Most Hedge Funds Don’t Consider ESG Factors When Stockpicking

Skeptics remain in the industry, but overall allocations are improving.

When it comes to environmental, social, and governance (ESG)-focused equities, it seems most hedge funds could not care less.

Although ESG investments are gaining importance among institutions such as pension funds, endowments, and foundations, hedge funds are not as interested, according to the latest quarterly survey from index provider BarclayHedge. The firm says 41% of respondents considered these factors in their allocations.

Although BarclayHedge did not ask the hedge fund skeptics why ESG is not top of mind, Sol Waksman, its president, thinks speculation has a lot to do with it, surprisingly based on his own experience.

“Before I started seriously looking at ESG, I thought it was all hype,” he told CIO. “I thought it was a feel-good type of approach that made no sense whatsoever.”

ESG needs time to develop asan investing trend, Waksman said. He used Vanguard’s 500 index fund, which launched in the 1970s, as an example of how it takes time for some things to thrive. “Look how long it’s taken that type of low-cost index-based mutual fund to gain traction,” he said, adding that the research to support it “has been there since the 1950s.”

He said CIOs who aren’t big on the growing ESG space should conduct more research “so that they can make a more informed decision.”

For those hedge funds that do use ESG to pick stocks, about 52% of their assets are decided on ESG ratings, up 10% from the previous year. That number is set to increase to 58% by next year, the survey said. Most like Bloomberg and Sustainanalytics (33% each) as their ratings providers. Others prefer MSCI (21%) and Thompson Reuters (13%).

Waksman said increased interests in social impact investments, the growing recognition of the link between governance and performance, and the awareness of how human activity causes climate change are responsible for the uptick in ESG investments in the hedge fund space.

“Everyone’s talking about it, and when your customers come to you, you have to have an answer,” he said, noting that the trend is increasing thanks to big pension funds, such as the $374.8 California Public Employees’ Retirement System and the $212 billion New York Common Retirement Fund adopting ESG investments into their portfolios.

Governance is one indicator that ESG fans look hard at. He said the close correlation between good governance and company performance proved his point. Governance shortfalls product the opposite result, he argued. (Just ask Papa John’s and Bed Bath & Beyond.)

“By focusing on governance, you can pick better-performing stocks and you can pick under-performing stocks,” Waksman said, noting that it becomes easier to do so this way.

Environmental and social factors are also heavily considered as top factors among respondents.

Social matters Waksman said funds should look for are work culture at these companies and how they handle employee issues such as equal pay. Environment-wise, he suggests looking at companies that care more about it.

“We all see climate change happening in front of us,” he said. “If a firm is not trying to reduce its impact on climate change, on other types of pollution, they’re subject to lawsuits…which have economic impact on the firm.”

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