Primes and the hedge fund push into ESG

• ESG
• Hedge Funds
• Prime Brokers

As with many other asset classes, hedge funds are increasingly integrating Environmental, Social, Governance (ESG) criteria into their investment strategies and risk profiles.

This, in turn, is forcing prime brokers to rethink their service proposition, as Linear Investments explains.

Hedge funds move towards ESG

Inflows into ESG focused funds of all stripes, including hedge funds, is on the ascent.

Data from Preqin, for instance, found ESG orientated alternative asset managers saw a three-fold increase in the amount of capital they raised between 2020-2022, rising from $29 billion to $92 billion.

This is backed up by a report from Barclays, which found 30% of investors are making hedge fund allocations based on their ESG preferences, up from 8% in 2018.

Investors are building up their exposures to ESG hedge funds for several reasons.

Firstly, there is a genuine belief among investors that ESG funds offer better returns and downside protection, versus non-ESG funds.

Additionally, regulators are also putting pressure on allocators to demonstrate how they are integrating ESG into their investment decision making processes and risk management.  Again, this is helping to drive capital flows towards ESG investments.

ESG is rife with complexity

Although we are seeing increasing appetite for ESG investments, there are still a lot of problems plaguing the ESG trend.

Regulation globally on ESG is not consistent, and neither are the ESG standards, which not only creates confusion for investors but has allowed greenwashing to be highlighted on many occasions.

As a result, some institutions are becoming increasingly sceptical about investing in funds purporting to be ESG. Although we are seeing some harmonisation of ESG standards, the likelihood of regulators sitting together and homogenising the disparate rules on ESG seems a remote possibility at best.

Anti-ESG backlash from politicians is another problem, albeit one which is particularly unique to the US. Unfortunately, politics has been thrust into the debate on ESG investing, resulting in some conservative-leaning states imposing restrictions on public sector pension plans investing in ESG assets.

How do prime brokers respond to this?

A number of prime brokers are making changes to their operating models in response to the growing demand for ESG.

For instance, some prime brokers are reforming their securities lending practices amid pressure from investors. In some cases, primes are putting limits on the type of non-cash collateral they can accept, so as to exclude non-ESG assets.

Others are hosting cap intro events, which are focused purely on ESG hedge funds and themes.

With ESG now a critical component in the service provider selection process, a number of banks are keen to reduce their carbon footprints by limiting corporate travel in favour of virtual communications.

However, prime brokers do need to be conscious that not all investors share the same views on ESG, and this is something which should be taken into consideration. If you would like to understand more about how we support our clients, get in touch.