Hedge funds and private equity improve ESG focus yet face differing reporting and monitoring challenges

ESG definition

Hedge funds and private equity are both improving their transparency over ESG. However, while on the private equity side, ESG is more seen as an investment opportunity, complexities remain on the hedge fund side around issues of reporting and shorting, according to Cambridge Associates.

Trudi Boardman, Hedge Fund Specialist at Cambridge Associate said that many hedge funds are still in the earlier stages of introducing ESG policies and processes, and that “there’s still a long way to go.”

She commented: “The ESG area is still very much a work in progress on the hedge fund side. There are challenges in terms of how to measure existing exposures, for example  whether to count shorts as an offset and how to account for derivatives.

"There are monitoring challenges that exist particularly outside equity-oriented strategies. Though there is certainly a positive trend that we anticipate will continue, it does require active engagement from investors to convey the importance of ESG considerations.”

Boardman explained that bringing ESG considerations into practice is a simpler case for private equity, where impactful solutions can be more clearly identified.

She added: “There are very few hedge funds focused specifically on identifying positively impactful solutions – more are probably willing to avoid more ESG-exposed industries through exclusions– while in the private markets space, the nature of the asset class means that involvement in impactful businesses can be a lot more significant.”

A survey conducted by Cerulli Associates last month revealed that though 73 per cent of hedge fund managers surveyed prioritise incorporating ESG considerations into their investment process, the AUM of dedicated ESG liquid alternative funds represent only 2 per cent of total industry AUM.

Dan Aylott, Managing Director and Head of European Private Investments at Cambridge Associates, said that ESG is a big focus of due diligence on the private equity side, and something his team continues to monitor once clients have invested.

PwC’s 2021 Global Private Equity Responsible Investment Survey found that 65 per cent of PE firms that responded have developed a responsible investing or ESG policy and the tools to implement it.

Aylott added however that monitoring remains difficult especially around climate and emissions issues. “It’s still very challenging to get that right, to help clients understand those exposures in their private market portfolios. It’s going to take time overall, there’s definitely quite a dispersion at the moment between those managers that understand it very well and those that are only just starting to think about it,” he said.