immediate future with governments, regulators, asset owners and asset managers collectively pulling in the same direction. ESG concerns are the biggest challenges of our age. Industry leaders can make a huge difference.
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KPMG is a global network of professional services firms providing Audit, Tax and Advisory services. We operate in 147 countries and territories and have more than 219,000 people working in member firms around the world. The independent member firms of the KPMG network are affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. Each KPMG firm is a legally distinct and separate entity and describes itself as such.
In 1992, KPMG became the first international accounting network to be granted a joint venture licence in mainland China. KPMG was also the first among the Big Four in mainland China to convert from a joint venture to a special general partnership, as of 1 August 2012. Additionally, the Hong Kong firm can trace its origins to 1945. This early commitment to this market, together with an unwavering focus on quality, has been the foundation for accumulated industry experience, and is reflected in KPMG’s appointment for multi-disciplinary services (including audit, tax and advisory) by some of China’s most prestigious companies.
The Alternative Investment Management Association (AIMA) is the global representative of the alternative investment industry, with more than 2,000 corporate members in over 60 countries. AIMA's fund manager members collectively manage more than $2 trillion in hedge fund or private credit assets. AIMA draws upon the expertise and diversity of its membership to provide leadership in industry initiatives such as advocacy, policy and regulatory engagement, educational programmes and sound practice guides. AIMA works to raise media and public awareness of the value of the industry. AIMA set up the Alternative Credit Council (ACC) to help firms focused in the private credit and direct lending space. The ACC currently represents over 170 members that manage $400 billion of private credit assets globally. AIMA is committed to developing skills and education standards and is a co-founder of the Chartered Alternative Investment Analyst designation (CAIA) – the first and only specialised educational standard for alternative investment specialists. AIMA is governed by its Council (Board of Directors). For further information, please visit AIMA's website, www.aima.org.
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