As allocators we have, in part, a responsibility for the actions and inactions of the managers we select.
When it comes to responsible investing there is certainly very little consensus on the right approach, and ultimately investors tend not share identical views of what is or is not an appropriate SRI investment policy to adopt. However, over the past two years now we have witnessed significant progress on this front and a huge movement in the right direction from investors all over the world. One area that has perhaps lagged the rest of the industry would be hedge funds. An alarming 73% do not currently have in place an active SRI policy, and only a small fraction of those managers are even considering implementing one, according to the 2021 Preqin Global Hedge Fund Report.
The difficulty we have as allocators, is that it’s not in our clients’ interests for us to write off an entire asset class or strategy on the basis that it doesn’t integrate SRI as easily as say, a public equity fund might. In those cases, we simply have to adopt a more qualitative approach, working closely with our managers to understand where they can make improvements, and how likely they are to do so. Here, we explore some of our findings in that process.
Equity and credit hedge funds are improving
Because hedge funds tend to engage in more short-term trading than their equity long-only peers, by their very nature they send fewer direct signals when it comes to exercising voting rights and engagement with corporate management. While this is often used as an excuse by hedge fund managers for not undertaking some of the difficulties that come with applying the SRI principles to their investment process, we have begun to see some encouraging improvements. Both on the credit and equity side, hedge funds are beginning to integrate SRI policies within their investment analysis. Examples include the incorporation of sustainability rankings, which leads to the exclusions of certain companies, and clearer plans for engagement and active voting against management proposals.
But macro hedge funds are notable laggards
When it comes to macro hedge funds however, the picture is very different. There is a widespread lack of engagement in the idea of integrating SRI factor analysis to an investment process that encompasses the largest and most liquid markets in the world. The problem macro managers face is that SRI investing when you operate at a sovereign-level is not an easy task. Take for example a company with thermal coal exposure that is being excluded by an equity manager. If a macro manager were to apply the same reasoning to the instruments they trade, then this would probably rule out almost all of the large sovereigns. This applies to nearly all markets macro funds will trade, from currency pairs to fixed income. The difficulty of this undertaking has prompted many macro managers to simply put their hands up and concede that the SRI does not apply to their world.
Developments on the business side
Where we have seen some encouraging developments has been on the business side. Many hedge funds have been making efforts to become carbon neutral as businesses, which includes recording and offsetting greenhouse emissions resulting from travel, office building power consumption and other related activities. Developing a social purpose within the team has become much more important and, in some cases, we have even seen firms committing a portion of annual profits to be used for separate measurable impact investments. Another area of notable progress has been within recruitment, and the continuing effort to welcome a more diverse intake, not to mention efforts in tackling what is undoubtedly a male-dominated industry.
The $1.1trn untapped SRI opportunity
While these are encouraging developments, they are dwarfed in comparison to what macro hedge funds could achieve through wielding their power as allocators of capital. Together they represent some $1.1trn in assets, which is of course then amplified by leverage. That capital is constantly shifting across country borders, and could be a key tool for the macro industry to send powerful signals – both good and bad – to governments. Rather than simply looking at fiscal and monetary policy of economies, macro managers could focus on SRI factors as well; countries that prioritise tackling climate change, improving access to basic services or who (at least on a relative basis) demonstrate high-level institutional ethics. At the very least, macro managers could be recording and reporting on these factors, so that both managers and underlying investors can integrate material sustainability data into their fundamental analysis.
Another important area where macro managers are in the position to make a real difference is with the service providers they use, and how they can be held to account for their SRI credentials. The fees paid to counterparties are certainly significant and they should be evaluated based on the manner in which they conduct business. Examples of such considerations can include screening out service providers that have any association with certain geographic areas or governmental entities, and those that are engaged in certain business practices deemed unethical.
Conclusion: The role of fund selectors
There is certainly scope for more exchange and dialog within the industry on this subject and in time this should lead to better ideas and more common ground between investors. In fact, in the recent Preqin survey with hedge fund managers, it was revealed that the single largest challenge facing SRI policy implementation was knowing what investors want with regards to SRI. Instead of accepting the inherent difficulties applying the SRI framework to investing at a sovereign level, macro managers need to be encouraged to take responsibility and work towards developing an SRI framework that is more applicable to their investment universe, and that guidance needs to come from investors. It will be an iterative process where no one is expected to get everything right first time, but the earlier this begins, the sooner we, as an industry, can start to tackle these important issues and fulfil our duty as responsible investors.