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ESG Investing for Hedge Funds

Updated: Dec 21, 2022

Impact investing for alternative assets: improving and expanding ESG to become a superpower for alternative assets. Environmental Social Governance, or "ESG", has recently brought about a seismic shift in the investment industry. Andy Pitts-Tucker, global head of ESG at Apex Group, notes that alternative asset funds have undoubtedly felt this transition as more fund managers strive to incorporate ESG elements into their investment strategies.

We investigate the factors underlying ESG's fast-rising role and how businesses are adapting to maintain a competitive advantage.

Why do funds have a growing commitment to ESG?

We see three primary causes driving the growing importance of ESG in private equity, private debt, real assets, and hedge funds.

Greater scrutiny and pressure to "do good" by adhering to ESG norms have been placed on privately-held businesses as a result of societal shifts. This is a result of well-publicized global problems such as climate change and income inequality. Companies are increasingly obligated to be part of the solution, rather than the problem.

In the past, the environmental impacts of private enterprises were difficult to measure, which posed substantial obstacles for ESG. With the expanded ability to collect data on CO2 emissions, water usage, and other environmental concerns, technical advancements have made a significantly greater level of transparency possible.

The perception that ESG entailed a trade-off between fund performance and contributions to the well-being of society was an even greater barrier. This perspective has evolved because studies have demonstrated that ESG can assist funds in generating superior returns, especially over longer time horizons. In terms of annualized return, ESG-compliant funds have outperformed their non-ESG counterparts over the past three, five, and ten years (10.59%, 10.03%, and 7.59%, respectively).

What do managers perform?

As ESG becomes increasingly significant, CEOs are developing a more structured, methodical approach to relevant activities in order to adapt. This is particularly true for early adopters of ESG who based their efforts on investor requests rather than a uniform set of objectives.

Leaders are developing a well-defined ESG strategy that provides genuine value and market distinction in order to achieve high investment returns as well as tangible societal benefits. As the company creates further ESG initiatives, it is crucial for senior management to voice their support and emphasize the importance of ESG. Service providers can also contribute to a successful ESG strategy, including the creation of an ESG management platform at the fund level.

As companies implement ESG initiatives, it is crucial to generate ESG case studies to illustrate their efficacy. Firms are required to measure progress against key criteria and objectives while monitoring investment returns. This will provide market leaders with a compelling narrative to communicate. Firms must create strong reporting procedures that give specific information on ESG performance in order to develop case studies. In addition to seeking ways to enhance their ESG strategy, leaders should also participate in industry forums to uncover ESG-related opportunities and dangers.

How are companies implementing ESG programs?

Firms cannot rely on a single ESG strategy due to the diversity of investor needs. When adding ESG variables into an investment plan, they must instead customize their method.

Large institutional investors with ESG investment criteria may wish to avoid mutual funds. These investors will instead deploy capital to separately managed accounts, which will allow them to determine the ESG parameters that apply. This enables portfolio transparency to verify the fund adheres to the ESG standards of the account. In addition, the management can evaluate the investment's effectiveness from an ESG standpoint. Leading hedge funds leverage ESG-specific reporting tools that provide managers and investors with real-time insights to achieve both objectives.

Other ESG-aware investors may invest in commingled funds. In this situation, funds must be ready to adopt ESG rules and respond to inquiries regarding due diligence. To facilitate this, businesses are forming alliances with service providers such as the Apex Group, which can assist with research and provide insights that help uncover ESG risks and opportunities. Moreover, enterprises rely on these service providers to assist them in comprehending and populating the due diligence questionnaires, policies and procedures, and frameworks that LPs require.

Some funds also utilise excusal rights in order to match LP ESG preferences. This can be a simpler option than establishing a separate vehicle, allowing investors to avoid exposure to a particular industry or asset. When companies take this method, they will discover that it is most appropriate when the exclusion is rarely invested in and comprises a tiny fraction of their assets.

The competitive advantage of ESG

ESG is not a passing craze that will disappear in a few years. As investors analyse the ESG-representing non-financial aspects, we anticipate that ESG will play an increasingly important part in the analysis process. As ESG becomes a more prominent factor in investor decisions, it also influences the decisions of fund managers. They are developing more unified ESG strategy and tracking the outcomes of projects with greater accuracy. Firms are discovering that greater effort is required to adjust ESG practises to varied LP preferences as they try to meet investors' expectations.

No longer a "nice-to-have," ESG is now a need. With the proper partners, hedge funds may transform ESG into their superpower by relying on professionals and technical solutions to execute an effective plan. Therefore, selecting a service provider is essential to building a successful ESG programme. When corporations collaborate with a team that can support the ESG requirements of the fund and its investors, they can deliver excellent investment returns and substantial societal benefits.

This versatile role, expectations from the person-in position, sound decision-making and much more can be understood through an e-learning course offered by Director’s Institute, a leading learning platform for professionals. The institute offers courses like corporate governance, independent director certification, and ESG certification in India. These courses are not limited to learning and developing skills but also allow you to connect with other professionals and board members in the community.

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