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19 May 2011
HFMWeek: Beyond the fundamentals
Source:
www.hfmweek.com
Author: Elana Margulies
Investment funds that take into account the impacts of environmental, social and governance issues are gathering momentum with investors, thanks to a recognition of the value of extra-financial analysis and a strong run of performance in 2011
Socially responsible investing (SRI) has always been seen as worthwhile, but not necessarily a partner for good returns. However, looking beyond a corporate’s bottom-line to factors that shape its internal and external image can pay dividends. Environmental, social and governance investing (ESG), a concept with its roots in SRI, has become a useful tool for hedge funds, as they evaluate prospects and gather alpha.
This form of sustainability investing is picking up steam on the premise that returns will be higher if managers can peer behind a firm’s basic fundamentals. UK-based Auriel Capital Management is in the process of launching an offshore version of its existing market neutral strategy, which looks at extra-financial information of companies, specifically ESG factors. GLG Partners is also figuring out how to apply this additional analysis to its hedge funds, after using it with the firm’s long-only offerings.
Ada Investments, a New York-based asset manager founded in July 2008, which has, since its inception, incorporated ESG factors into the investment process for all three of its US funds, believes that its portfolios have generated higher returns.
“We believe that when you evaluate a security, you need to consider both financial and extra-financial information, or you are not getting the full picture on what drives prices,” said Anton Honikman, managing director. “Most of our industry will look at the financial part in depth. ESG provides an important lens on the extra-financial, using how a company behaves to support a holistic view on its market value.”
Hedge funds look at various ESG components. On the environmental side, they might examine what corporations are doing to reduce pollution and emissions. On the social side, they will look at an entity’s consumer protection and human rights factors. And finally, with respect to corporate governance, they will potentially look at enterprises’ ownership structure and shareholder rights.
While generating higher returns is the first motive for managers, ultimately, some hope this method of looking at extra-financial information on companies could become more mainstream. In other words, they hope that these companies will alter their business practices in response to the demands from important sources of capital.
Both the Ada US Equity Market Neutral Fund and Ada US Equity Long/Short Fund, in addition to its long-only offering, called the Sustainable Active Equity Fund, examine all parts of the ESG acronym.
GLG Partners, which is currently working toward applying ESG to its hedge funds, is discussing with consultants and investors which strategies would be most viable.
Jason Mitchell, portfolio manager for GLG’s sustainability strategy, said once the firm determines whether ESG factors or underlying investment themes are able to outperform the index on the long-only side, there is then an opportunity to look at the long/short side and apply it to a breadth of asset classes.
“It is not simply proving that ESG produces alpha,” he said. “When you look at long/short opportunities and what clients want, you need to put a lot of thought into how it is applied. Is it purely stylistic? Are you neutralising market risk or running it from an absolute return perspective?”
GLG’s move into ESG began in 2007 when it incorporated an environmental strategy. However, it quickly realised that applying a rules-based system concentrating on environmental factors was problematic, because this type of approach isn’t forward-looking. As a result, it now takes a more holistic approach to incorporating ESG.
While the interest from investors varies across the globe, with Europe being more advanced than the US – Auriel Capital has just created a fund for US-taxable persons to meet nascent US demand – as a group, public pensions and sovereign wealth funds seem to be the biggest advocates of incorporating ESG factors into their portfolios, some of which include the California Public Employees’ Retirement System, North Carolina Retirement Systems and Caisse de depot et placement du Québec.
“We have seen some demand for themed funds and the interest we’ve had in our work has come from public pensions, particularly those who’ve signed onto the United Nations Principles for Responsible Investment (PRI) initiative,” said Larry Abele, founding partner, Auriel Capital.
PRI is a network of international investors, which maintains that ESG factors can affect the performance of investment portfolios. As more investors inevitably adopt these standards, ESG principles could well break into the mainstream, however, the possibility of heightened performance may pull them in first.
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Sustainable Investment Research Platform
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