Sustainable Investing (KPMG)

Sustainable
investing:
fast-forwarding its evolution
February 2020
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Acknowledgments
This report is a joint effort, involving KPMG International, CREATE-Research, AIMA
and CAIA.
It examines in detail sustainable investing and its impact on the alternative In the middle
investment industry. Focusing on hedge funds and institutional investors, together
with best practice from the asset management sector, the report investigates how of difficulty lies
sustainable investing is gathering momentum across the investment universe. opportunity.
Our foremost thanks go to some 135 institutional investors, hedge fund managers,
1
long only managers and pension consultants in 13 countries in all the key regions, Albert Einstein
who participated in the research on which this report is based.
We would also like to offer our special thanks to those CEOs, CIOs and board
directors who participated in our face-to-face structured interviews. Their insights Executive
and foresights helped to produce a clear vision of the future of their industry. summary
Finally, special thanks also go to the members of the project team, editorial
board and other colleagues around the world who helped us in carrying
out this research: in particular Dmitriy Ioselevich from 17 Communications,
Christina Farrace from KPMG International, Dylan Thomas and Sarah Wium from
KPMG in the Cayman Islands, Tom Kehoe and Jack Inglis from AIMA, William J. Kelly
from CAIA Association, and Lisa Terrett, Anna Godden and Dr. Elizabeth Goodhew at
CREATE‑Research.
Anthony Cowell Amin Rajan

Partner CEO
Head of Asset Management CREATE-Research
2
KPMG in the Cayman Islands
The rise of ESG

in the hedge
fund industry
Editorial board
Darina Barrett (KPMG in Ireland) Bonn Liu (KPMG in Hong Kong SAR)
Ravi Beegun (KPMG in Luxembourg) Troy Mortimer (KPMG in the UK)
Ben Blair (KPMG in the Cayman Islands) Tomas Otterström (KPMG in Finland and Sweden)
Tom Brown (KPMG in the UK) Rebecca Palmer (KPMG in the Cayman Islands)
Jack Inglis (AIMA) Riikka Sievänen (KPMG in Finland)
Dmitriy Ioselevich (17 Communications) Jim Suglia (KPMG in the US)
Tom Kehoe (AIMA)
William J. Kelly (CAIA Association)
Andrew Weir (KPMG in China)
Greg Williams (KPMG in the US)
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The rise of
sustainable
investing
i Sustainable investing: fast-forwarding its evolution

© 2020 KPMG International Cooperative (“KPMG International”). KPMG International provides no client services and is a Swiss entity with which the independent member firms of the KPMG network are affiliated.
Geographical coverage of research
participants
Australia Luxembourg
Belgium Netherlands
Canada Sweden
Denmark Switzerland
France UK
Germany
Hong Kong (SAR), China

US
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Executive
summary
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The rise of ESG
in the hedge
fund industry
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The rise of
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ii Sustainable investing: fast forwarding its evolution

Contents
1 2 1
Executive
summary
The rise of ESG in the hedge

fund industry19
How are managers advancing?
1. Key drivers 21
2
2. Key constraints 27
3. Emerging best practice 30
3
The rise of ESG
in the hedge
Executive summary 1 fund industry
Introduction and aims
Report highlights 3
Headline findings 4
Part I. Hedge funds: a progress report
1. Institutional investors are driving the
ESG agenda 4
2. ESG investing faces various obstacles 6
8
3
3. Perfection cannot be the enemy of progress
4. Best practice can shift the needle 10
Part II. Early adopters: their story The rise of sustainable investing 36
1. Sustainable investing is about creating What lessons can be learned from early adopters? The rise of
businesses of enduring value 13 sustainable
1. Progress along the Spectrum of Capital 38 investing
2. Capital markets are slow to price
in sustainability risks 15 2. Factors slowing progress 43
3. Best practice is emerging 16 3. Developing best practice 48
iii Sustainable investing: fast-forwarding its evolution

1 Executive summary
Introduction and aims
1
Executive
summary
2
The rise of ESG
in the hedge
fund industry
3
The rise of
sustainable
investing
1 Sustainable investing: fast-forwarding its evolution

The EU set out its landmark legislative This research report highlights the
plans to deliver carbon neutrality by lessons learned so that others can
2050: yet another defining moment benefit from them. In the process, it
when one of the three key global regions explores three issues. Globalization has
became the first to make such a bold legal
— What is the current state of progress been the engine
commitment.
in implementing sustainable of global growth.
Before then, in the last decade, various investing?
governments worldwide had enacted But it has, as a side
— Why is the pace of progress being
over 500 new measures to promote
held back by various barriers? effect, inflicted much
environmental, social and governance
issues (ESG). — How are these barriers being tackled damage on certain
Given the magnitude of the task, various
on the ground by evolving best communities and their
practice?
1
players are involved: governments, environment.
regulators, capital markets, businesses Focusing on North America, Europe
and consumers; and they are aided and, to a lesser extent, Asia Pacific, A US pension plan
and abetted by green technologies and our research method has targeted two
business model innovations. separate constituencies. Executive
summary
This survey report focuses on capital — Hedge fund managers and
markets in general and sustainable their institutional clients: via
investing in particular. two separate electronic surveys,
bolstered by structured interviews.
The latter can best be described as an
This group accounted for
evolutionary investment journey ABC:
US$1.65 trillion of assets.
(A) avoid harm and mitigate ESG risks;
(B) benefit all stakeholders; and — Early adopters: via a structured
(C) contribute solutions to societal interview survey to hear the story
problems. This definition embraces from C-suite executives from
approaches that variously come a sample of large institutional
under the generic headings of ESG, investors, and global hedge fund
responsible investing and impact and long only asset managers, with
investing. Throughout this report,
sustainable investing is based on this
definition, except where ESG has been
more prevalent. Both are now widely
viewed as smarter ways of investing.
US$4.6 trillion of assets.
The geographical coverage of
respondents in the two constituencies
is given in the table on page ii.
2
The rise of ESG
in the hedge
Detailed results are given in Sections 2
Institutional investors were the original fund industry
and 3, respectively.
early advocates of sustainable investing,
working initially with specialist asset In the rest of this section, our headline
managers. While some hedge funds findings are organized under two
were early adopters, the overall hedge distinct parts, covering two distinct
fund industry's advance has been questions.
incremental thus far. This is now
— How far have hedge fund managers
changing as: their investors demand the
progressed along the ESG journey?
adoption of ESG into the investment
process; the industry recognizes the — What are the key lessons they and
potential for alpha generation through others can learn from the early
ESG factors; and regulators force hands adopters?
through new rules.
3
The rise of
sustainable
investing

Report highlights
Hedge fund managers’ survey — Key data points
85% 55% 15% 63%

Institutional investors
are the biggest drivers of
demand for ESG-oriented
hedge funds
ESG-oriented hedge
funds continue to target
alpha returns, while
managing fat-tailed
Hedge fund managers
have embedded ESG
factors across their
strategies
Progress hampered by
lack of robust templates,
consistent definitions and
reliable data
1
Executive
summary
far‑off risks
Institutional investors’ survey — Key data points
44% 34% 75% 49%

ESG-oriented hedge
funds can deliver
alpha and also manage
fat-tailed far-off risks
ESG is material to the
financial performance of
investee companies
Too early to decide
whether sustainable
investing delivers double
bottom-line outcomes
Lack of consistent quality
data is a challenge in the
adoption process
2
The rise of ESG
in the hedge
fund industry
Early adopters’ narrative — Key messages
Markets are slow to A new infrastructure Active Ownership Savvy

price in sustainability of skills, data and 2.0 is emerging as implementation of
risks due to their technology is the best practice sustainability factors
3
excessive focus on creating tailwinds for model for effective is vital for achieving
short-termism sustainable investing engagement the expected
outcomes
The rise of
sustainable
investing

Headline findings
Part I. Hedge funds: a progress report
1 Institutional investors are driving the ESG agenda
Having established a good track record Thus, the traditional risk–return

in promoting good governance among equation is being rewritten to include
their investee companies, hedge fund ESG factors. This, in the belief that it is
managers are advancing in other areas now becoming material to investment ESG is no longer a
nice‑to-have; it’s a
1
of ESG. Some are leading, others are returns, as our societies tackle
catching up. The advance is principally environmental and social challenges
driven by institutional investors and their such as climate change, water scarcity must‑have.
consultants (Figure 1.1). and loss of biodiversity.
A global alternative Executive
Until fairly recently, these investors have For their part, hedge fund managers investment firm summary
been mostly focused on uncorrelated are well placed to respond on account
absolute returns. They now want their of their deep talent pool, technological
investments to target double bottom- capabilities, nimble investment
line benefits: do well financially by doing strategies and activism track record.
good socially and environmentally, while Their short-selling expertise has always
promoting high standards of governance been valued in encouraging their
and avoiding reputational risk. investee companies to up their ESG
game.
Specifically, they want their hedge
fund managers to not only screen out The transition is a double-edged sword,
activities such as tobacco, defence however. It offers opportunities by
weapons, poor labor practices, and promoting new ‘green’ industries, but it
2
environmental pollution but they is also fraught with fat-tailed far-off risks
also want them to target positive that are hard to model statistically, for
environmental, social and governance lack of historical precedence.
outcomes, on top of the financial ones.
The rise of ESG
in the hedge
Figure 1.1 Who is driving interest in ESG investing? fund industry
Institutional investors 85%
Institutional consultants 39%
Internal stakeholders 30%
HNW investors 19%
3
Politicians or regulators 13%
Industry trade bodies 6%
Source: KPMG–CAIA–AIMA–CREATE Survey 2020

The rise of
sustainable
investing

In our surveys, 35 percent of hedge opportunities to generate alpha, while
fund managers and 34 percent of offering a more defensive portfolio
their institutional clients support the by looking beyond the blind spots as
materiality argument — as shown in markets are slow to price in ESG risks.
Section 2.
In response, hedge fund managers are
Indeed, 44 percent of institutional deploying ESG factors to target three
investors go a step further and base goals: alpha returns, beta returns and
their investments in ESG hedge risk management (Figure 1.2).
funds with the view that they offer
Figure 1.2 How are ESG factors being used?
38%
1
Executive
summary
55%
7%
Target alpha
2
Target beta
Manage fat-tail/far-off risks

The rise of ESG
in the hedge
fund industry
3
The rise of
sustainable
investing
5 Sustainable investing: fast-forwarding

fast forwarding its evolution
2 ESG investing faces various obstacles
a. Data problems
In terms of the familiar life cycle, hedge A number of factors have conspired
fund managers’ advance into ESG is against progress thus far. ESG should come
happening incrementally (Figure 1.3).
Far and away, the most important one with a story. It can’t
Currently, 15 percent of our surveyed is the lack of quality and consistent data
managers define themselves as at on ESG factors, as cited by 63 percent just be about financial
the ’mature‘ stage, where ESG is of our hedge fund respondents performance.
implemented across the firm via in Section 2. Another notable one
appropriate policies, committees, has been confusion over industry
1
A US alternative
research and data. terminology (36 percent). investment firm
A further 44 percent are at While there is widespread acceptance
the ‘in progress’ stage, where that the currently available data suffer
implementation is piecemeal across the from many shortcomings — such as Executive
business, while a significant 31 percent inconsistent company disclosures, summary
are still at the ‘awareness-raising’ stage, voluntary reporting, opaque research
leaving the remaining 10 percent at the methodologies and unreliable ratings —
‘no implementation to date’ stage. there is also recognition that the quality of
the available data is improving constantly.
Figure 1.3 Where is your organization currently in the ESG-implementation life-cycle?
15% 10%
2
The rise of ESG
in the hedge
31% fund industry
44%
No implementation to date
Awareness-raising
In progress
3
Mature already
The rise of
sustainable
investing

b. Divided views
When it comes to the quality of ESG available data or overwhelmed by
data, hedge fund managers‘ views the challenge of filtering out the
differ (Figure 1.4). noise. Inconsistencies in data and
company disclosures make it difficult
On the plus side are managers who
to incorporate them into research and
take an opportunistic or inquisitive
investment processes. Extracting
stance in the belief that the data
meaningful alpha signals from them
problems are nothing more than
remains a herculean task for some
disguised opportunities to deliver alpha
managers.
by exploiting the resulting market
inefficiencies. Unstructured data Hence, they are cautious about making
sets provide an opening to employ bets on strategies not tested by time or
1
machine learning and other quantitative events over extended periods.
solutions to better understand the
Finally, apart from the data issues,
market.
two other factors were also identified
Indeed, many of their institutional by a minority of surveyed hedge fund
clients believe that such inefficiencies managers as slowing progress. Executive
will be a key source of alpha, which summary
Shown in Section 2, the factors are:
hedge fund managers are well placed
ESG is not relevant to the investment
to harvest on account of three inherent
strategies being pursued (25 percent)
advantages: their deep talent pool;
and lack of quality investment
their widely acclaimed expertise
opportunities (21 percent).
in shareholder activism; and their
sophisticated trading and machine The implications are clear: not all hedge
learning algorithms, which are geared fund strategies are created equal from
towards real-time investing. an ESG perspective because not all
managers see ESG in the same light.
On the opposite side are managers
who are either skeptical about the
Figure 1.4 Which of the following best describes your organization’s attitude
towards ESG data?
9%
2
The rise of ESG
in the hedge
25% fund industry
47% 19%
Opportunistic
Inquisitive
Skeptical
3
The rise of
sustainable
Overwhelmed investing

3 Perfection cannot be the enemy of progress
a. ESG approaches
That ESG is coming into the hedge fund traction lately as management teams
space is not in doubt; nor that it is coming have been slow to react to both ESG ESG takes time,
on the back of a variety of approaches, challenges and opportunities.
reflecting the heterogeneity of hedge patience and skill.
While implementing ESG factors into the
fund strategies (Figure 1.5).
investment process, portfolio managers A global alternative
Three approaches have been used by at make various assumptions about their investment firm
least three in every 10 surveyed hedge relevance, weight and intercorrelation.
fund managers with many of them These may or may not be correct. The
adopting more than one approach.
The first one is ESG integration
(52 percent). This has involved
identifying material factors and
incorporating them into traditional
underlying relationships they seek to
establish may or may not remain stable.
The forecasts they seek to build on may
or may not be viable.
To complement the exercise, therefore,
1
Executive
summary
investment processes. In most cases, shareholder engagement is seen as
such factors are treated on a par with a vital tool that serves two purposes:
financial factors. to enrich the investment process with
firsthand knowledge about the investee
The second approach is negative
company; and to steer the investee
screening (50 percent). This involves
company into the ESG space via
excluding stocks that sit uncomfortably
discussion, dialogue and proxy voting.
with the value system of investors as
mentioned earlier. Given the clarity of For their part, investee companies need
exclusion criteria, this approach has to have a clear ESG policy as well as
been the easiest one to implement. mechanisms for monitoring outcomes.
The third one is shareholder engagement
(31 percent), which has been gaining
Figure 1.5 Which of the following best describes your organization’s strategy when
it comes to ESG?
2
The rise of ESG
in the hedge
fund industry
52%
50%
31%
19%
Sustainability Negative
integration screening
Shareholder
engagement
Impact
investing
12%
Positive
screening
5%
5%
Thematic
investing
3
The rise of
sustainable
investing

b. ESG outcomes
Against this background, when asked report ‘positive’ outcomes; 14 percent
to describe the performance outcomes report ‘negative’ outcomes; and the
of their organization’s ESG-oriented remaining 75 percent saying neither.
investments so far, the verdict from
In both cases, the implied message
both our surveys is broadly similar
is simple: it’s too soon to tell, given
(Figure 1.6).
the rather short track record of these
Taking them in turn, 29 percent of investments.
hedge fund managers in our survey
However, our post-survey interviews
report ‘positive’ outcomes and none
also indicate that the managers who
report ‘negative’ outcomes; leaving
took an early lead are not only meeting
the remaining 71 percent saying it is
performance expectations via prime
1
neither positive nor negative.
mover advantage, they are also
As for their institutional clients, they emerging as the ‘best in class’ across
appear less sanguine so far: 11 percent the entire investment spectrum.
Executive
summary
Figure 1.6 Which of the following best describes the outcome of your
organization’s ESG-oriented investments so far?
Hedge fund managers' survey Institutional investors' survey
14% 11%
29%
2
The rise of ESG
in the hedge
71% fund industry
Positive
75%
Uncertain
Negative
3
The rise of
sustainable
investing

4 Best practice can shift the needle
Best practice in the ESG space is a a. Guard against greenwashing

moving target. It’s no longer enough
The template of taxonomy and data that
for a hedge fund manager to rely on
sit at the heart of sustainable investing As a firm, we have
exclusion screens. Increasingly, there is
an expectation that investments should
is evolving, while institutional investors’ a strong view that
interest in green issues has skyrocketed.
generate a positive (and measurable)
Hopes have run ahead of expectations. ESG integration
ESG impact, while managing the
inherent risks. The result has been greenwashing: is at the core
Additionally, as the hedge fund industry
shortcuts taken by some managers of sound risk
to repurpose their old funds with
1
becomes ever more institutionalized, its
an ESG label without rejigging the management.
ESG practices are likely to attract much
underlying investment process. The
greater scrutiny. A global alternative
problem is widespread right across
The business model of hedge funds the entire investment industry. It is investment firm
Executive
will likely be dependent on delivering largely attributed to the data problems
summary
decent financial returns (and thus mentioned earlier.
generating performance fees). But it
As for hedge funds, 41 percent of
may be expected to deliver nonfinancial
respondents in our institutional investor
outcomes too, over time.
survey report a ‘significant amount of
To fast-forward the ESG implementation greenwashing’; 11 percent report ‘some
cycle, our survey identified four key greenwashing’; and 48 percent are
enablers. ‘not sure’. Those reporting a ‘minimal
amount’ is zero (Figure 1.7).
Figure 1.7 From the investor perspective, which of the following best describes your
2
views about the extent of ‘greenwashing’ in the hedge fund industry at
this early stage as it embraces ESG investing?
The rise of ESG

in the hedge
41% fund industry
48%
11%
Significant amount of greenwashing
Some amount of greenwashing
Minimal amount of greenwashing
Not sure
3
The rise of
sustainable
investing

The concerted action now in progress signatory, 17 percent are in the process all. Of those who do, 23 percent use
by data vendors, index providers, asset of becoming one and the remaining the PRI framework and 11 percent use
managers and listed companies to 48 percent are not planning to do so in customized metrics — as shown in
improve data quality and their definitional the near future — as shown in Section 2. Section 2.
consistency is expected to ease the
Currently, 56 percent of managers Yet, from the perspective of institutional
problem over time. The tighter regulatory
have a policy of embedding PRI into investors, the problem seems far more
oversight on greenwashing is hastening
the cultural fabric of the business. widespread: 85 percent of them state
the process, especially in Europe.
This is essential if managers are to that their hedge fund managers do not
For their part, some institutional enhance credibility, authenticity and report on nonfinancial impacts.
investors also take a pragmatic view. transparency.
Once again, the numbers indicate huge
As an investment elixir, ESG’s advance
The numbers in both cases leave scope for improvement if hedge fund
requires them to accept that at least a
significant scope for increase in the managers are to attract the rising tide
part of today’s greenwashing reflects
1
next few years for strategies that are of institutional money.
the teething problems of a better form
amenable to ESG investing.
of investing. Progress may come at
a price. In the meantime, they are
c. Improve ESG reporting
getting better at separating winners
Measurement and reporting on the Executive
from spinners.
summary
nonfinancial impact of investments Integrity is critical.
b. Comply with industry codes represent the next frontier for
and principles sustainable investing, as investors and If you’re going to
The UN-sponsored Principles for
regulators are stepping up demand for call yourself an ESG
timely and fuller disclosures. Hedge fund
Responsible Investment (PRI) are now
managers need to stay ahead of the investor, it’s vital
widely adopted as an industry wide
standard — by asset managers and their
curve to remain relevant in a world where to have the right
best practice is a moving target.
institutional clients alike. processes in place.
Currently, more than half (57 percent)
Thirty-five percent of hedge fund
of the surveyed hedge fund managers An impact investing
managers in our survey are a PRI
do not report on ESG performance at consultant
2
The rise of ESG
in the hedge
fund industry
3
The rise of
sustainable
investing

d. Adopt Active Ownership 2.0 the surveyed hedge fund managers
Hedge funds are ideally suited for are already relying on shareholder
engagement to advance their ESG
shareholder activism that targets
agenda — as shown in Section 2. Is this a magic
companies underperforming on
sustainability issues. Our interviews However, except for high-profile proxy moment to remake
show that there is a return premium in cases, end-investors do not as yet our business?
helping an ESG laggard among investee have a clear idea on what value is being
companies to become a leader. generated by engagement activities due A US hedge fund manager
The emerging model shows that to the lack of fuller details. Engagement
responsible ownership is an important reports need to carry far more
part of the ESG toolkit that must be granularity than seems to be the general
taken seriously. Indeed, 74 percent of practice currently.
To conclude this subsection, therefore, the overriding message

from the surveyed hedge fund managers and their institutional
investors is simple: ESG investing will likely continue to gain
1
Executive
summary
traction in the hedge fund industry, duly taking into account that
some hedge fund strategies are more amenable to ESG than
others.
ESG investing is not about jumping on the bandwagon; rather, it is
about seeking to deliver financial and nonfinancial outcomes while
managing the inherent risks.
2
The rise of ESG
in the hedge
fund industry
3
The rise of
sustainable
investing

Part II. Early adopters: their story
Sustainable investing is about creating businesses of

1 enduring value
The ecosystem of capital markets is As a result, early adopters have
evolving gradually towards sustainable augmented their approaches by
investing. But it remains a slow process. integrating key sustainability features
Large institutional investors have into their investment processes to There are no shortcuts
been at the vanguard, according to achieve a double bottom-line: do to sustainability.
the three groups who participated in well and do good, according to our
our interview survey for this section:
institutional investors, large hedge fund
managers and large long only managers.
Their approaches extend beyond ESG
and cover sustainable investing in
interviews with early adopters. Over
80 percent of their sustainability assets
are at this aspirational stage.
A minority have also ventured into
private markets — private equity,
A Swedish institutional
investor
1
Executive
summary
its broadest sense, as defined in the
infrastructure and private debt — to
introduction to this section.
target measurable societal outcomes on
top of the financial ones.
a. In the beginning
For early adopters, the journey started In all cases, progress is driven by large
with the exclusion of ‘sin’ stocks: shares institutional investors who are moving
in companies associated with activities well beyond a green ‘do-gooder’ image,
deemed unethical. duly taking account of the multidecade
nature of their future liabilities.
Over time, it was recognized that
exclusion reduced the scope for In deference to enlightened self‑interest,
diversification somewhat. In any case, these investors are seeking to future‑proof
their portfolios against hard-to-model risks
2
dumping ‘sin’ stocks yielded handsome
profits to those who bought them that are inherent in secular forces — like
without doing anything to pressure or global warming, governance lapses,
influence the ‘sinners’. inequalities — that could pose existential
threats to investee companies.
The rise of ESG
in the hedge
fund industry
3
The rise of
sustainable
investing

b. Current journey — creating a culture and belief that
As a result, such investors are now sustainability is not just another
fad, but a sea change in the way
increasingly embedding sustainability
investing is to be done Sustainable investing
into the DNA of their own organization
and enjoining their asset managers to — harnessing the collective memory of requires a joined-up
do the same in the emerging model of the business via joined-up thinking business.
sustainability that focuses on a number between the investment team and
of critical areas and their interlinkages the stewardship team A large US fixed income
(Figure 1.8). manager
— ensuring that their portfolio
The model perceives capital markets managers and research analysts
as an essential bridgehead to a more develop the requisite expertise
purposive capitalism that delivers into the dynamics of sustainability
1
businesses of enduring value for factors
their four key stakeholder groups:
shareholders, employees, customers — encouraging regular engagement
and wider society. with investee companies,
setting realistic expectations and
At this early stage, the model also Executive
continuously monitoring progress.
envisions sustainability as an evolutionary summary
journey of experiential learning where These requirements impact on all
ideas beget ideas. It enjoins business vital activities in the investment value
leaders at asset management firms to set chain. So, the process is necessarily
the ‘tone at the top’ by: evolutionary.
Figure 1.8 Creating sustainability DNA in business models
Leadership
Inve
stment team
2
The rise of ESG
in the hedge
fund industry
Research
Beliefs Integration
Monitoring Engagement
Ste
Collaboration
w ardship tea m
3
The rise of
sustainable
investing
C u lt u r e
Source: KPMG–CAIA–AIMA–CREATE Interview Survey 2020

2 Capital markets are slow to price in sustainability risks
Three forces inherent in capital markets institutional investors who are at the c.Tentative evidence of success
are slowing progress. Each is expected vanguard of sustainable investing. so far
to weaken over time, as ever more
Under it, listed companies are Evidence suggests that the early
investors switch from the old ways of
incentivized on short-term profits at generation of investors in sustainability
investing that solely targeted financial
the expense of long-term growth. are satisfied with their returns so far. But
returns.
Some institutional investors believe as the new wall of money has arrived, a
that equity markets have, as a result, critical question has come to the fore:
a. Steep learning curve of data
morphed from a source of raising Is sustainability a risk factor?
Currently, investors are enjoined to investment capital for growing
1
climb a steep learning curve because companies to a vehicle for cash Early adopters fall into two camps:
of a lack of the requisite data on three distribution and balance sheet believers and pragmatists.
foundational concepts in sustainable management. Believers advanced three arguments.
investing: materiality, intentionality and
additionality. Markets are no longer effective — Sustainability is a risk factor for sure;
Executive
conduits between savers planning except that, so far, it is a compensated
Respectively, they seek to assess: summary
for a decent retirement nest egg and factor in Europe, but much less so in
— how material are various borrowers deploying savings to create the US and Asia Pacific.
sustainability factors to a company’s wealth, jobs, skills and innovation.
— The compensated element has
financial performance, such that In the ‘new economy’, capital formation varied over time and between
their inherent risks are managed? is mainly happening in the private the three individual components:
— does the company intend to act on markets where transparency is low. environment, social and governance.
them and ‘do good’ via its products, Companies are staying private longer
and are mostly outside the public — The huge collective push from
services and interactions with wider governments, international agencies
society? purview.
and investors worldwide will reshape
— does it generate societal benefits in There may be other, deeper, causes investor behaviors overtime. It is hard
addition to financial benefits? that may lead to the perception to believe that nothing will change
2
or manifestation of increasing after all that is happening now.
For asset managers, while their short-termism in the developed
sustainability policies are evolving economies. These could include: the
rapidly, the requisite infrastructure of move away from industries depending
data, skills and technology has yet to on fixed capital expenditures to The rise of ESG
catch up. more service-oriented businesses in in the hedge
The problem is exacerbated by the fact mature economies; increased market fund industry
that there are no generally agreed upon power of individual companies in
guidelines on what constitutes a ‘good’ certain industries leading to excessive
or ‘bad’ company. The result is twofold: profits and underinvestment; and
greenwashing, as asset managers the deepening of global trade or an
repurpose their old funds with increasing rate of the underlying
sustainability labels; or whitewashing, technological change.
as investee companies overstate their All these factors could lead to changes
green credentials. Both are widespread in the way our economies function On the data front,
in developed markets. that are either harmless and a simple progress may be
manifestation of reaching another
exponential, but it is
3
b. Quarterly capitalism stage of economic development, or
The second force slowing down potentially harmful but not necessarily still not enough.
progress is the rise of ‘quarterly related to capital market or financial
capitalism’, as identified by some institutions' behavior. A Danish institutional investor
The rise of
sustainable
investing

Pragmatists, in turn, think that it is too banks. Asset valuations have been
early to say, for two reasons. lifted indiscriminately. Hence, the
true test of sustainability should
— For any return driver to be treated
not be judged by the assets it has Just as it is foolhardy
as a risk factor, it needs a long
performance history over multiple
attracted so far, but by how resilient to drive a car by looking
these flows will be when the next
cycles in multiple regions, within a
downturn comes. in the rearview mirror,
replicable investment process. Data
on sustainable investing thus far fall Both camps agree on one point, though: so must investors look
short of these criteria. given the powerful tailwinds from forward and factor
institutional investors, sustainability
— Capital markets have enjoyed the
will be the new frontier of innovation in change. The world
longest bull run in history, thanks to
the easy money policies of central
in the 2020s. does not stand
1
still.
A UK asset manager
Executive
3 Best practice is emerging summary
The challenges outlined above have are also collaborating with not-for-profit
intensified efforts to develop best institutions globally to develop
practices that can put sustainability methodologies on how to measure,
at the heart of investing. Progress is report, benchmark and improve
evident in three areas. sustainability performance.
For their part, data vendors are
a. Data: room for improvement
experiencing rapid consolidation
Different constituencies are being and innovation, as competition has
encouraged in a concerted action to intensified. Asset managers, too,
2
tackle what is now sustainability’s are developing their own proprietary
Achilles’ heel: the lack of a robust methodologies in order to gain an
template with consistent definitions and information edge on the mispricing of
reliable data on how companies score assets. Learning-by-doing remains a
on various sustainability factors. powerful tool of progress. The rise of ESG
in the hedge
From the investor perspective, for
b. Engagement: the new alpha fund industry
example, climate change is an inexact
science. Various risks identified by behind alpha
the Task Force on Climate-related Best practice in sustainability involves
Financial Disclosures have made it enriching the current infrastructure
hard for investors to establish a direct of data, skills and technology
line of sight between climate science with shareholder activism that
and investment outcomes. They are targets real-world outcomes at scale.
fraught with as many unknowables as
For those investment strategies that
unknowns.
can do so, their principal tool is direct
Both institutional investors and asset engagement.
3
managers are collaborating with over
150 data vendors to up their game. They
The rise of
sustainable
investing

It rests on the belief that sustainability by seeking progress in three
only works if company boards are not mutually reinforcing related areas:
only called to account but also held communication, learning and internal
accountable. They must: politics (Figure 1.9). Effective
— justify their decisions and be These approaches seek to promote new engagement
responsible for their outcomes learning in the belief that ideas breed requires deeper
ideas and only improved collaboration
— c reate an agenda for change and
can deliver the goals of all stakeholders. communication,
acceptable standards that are
consistent with its delivery Indeed, some investors believe continuous learning
— engage in proxy voting to ensure
that engagement enables them to and minimal internal
develop structural capital that offers
that investors’ voices are heard in
an informational edge: ever-deepening politics.
board‑level deliberations
1
knowledge about how sustainability
— foster year-round dialogue with is actually being implemented on the A large German asset
investee companies beyond ground via positive feedback loops. manager
shareholder meetings.
Indeed, as they have moved up the
Executive
The days when engagement was a learning curve, asset managers have
summary
box-ticking exercise using a boilerplate realized the power of engagement —
narrative are over. often in collaboration with other investors
who have, for example, worked closely
Asset managers are increasingly with energy giants on plans to reduce
expected to act as agents of change their carbon emissions.
Figure 1.9 Engagement that goes beyond the hype of sustainability
Communication Learning
— Promoting a free exchange
of ideas
— Setting mutually
demanding expectations
— Building trusting relationships
— Going behind the dry
financial numbers
— Gaining insights into the harsh
reality on the ground
— Building structural capital
2
The rise of ESG
in the hedge
via year-round conversations that provides an informational fund industry
— Engaging in proxy voting edge on sustainability issues
— Devising collaborative
solutions
Internal politics
— Understanding the internal
politics and constraints within
both parties
— Devising approaches that
3
navigate the resulting
complexity
— Minimizing compliance
box-ticking
— Bridging the rhetoric–reality The rise of
gap around sustainability sustainable
investing

A more pragmatic ‘carrot and stick’ — Integration: develop an integrated
approach to engagement is coming into core–specialist portfolio to give
view. Under it, if engagement does not investors greater choice and diversity
work, asset managers will resort to the By the end of the
— Clarity: deliver transparency that
nuclear option — divestment.
sets a direct line of sight between the 2020s, sustainability
c. I mplementation: upping the
sustainability policy of the manager will be the gold
and its activities
game standard of
Except for large institutional investors, — Articulation: demonstrate how
their peers do not as yet have the sustainability is integrated into investing.
resources to do in-house investing and/ covenants that currently disallow
voting at AGMs or meaningful A Belgian asset manager
or engage directly with their investee
companies — they rely on their asset engagement
1
managers. Hence, sustainability — Interest alignment: have an
capabilities are the most important equitable sharing of pain and gain
criteria in manager selection. with clients, as well as common
Asset managers are thus enjoined to seek beliefs and time horizons.
Executive
continuous improvements in five areas:
summary
— Data: step up pressure for quality
improvements in the supply chains of
sustainability data
To conclude, therefore, early adopters see sustainable investing as

serving their own long-term enlightened self-interests as much as
those of wider society.
Progress so far confirms that sustainability is a long journey of
experiential learning in which a series of small steps will add up to
2
a giant leap by the end of this decade.
The rise of ESG

in the hedge
fund industry
3
The rise of
sustainable
investing

2 The rise of ESG in the hedge
fund industry
How are managers advancing?
1
Executive
summary
2
The rise of ESG
in the hedge
fund industry
3
The rise of
sustainable
investing

As in the long only space, so in the hedge fund industry: there is no one-size-fits-all approach to ESG.
Different strategies and fund sizes demand different approaches. This is not a flaw: it is an important
characteristic of ESG. There is room for everyone, including short sellers.
But this range of approaches brings its own challenges: a lack of quality data; a lack of uniform
disclosure criteria; a shortage of knowledge or expertise; difficulty in finding the right investment
opportunities; and lack of internal consensus. These and other challenges are all surmountable, with
enough time and effort.
Advancing in the implementation cycle requires time, patience and skill. Hedge fund managers
must learn by doing, but fortunately, they tend to be fast adopters and quick learners. Hedge fund
1
managers should seek to collaborate with peers, competitors and specialist global networks to catch
up in the ESG space.
Best practice is a moving target. Data are getting better. Shareholder engagement is getting stronger.
Executive
ESG metrics and reporting frameworks are becoming standardized. Talent is becoming more
summary
accessible. Tailwinds are gathering behind the adoption process.
Information in this section is based on fund managers can offer ESG-oriented

two electronic surveys carried out for this investors, especially when compared
report, involving hedge fund managers with many of their long only peers.
and their institutional clients, and is We are seeing the
— Talent: hedge fund managers are
bolstered by post-survey interviews.
well known for the breadth and hedge fund industry
Their focus was on ESG investing.
depth of their talent pool, whether evolve from a mindset
When it comes to ESG, hedge funds it’s portfolio managers, traders,
were an outlier. Whereas their peers in researchers or, increasingly, of resistance to one of
adoption on ESG.
2
other investment sectors were moving computer scientists
apace, the hedge fund industry was a
— Technology: they have long
relative latecomer. An institutional consultant
harnessed the power of technology
There are a variety of contributing by building sophisticated trading The rise of ESG
factors, ranging from skepticism about and machine-learning algorithms in the hedge
the value of ESG, to confusion over that permit real-time investment fund industry
industry terminology, to legitimate decisions
challenges incorporating ESG factors.
— Flexibility: the legal structure of
The Spectrum of Capital, discussed in a hedge fund makes it one of the
Section 3, is an appropriate parallel for most flexible investment vehicles,
the wide diversity of strategies in the investing across asset classes and
hedge fund industry. Indeed, even the using derivatives, leverage and
term ‘hedge fund’ is not a particularly shorting, as needed
useful identifier for what a hedge fund
— Activism: many hedge fund
is or does. No two hedge funds are the
managers made their name by
same, and therefore, no two approaches
engaging in public proxy fights and
3
to ESG either should or will be the same.
other shareholder battles, and have
Yet, our post-survey interviews identified extensive experience in the art of
several potential advantages that hedge shareholder engagement.
The rise of
sustainable
investing

However, these advantages will only C. What are the emerging best practices
come to the forefront if hedge fund that hedge fund managers can adopt
managers take concrete steps to to fast-forward their progress in the
embrace ESG across the organization. implementation cycle? We see growing
Accordingly, this section seeks to These questions are separately evidence of
answer three key questions. considered in the next three subsections immediate or short-
in order to highlight how hedge fund
A. What are the key drivers of the
managers are progressing towards a term value creation in
increased interest in ESG?
sustainable future. sustainability rather
B. What are the key constraints
preventing its faster adoption within the than just long term.
hedge fund industry?
An institutional consultant
1. Key drivers
1
Executive
summary
It is clear that there is growing interest ‘no change‘ in interest. Not a single

in ESG-oriented strategies, products and survey respondent reported decreased
funds across the hedge fund industry, interest when given the choice: a clear
according to our survey of hedge fund sign that sustainability is a credible
managers (Figure 2.1): 84 percent of phenomenon in the hedge fund
them reported an increase in interest industry.
over the preceding 12 months, with
Further analysis revealed two key drivers
more than half (58 percent) citing it as
to be at work: growing investor demand
a ‘significant increase’. The remaining
and growing evidence of the materiality
16 percent said that there was
of ESG, as shown in Figure 2.2.
Figure 2.1 How would you describe the change in interest or demand in your
organization’s ESG capabilities or strategies over the last 12 months?
16%
2
The rise of ESG
in the hedge
fund industry
26%
58%
Significant increase
Modest increase
3
The rise of
sustainable
No change investing
Decrease

a. Growing investor demand launched dedicated ESG funds, while
Like in other parts of the asset others have crafted policies that clarify
how sustainability factors were taken
management industry, the initial
into consideration as part of their Hedge fund managers
wave of interest in sustainability in
the hedge fund industry has come investment processes. should focus on the
from institutional investors and their While the scope and scale of the economics of ESG,
consultants, as cited by 72 percent response to investor demand seems
of surveyed hedge fund managers to vary widely across the hedge fund not its morality.
(Figure 2.2). industry, the speed of the response
has been notable. Almost every hedge An institutional consultant
These institutional investors — and
their consultants — have been vocal fund manager who participated in
in demanding that their portfolios our post-survey interviews had made
improvements to their ESG programs
1
not be exposed to the so-called ‘sin’
industries like fossil fuels or weapons (or started them from scratch) in the
manufacturing, with a growing number last 12 months, potentially signaling a
of them also seeking to use their coming sea-shift across the industry.
capital to generate positive social and This is further corroborated by a Executive
environmental outcomes. recent survey of over 600 institutional summary
Hedge fund managers, accordingly, investors, evenly split among the US,
have begun to respond by making the UK, Canada, Germany, Japan and
their investments more ESG-oriented. the Netherlands, with US$9 trillion in
Some of our survey respondents have combined assets. The survey provides
further insights into investor thinking1.
Figure 2.2 What are your organization’s biggest drivers when making ESG-oriented
investments?
Hedge fund managers' survey
Growing institutional investor and/or consultant demand
Alignment with the corporate mission or values
Evidence of the materiality of sustainability issues

37%
35%
72%
2
The rise of ESG
in the hedge
Opportunities to generate alpha 22% fund industry
Competitive pressure 19%
Regulatory or political pressure 16%
Attracting and retaining talent 7%
3
The rise of
sustainable
investing

It showed that: a positive correlation between ESG and
financial performance, and just 8 percent
— 84 percent of respondents agree
reported a negative correlation2.
that maximizing shareholder returns
can no longer be the primary goal of Of course, there is not yet conclusive
the corporation: business leaders evidence that there is a positive
must commit to balancing the needs correlation between ESG and
of other stakeholders performance. Some have even
vocally argued that there is a negative
— 87 percent of respondents say
correlation, and that sustainability
their organizations have changed
considerations may actually hurt portfolio
their voting and/or engagement
performance — at least when applied
policies to be more attentive to ESG
over shorter time horizons.
risks
1
While there may be some validity to
— 86 percent would consider investing
these arguments, there are clearly
with a lower rate of return, especially
a growing number of hedge fund
if it meant investing in a company
managers who have bought into ESG as
that addresses sustainable or impact
a way to generate outsized returns. The Executive
investing considerations
materiality debate has also turned the summary
— 61 percent have increased their spotlight on the role of shorting in ESG
investment allocation to companies investing (case study 2A).
that excel in ESG factors and more
than half of investors believe that c. Other factors
ESG practices positively impact trust There were two other notable drivers
— 99 percent of respondents expect cited by hedge fund managers that also
the board of directors (of the influenced their increased adoption of
companies in which they invest) ESG. While these paled in comparison
to oversee at least one ESG topic. to the top two drivers mentioned above,
they are important to keep in mind as
b. E
vidence of the materiality the industry evolves, for they have the
2
of ESG potential to act as catalyzing forces in the
years ahead.
There is a growing body of academic
literature and industry research that i. Regulatory changes
supports the double bottom-line
Currently, hedge fund managers seem The rise of ESG
proposition: an investor can do well
relatively unperturbed by regulatory or in the hedge
financially by being good socially. That is,
political pressures when it comes to fund industry
ESG is not only a part of the risk–return
ESG for a simple reason: its rise so far
equation, it could potentially also
has largely rested on voluntary or self-
generate additional benefits for the wider
regulatory initiatives. But it is highly
community, as discussed in Section 3.
likely that this bottom-up momentum
For instance, a meta-study of more than will be complemented by new
2,000 research papers on equity returns regulation in certain parts of the world.
found that 63 percent of studies reported
3
The rise of
sustainable
investing

In the past 2 years alone, there has consensus that there will eventually be
been a dizzying array of proposals a dramatic policy response that will up-
across different jurisdictions that end global financial markets3.
would, if implemented, rewrite the Regulation is coming
To take one example, consider the issue
rules of finance — as described in
of stranded assets. The Carbon Tracker to give sustainability
Section 3. Initial indications are that,
like their long only peers, most hedge
Initiative estimates that as much as more teeth, with the EU
US$2.3 trillion of oil and gas assets may
fund managers have yet to take
become stranded as the world shifts to leading the way.
proactive steps in preparation for
a low- or zero-carbon economy. Already,
policy changes, likely since most of the A global alternative
major fossil fuel companies have written
proposed rules are still at the outline investment firm
off billions of dollars’ worth of oil and
stage and months and years away from
gas assets from their balance sheets.
enactment.
The stranded asset problem may also
As an additional resource, hedge
funds should familiarize themselves
with the PRI’s report on the ‘Inevitable
Policy Response'. While governments
are clearly behind actions to address
eventually apply to plastics companies,
manufacturing companies, agricultural
companies and even some food
companies, which would force a broad
repricing of their market valuations
1
Executive
summary
climate change, there is growing over time4.
Case study 2A:

The ethics of shorting
A philosophical debate has involves potentially profiting can then be used to help fund
erupted over the last couple of from job losses if a company additional investment, research
years on whether shorting has a has to lay off workers or even or engagement activities.
place in ESG-oriented portfolios. goes bankrupt. Another is that
2
Shorting can also be a source of
it requires holding ‘sin’ stocks
The latest salvo came from Hiro differentiated returns, particularly
if betting against a company in
Mizuno, chief investment officer in down markets.
a sector like tobacco, which is
of Japan’s Government Pension
an issue for investors with strict We don’t think there’s a simple The rise of ESG
Investment Fund (GPIF).
exclusion lists. answer to the shorting question. in the hedge
In December 2019, the GPIF There should be nothing wrong fund industry
But we take a different view,
announced that it would stop with hedge fund managers
which is that short selling has an
lending its global equity stocks out profiting from the sunsetting
important place in the investment
to short sellers, arguing that short of certain carbon-intensive
industry, especially in the broader
selling promotes a short-term industries, as long as they
sustainability context.
mindset and is therefore contrary are clear about their intended
to the idea that sustainability Short selling can increase the approach.
should be a long-term game. cost of capital for sin stocks,
Ultimately, it should be the
especially if shorting bonds
We have heard opponents of prerogative of the investor to
within a fixed income strategy.
shorting cite a number of reasons decide whether or not to invest in
for why short selling is ’bad‘.
One of the key arguments is
that short selling, if successful,
Short selling, if done
successfully, can generate a
positive financial return, which
a fund manager that engages in
short selling.
A long-short equity manager
3
The rise of
sustainable
investing

ii. Alignment with the corporate investment management industry,
mission which is being held to a higher ethical
standard. The business model of hedge
Many hedge fund managers are also
funds will always be dependent on We see some hedge
looking at the ESG rise from a mission-
driven mindset. After all, it stands to
delivering decent financial returns (and funds write off
thus generating performance fees).
reason that if hedge fund managers
But although that will be necessary, it sustainability as an
believe in the positive relationship
between ESG and long-term value
won’t be sufficient. Implementing ESG exclusionary approach
factors where they are relevant will
creation, then they would also agree that
be essential for attracting institutional and continue to peddle
having strong requisite practices internally
is also a recipe for long‑term success.
money. misconceptions about
Many managers have always known that d. Investor perspective it to investors.
1
having a diverse team, strong corporate We also surveyed institutional investors
governance and fair compensation An institutional consultant
to ascertain the key factors driving their
schemes are all key to running a well- allocations to ESG-driven hedge funds.
functioning business. Those managers We found several parallels between
that best articulated a corporate mission what drives hedge funds and what drives Executive
and a set of values beyond just generating investors, with materiality at the core of summary
strong financial returns also tended the decision-making processes of both
to attract and retain the best talent, groups (Figure 2.3).
according to our post-survey interviews. It
confirmed the point in Section 3 that ESG Nearly half (44 percent) of surveyed
is as much about mindset shifts as about investors said their allocations to
physical changes in business models. ESG-oriented hedge funds were driven
by ‘opportunities to generate alpha’ and
As the hedge fund industry becomes 34 percent were driven by ‘evidence of
ever more institutionalized, these the materiality of ESG issues’.
practices are likely to attract greater
scrutiny. This is true of the broader
Figure 2.3 What are your organization’s key drivers of ESG-oriented investments?
Institutional investors’ survey

Opportunities to generate alpha 44%
2
The rise of ESG
in the hedge
Evidence of the materiality of ESG issues 34% fund industry
Growing beneficiary/trustee demand 28%
Regulatory or political pressure 28%
Alignment with the corporate mission or values 25%
Attracting and retaining talent 6%
Competitive pressure 3%
3
The rise of
sustainable
investing

In contrast, relatively few investors These figures are supported by our
(28 percent) were driven by ‘growing post‑survey interviews with investors.
beneficiary/trustee demand’ or by They revealed overwhelming recognition
‘regulatory or political pressure’. that at least some aspects of ESG are
The lack of industry
Interestingly, investors didn’t seem clearly material and therefore should standards has given
any more or less mission-driven than be incorporated into the investment
hedge funds, with only a quarter process. It should come as no surprise,
hedge fund managers
(25 percent) of investors saying they then, that investors base much of their permission to not
were motivated by a desire to make due diligence around ESG and how well
investments that were aligned with the their underlying fund managers are able
take sustainability
corporate mission or values. to use the appropriate data and insights seriously.
to make better-informed investment
decisions (case study 2B). A US quant manager
Case study 2B:

1
Executive
summary
ESG as a risk management tool
As fiduciaries, we look at about each investment in our more of a company’s value now
anything that may materially portfolio. This picture allows us tied up in so-called ‘intangible
affect the financial returns of to more proactively identify and assets’ like brand recognition and
our funds. We believe that ESG monitor risks, both before and goodwill, it seems inevitable that
factors clearly belong in this after an investment is made. ESG components like employee
conversation, particularly as a This is by no means easy to diversity and environmental
risk mitigant. do, but we do think there are stewardship will take on
material signals out there waiting increased importance in future
While we recognize that the
to be found for investors willing investment decision making.
ESG data out there can be very
2
to do the work.
noisy, we have found success A European fund of hedge funds
by combining fundamental At the end of the day, ESG
analysis with select data sources factors should be treated just like
to create a more holistic picture other risk factors. With more and The rise of ESG
in the hedge
fund industry
3
The rise of
sustainable
investing

2. Key constraints
When asked to identify the constraints sustainability data should be viewed

that are slowing down the adoption of as an advantage — rather than a
ESG, the surveyed hedge fund managers disadvantage — for hedge funds, which
singled out a number of them, of which typically rely on market inefficiencies
two are particularly noteworthy. These are to generate outperformance. In other
considered separately below. words, hedge funds shouldn’t be using
the lack of ESG data as an excuse not
a. Lack of quality ESG data to pursue sustainable investments.
1
If there’s one thing that the hedge fund Instead, they should do the difficult
managers participating in our interviews work of identifying which signals are
agreed on, it’s that there isn’t enough material and which are not, whether
reliable ESG data to clearly identify through existing data sources or by
risk or alpha signals (Figure 2.4). As we developing proprietary approaches (case
Executive
shall see in Section 3, this challenge is study 2C).
summary
also pervasive across the investment
landscape, including for long only asset b. Shortage of ESG expertise
managers, institutional investors and Indeed, there were several other
other alternative investment firms. challenges that emerged from the
survey. They could all be traced back to
While it is true that the current ESG data
education and/or awareness problems.
suffer from many shortcomings — like
More than a third of hedge funds
inconsistent company disclosures,
(36 percent) said there was ‘confusion
opaque research methodologies and
over industry terminology’, 18 percent
unreliable ratings — it is also true
cited a ‘shortage of knowledge or
that the quality of the available data is
expertise’ and 9 percent were beset
improving every day.
by a ‘lack of consensus from internal
In contrast, some of our interviewees
took the view that the lack of quality
stakeholders’ (Figure 2.4).
Figure 2.4 What are your organization’s biggest challenges in making ESG‑oriented investments?
2
The rise of ESG
in the hedge
fund industry
Hedge fund managers' survey
Lack of quality/consistent sustainability data 63%
Confusion over industry terminology 36%
Not relevant to our strategy or mandate 25%
Lack of quality investment opportunities 21% 21%
Shortage of knowledge or expertise 18% 18%
Difficulty in delivering both financial and nonfinancial returns 13%
Excessive costs associated with incorporating sustainability 12%
Fiduciary concerns
3
9%
Lack of consensus from internal stakeholders
Political or regulatory uncertainty 1%
The rise of
sustainable
investing

Just as different hedge fund managers However, several organizations have
may have divergent views on ESG, stepped up to fill the implied education
so too do different employees within and talent gap, whether through
each of these individual firms. This conferences, trade associations, Small hedge fund
disconnect — whether between the academic research, third-party managers face
investment team and the research consulting or even specialist recruitment
team, or between the C-suite and the agencies. excessive costs
compliance team, or between investors
Many long only managers have hired in implementing
and the investor relations team — is a
major barrier to the adoption of ESG and
ESG specialists or have even built sustainability, while
dedicated ESG teams; other firms have
prevents some hedge fund managers
joined advisory committees at one of the large ones have a
from agreeing on a single approach.
many not-for-profits and standard-setting marketing machine to
In the early days of ESG there was a organizations engaged in the ESG space.
1
noticeable shortage of investment Most of the managers are upskilling help greenwash.
professionals who could combine rather than creating new teams,
financial expertise with ESG experience. however. A Nordic hedge fund manager
Executive
summary
Case study 2C:

Turning noise into signal
We’ve heard all of the complaints doesn’t mean that the data are a company’s financials or
about the low quality or irrelevant or unusable. sustainability reports.
unreliability of sustainability data,
For our part, we’ve looked It mines vast amounts of
arising from the inconsistencies
at many of the third-party unstructured data in near-real
in company disclosures and
sustainability data providers time, and gives us greater and
differences in the methodologies
to determine which data faster insights into both the
used by various data providers.
points generated a clear alpha risks and opportunities in our
While the quality of the data
is getting better every day, it’s
still nowhere near the level of
traditional financial data. But that
signal. We couldn’t find one.
Instead, we have devised
our own methodology, which
goes a layer deeper beyond
investment universe.
A global quant manager
2
The rise of ESG
in the hedge
fund industry
c. Other challenges slowing These costs can easily pile up and

down adoption may therefore be prohibitive for some
There are two other challenges worthy small- or mid-sized hedge funds. It’s no
of note. The first one is the high costs surprise that the hedge funds doing the
involved in implementing ESG across the most on ESG tend to be those with the
organization. These costs can be broken most operational resources. Alongside,
down across several areas: investments however, new firms are also emerging
in talent (hiring ESG specialists for the that specialize in ESG.
investment, research and shareholder The second challenge cited by about a
3
engagement teams), investments in quarter of the hedge fund managers we
data (purchasing datasets and data- surveyed said that ESG was ‘not relevant
mining technology from third‑party to their strategy or mandate’. They believe
providers) and investments in marketing that ESG could lose its materiality powers
(sponsorships, PR and thought leadership for trading strategies that rely on short The rise of
to build credibility in the market). sustainable
investing

holding periods or in an asset class like out by hedge fund managers, except in
currency that is extensively traded daily. one crucial area: the ‘lack of consensus
from internal stakeholders‘. While only
This may be true for high-frequency
9 percent of hedge funds cited this as The minimum bar for
trading strategies, but our interview
research suggests that while a longer
a challenge, a much larger percentage hedge funds is to have
of investors (23 percent) struggled with
holding period makes it easier to
this issue. a robust ESG policy
incorporate ESG into the investment
process, ESG factors could still This could be explained by the nature of with buy-in from the
potentially generate relevant signals over most institutional investors, which must top. ESG should be
a short time frame, especially as the pace answer to a wide range of stakeholders
of news and the speed of data continues with potentially diverse needs and part of the DNA of the
to increase. objectives. For example, a pension fund firm.
must meet the needs of its beneficiaries
d. Investor perspective
We also asked institutional investors
to highlight the challenges they faced
in making ESG-oriented investments
in hedge funds. They cited many of
but is ultimately only answerable to its
board, which may have widely different
views on ESG. This exact issue played
out in 2018 at an American retirement
organization, which elected a new
An impact investing consultant
1
Executive
summary
the same challenges as hedge fund President who took a very different
managers, suggesting that there are view of sustainability to that of his
common issues across the investment predecessor5. Pension plans with
management value chain (Figure 2.5). low funding levels and fast maturing
liabilities have faced a similar challenge.
The challenges identified by institutional
investors are similar to those singled
Figure 2.5 What are your organization’s biggest challenges in making ESG‑oriented investments?
Institutional investors’ survey

Lack of quality/consistent sustainability data
Not relevant to our strategy or mandate
Difficulty in delivering both financial and nonfinancial returns

Fiduciary concerns
26%
28%
38%
49%
2
The rise of ESG
in the hedge
fund industry
Lack of consensus from internal stakeholders 23%
Confusion over industry terminology

Lack of quality investment opportunities 18%
Shortage of knowledge or expertise

Political or regulatory uncertainty 10%
Excessive costs associated with incorporating sustainability 8%
3
The rise of
sustainable
investing

3. Emerging best practice
Our post-survey interviews identified is a challenging one to incorporate into

four sets of practices that could their funds, just as it is across the entire
potentially speed up the adoption of investment management industry.
ESG and generate improved outcomes
But, as in all fields of human endeavor,
for hedge fund managers and their
the challenges are all surmountable with
institutional clients alike.
enough time, patience, persistence and
diligence.
a. Avoid greenwashing
1
Those firms that fall short of best
Best practices in the ESG space are
practices are likely to fall victim to the
a moving target. Whereas negative
investment management industry’s new
screening may have historically been
‘G’ word — greenwashing. Our research
the dominant approach, today the bar
suggests that, as in the long only space,
is clearly being raised. It’s no longer Executive
there is still a greenwashing problem
enough for a fund manager to just avoid summary
in the hedge fund industry. However,
‘sin’ stocks; increasingly, there is now
institutional investors are getting more
an expectation that investments should
savvy in how they approach ESG in
generate a positive (and measurable)
their due diligence, duly separating the
social, environmental or economic impact.
leaders from the pretenders and the
This is easier said than done. For many winners from the spinners.
hedge fund managers, the idea of ESG
Figure 2.6 As an institutional investor, do you include ESG considerations as part of
your due diligence prior to making an allocation to a hedge fund manager?
2
The rise of ESG
in the hedge
45% fund industry
55%
Yes
No
3
The rise of
sustainable
investing

Indeed, more than half of the To minimize the problem, hedge
institutional investors (55 percent) fund managers are developing the
reported that they include ESG necessary practices (Figure 2.7). These
considerations as part of their due take into account the fact that investor We’re seeing a
diligence prior to making an allocation expectations vary when it comes snowball effect in
to a hedge fund manager (Figure 2.6). to hedge fund firms practicing ESG
investment. For many investors, this the hedge fund
However, early indications suggest
that investors were concerned
may be as simple as expecting their industry now
managers to screen certain assets out
with what they found, as we saw in
of their portfolios — particularly those that sustainability
Figure 1.7 in the Executive summary.
It reported that 41 percent saw a
assets that might cause the investor is becoming
reputational harm. Other investors,
‘significant amount of greenwashing’,
however, may expect a manager to mainstream.
with a further 11 percent reporting
1
implement ESG analysis, or even to
‘some greenwashing’. The remaining An institutional consultant
measure the environmental footprint of
48 percent said they were ‘not sure’.
its investment activities.
Executive
Figure 2.7 What do institutional investors expect? summary
Investor expectations
Firm has a policy on responsible investment and has thought through the implications
Policy
thereof for its investment strategy and operations.
Relevant investment staff have been trained in responsible investment; accountability

Talent
for responsible investment policy does not only sit in compliance/legal.
Firm has a screening policy, and has demonstrably thought through the impact of
Investment strategy
responsible investment and sustainability concerns on its investments.
Engagement
Reporting
Firm engages with investee companies where possible, and reports on the outcomes
of those engagements to its investors.
Firm has internal controls to ensure its responsible investment policy is properly
2
The rise of ESG
in the hedge
enacted.
fund industry
3
The rise of
sustainable
investing

b. Comply with industry codes Hence, as they advance into the
and principles implementation cycle, hedge fund
managers should consider good
As mentioned previously, there is
practices enshrined in the PRI. Currently, Active ownership
no one‑size-fits-all approach when
it comes to ESG. This is also true of
35 percent are already a signatory to and responsible
these Principles, and a further 17 percent
implementation efforts6. stewardship are
are in the process of becoming a
ESG is not a race but rather a unique signatory (Figure 2.8, left‑hand panel). a critical part of
journey, with unique challenges and
unique opportunities for individual hedge
As for embedding the PRI policies into sustainability,
the cultural fabric of the firm, 56 percent
fund managers. It is a journey based
of hedge fund managers currently have a regardless of whether
on experiential learning; questioning
what works, what doesn’t and why, and
policy to do so, and a further 36 percent you are active or
are in the process of developing one
1
applying the resulting lessons going
(Figure 2.8, right-hand panel). This shows passive.
forward.
significant progress when compared
As we saw in Figure 1.3 in the Executive with a November 2018 Preqin survey A US quant manager
summary, only 15 percent of hedge fund on the same question, which found that
managers would define themselves 20 percent of hedge fund managers have Executive
as being at the ‘mature’ stage of the an ESG policy in place, 15 percent don’t summary
implementation cycle, where ESG have a policy yet but are working on one,
is implemented across the firm via and 65 percent aren’t actively working
appropriate policies, committees, towards a policy at all 7.
research and data. The rest of the
These data invite a caveat, however. As
managers are either at the ‘in progress’
mentioned previously, not all hedge fund
stage, where implementation is
strategies are amenable to ESG investing
piecemeal (44 percent) or the ‘awareness
and, by extension, to UN PRI.
raising’ stage (31 percent), with the
remaining 10 percent reporting ‘no
implementation to date’.
Figure 2.8 Is your organization a current UN PRI signatory? And does your organization currently have an ESG policy or
statement?
UN PRI signatory ESG policy or statement

2
The rise of ESG
in the hedge
8% fund industry
35%
48%
36%
56%
Yes
17%
3
The rise of
sustainable
No, but in the progress of becoming/having one investing
No, and with no intention in the near future

Implementation progress is evident Where the PRI are less relevant, the
with regard to those that are, in order to industry needs to work together to
enhance the credibility, authenticity and create a set of its own harmonized
transparency required by institutional principles. Integrity is critical.
investors (case study 2D). If you’re going
to call yourself a
sustainability investor,
Case study 2D: it is important to have
Embedding ESG into corporate DNA
the right processes in
We look for hedge fund are willing to ‘walk the walk’ place.
managers that clearly have ESG of ESG by asking themselves
in their DNA. We evaluate these
managers for how well they
integrate it into their research
and investment processes,
how committed they are to
the same sorts of questions
that they would ask of portfolio
companies. That means a hedge
fund should have a commitment
to employee diversity, equitable
An impact investing consultant
1
Executive
summary
responsible ownership, and pay, appropriate fees and fund
the quality of their approach structures, and strong corporate
to sustainability data and governance. If a hedge fund
nonfinancial reporting. An truly believes in ESG as part of
ESG policy is the absolute its core investment philosophy,
bare minimum and it is not then it follows that it should be
usually enough to earn a seamlessly integrated across
recommendation from us. the organization.
We also want hedge fund An institutional consultant
2
managers to show that they
at all, as mentioned in the Executive

The rise of ESG
c. Improve ESG reporting in the hedge
summary. Of those who do, 11 percent
Measurement of and reporting on the fund industry
use customized metrics and 23 percent
nonfinancial impact of investments
use PRI, with other standards far behind
represents the next frontier for ESG
in terms of adoption.
investing. Investors and regulators are
increasingly demanding information Of all the data points we looked at,
on the nonfinancial performance of we expect this one to change the
all investments. In response, there most year on year. Reporting is no
has been a growing list of standards, longer seen as a nice-to-have by most
frameworks and principles developed to investors; it has become a must-have.
create a shared language for investors While there may not ever be a single
who wish to report on ESG. While reporting standard that satisfies a
no single standard has emerged as range of conditions for different types
universal, there is an expectation that
best-in-class managers will report using
one or more of these standards — or
develop proprietary ones.
When asked what different approaches
of investment strategies, that doesn’t
mean hedge fund managers can get
away with no reporting of any kind.
It is essential for them to focus on
reporting what is most material and
3
The rise of
sustainable
were used in their ESG reporting, more relevant to a particular strategy. There are investing
than half (57 percent) of the surveyed plenty of tools available that can be used to
hedge fund managers said they do not come up with standardized reports or feed
currently report on ESG performance into a customized reporting mechanism.

d. P
ublish the outcomes of used, owing in part to how resource
shareholder engagement intensive activist battles can become.
On the other hand, collaboration with
The final area to improve current
other managers and external networks Sustainability is a
practices is shareholder engagement. It’s
not enough to just invest in ESG‑friendly
is on the rise (case study 2E). great opportunity
securities; hedge fund managers must Hedge funds are ideally suited for for hedge funds to
also engage with the underlying portfolio activism that targets companies
companies and make the case for underperforming on ESG issues. Our rebrand and show
improving their ESG outcomes. Indeed, interviews show that there is a return their commitment
this is, in fact, already being done in premium in helping an ESG laggard to
significant numbers (Figure 2.9). become a leader. It also shows that to inclusivity and
The most dominant approach to
responsible ownership is an important sustainability.
part of the ESG toolkit and must be
1
shareholder engagement is also the
taken seriously. An institutional consultant
most opaque: nearly three-quarters of
managers (74 percent) said they privately Above all, the outcomes of all
engaged with companies on ESG issues, engagements must be transparently
compared with 25 percent of managers conveyed to end-investors. Except for Executive
who engage publicly and 34 percent who high-profile proxy fights, end-investors do summary
vote their proxies. But the most active not as yet have a clear idea on what value
form of engagement — proxy fights or is generated by engagement activities
activist battles (6 percent) — were rarely due to this lack of transparent reporting.
Figure 2.9 What approach does your organization bring to shareholder engagement
when it comes to ESG?
74%
2
The rise of ESG
in the hedge
34% fund industry
25%
15%
13%
6%
Private Proxy voting Public Shorting Divestment Proxy fights or
3
engagement engagement activist battles
on ESG issues on ESG issues

The rise of
sustainable
investing

Case study 2E:
Progress requires collaboration
Adopting best practice can Investors Group on Climate Companies are learning too,
be rather expensive for some Change. and they want to work with their
fund managers, especially shareholders to understand
We think this is best practice
when it comes to shareholder what investors are looking for
for other smaller or mid-sized
engagement. We know that on ESG. It’s become much more
managers that want to engage
we’re too small to gain much of a dialogue or conversation.
on ESG issues but don’t have
traction on our own, so we look Not all engagements have to
the right expertise or resources.
for opportunities to collaborate be combative. Indeed, the best
1
Engagement looks different
with other asset managers conversations are discreet and
depending on the company,
through organizations and behind closed doors.
jurisdiction and culture, so there’s
initiatives like Climate Action
no one-size-fits-all approach. A boutique ESG manager
100+, Ceres and the Institutional Executive
summary
Best practice in the years ahead We may also see hedge funds
What may seem like a non-starter today and long only managers exploring
could easily emerge as best practice innovative lock-up structures that would
over the next few years. That is why allow them to tie up investor capital
one area that bears watching is a better for prolonged engagement campaigns
alignment of interests via fee and or specific thematic investments.
incentive structures that reward hedge Since most research suggests that
funds for both financial and nonfinancial ESG factors become more material
performance. While such fee structures over longer-term horizons, it would
make sense for fund managers and
2
are still in their infancy, hedge funds
that show a clear alignment of interests investors to mutually agree on seeing
when it comes to ESG — especially in an investment through to its natural
their remuneration schemes — will have conclusion, even if it takes years.
a distinct competitive advantage. Some The rise of ESG
niche players are already setting the trend. in the hedge
fund industry
To conclude, therefore, on ESG, hedge fund managers are moving

up the implementation ladder.
They must also embrace best practice and take control of their
own narratives — proactively making the case for how and
why ESG is material to their strategies rather than passively
reacting to external demands — whether those demands come
from investors, consultants, policymakers, regulators or even
employees.
3
The rise of
sustainable
investing

3 The rise of sustainable
investing
What lessons can be learned from early adopters?
1
Executive
summary
2
The rise of ESG
in the hedge
fund industry
3
The rise of
sustainable
investing

Sustainability is evolutionary in nature but revolutionary in potential. It envisions a key role for capital
markets — alongside governments, consumers and green technology. Neither capital markets nor
individual countries alone can deliver results. Transnational co-operation is essential.
Sustainability is set to reshape the ecosystem of capital markets and the behaviors of their participants.
It requires mindset shifts as much as physical changes from the way investing has been done
historically.
Barriers persist. Creating the necessary infrastructure of data, skills and technology is proving
challenging. Progress has been exponential but the task remains huge. Pragmatism has been all too
evident. Future demand prospects look promising. Regulatory pull remains strong. Early results are
1
encouraging.
Future success critically hinges on three factors: a new model of shareholder engagement that
enjoins investors to go from distant owners to vocal change agents; savvy implementation of
Executive
sustainability into investment portfolios; and business leadership that is keen to capitalize on the
summary
opportunities arising from the transition.
This section presents the results of a A. What is the current state of progress
stand-alone interview survey, which in the adoption of sustainable investing?
involved large institutional investors,
alternative investment managers and
B. Why is sustainability facing Markets usually price
headwinds from different sources?
global asset managers who are early in inflection points
adopters of sustainable investing, as C. What best practice is being
defined in the introduction to Section 1. developed by these global players to when they are in the
The survey aimed to shed light on three overcome these challenges? rearview mirror.
key issues:
Each issue is covered in the three
2
subsections below. A Canadian pension plan
The rise of ESG

in the hedge
fund industry
3
The rise of
sustainable
investing

1. Progress along the Spectrum of Capital
a. Adoption so far financial and nonfinancial goals targeted

Currently, there are over 80 different by investors as they advance in different
terms used to describe a mind-boggling stages. These two sets of goals are
array of approaches that have emerged accorded separate and varying weights
under the umbrella of ‘sustainable in investor portfolios, as they progress
investing’. from left to right in the figure.
To chart the way forward, many early The term 'sustainability' is used broadly to
adopters in our interview survey for describe the journey along this spectrum.
this section use the schematic entitled
the ‘Spectrum of Capital’, which was
developed by The Impact Management
Project 8, as shown in Figure 3.1.
It envisions sustainability as a
In the last decade, the journey mostly
involved the exclusion of ‘sin’ stocks:
shares in companies associated with
activities deemed unethical — like
tobacco, weapons, fossil fuels, abuse of
1
Executive
summary
progressive journey that focuses on the human rights and poor labor standards.
Figure 3.1 The Spectrum of Capital
1 2 3 4 5 6 7 8
Investment Traditional Responsible Sustainable Impact-driven Philanthropy
approach
Financial Tolerate Tolerate below Partial capital Accept full loss
Deliver competitive risk-adjusted financial returns
goals higher risk market returns preservation of capital
Avoid harm and mitigate ESG risks
Benefit all stakeholders
Contribute to solutions
2
The rise of ESG
in the hedge
Don’t Avoid harm; Benefit Contribute to solutions; have a fund industry
consider; may try to prevent effect; material effect on important
have significant important positive outcomes for
Impact significant effects on positive underserved people or the
goals negative important outcomes for planet
outcomes for negative various
people and outcomes for people and
the planet people and the planet
the planet
Source: The rise of impact — five steps towards an inclusive and sustainable economy; UK National Advisory Board on impact investing 2017 & Impact Management Project 2017
3
The rise of
sustainable
investing

The process of negative screening The ambition envisions a significant
narrowed the investment universe role for asset managers in its delivery.
somewhat and reduced the scope It also envisions intergovernmental
for diversification. Thus, exclusion co-operation on a scale far bigger With governments,
and diversification were not always than now. Acting alone, neither asset regulators, asset
compatible. managers nor individual nations can
make a big impact. owners and asset
Hence, most of the large institutional
investors have been advancing towards managers seeming
b. Root causes of the problem
the right end of the Spectrum into illiquid to pull in the same
markets — infrastructure, private equity The central thrust of the emerging
and private debt — to target societal policy framework is directed at one direction, it is hard
as well as financial impacts, while still overriding aim: to tackle negative to believe that we are
generating market-rate returns (Levels externalities resulting from those
1
4–5). In part, this is because these asset day‑to-day corporate activities that inflict not in the midst of
classes have customized vehicles of uncompensated costs on wider society. something profound.
much longer duration with clear metrics They include environmental damage,
and monitoring. governance lapses, poor labor practices, A Danish pension plan Executive
In contrast, in public markets, the same stagnant incomes, the hollowing out of summary
investors’ interest in sustainability has the middle class and rising inequalities.
largely progressed to Levels 2–3 due to These have ignited a powder keg of
a variety of challenges, such as the lack resentment in the West and fueled the
of reliable data on sustainability issues, rise of populism.
as we shall see below.
Markets have been slow to fully price in
There are regional differences, of these risks — especially climate risk —
course. Overall, in all asset classes, while quarterly capitalism continues
Europe leads the pack, followed by the to retain a decisive influence. Under
US and then Asia Pacific. it, investors are overly influenced by
These regional differences reflect quarterly earnings.
the stance of public policy and
2
Over time, sustainability will likely have
regulatory responses, as well as a growing impact on company valuation
cultural differences. These are well and cost of capital. Thus, by not acting
documented9. Among them, far and to future-proof their businesses now,
away the most ambitious program many listed and private companies The rise of ESG
promoting sustainable investing has risk harming the interests of their in the hedge
been enshrined in the EU's Action Plan: shareholders as well as those of wider fund industry
Financing Sustainable Growth. society, not to mention their own
Most importantly, the EU Council of long-term financial viability. This much
Ministers has recently committed was clear from our interviews.
to convert its Green Deal into law by
March 2020, which envisions the EU
achieving carbon neutrality by 2050
in line with the Paris Agreement.
3
The rise of
sustainable
investing

Thus, sustainable investing is first focus narrowly on shareholders and
and foremost about future-proofing their financial interests.
businesses against secular forces that
can cause existential threats, while
Of course, capital markets alone cannot Sustainability is the
tackle the negative externalities: in
generating positive spin-offs for the
the area of global warming especially, biggest leadership
wider society (case study 3A).
intergovernmental co‑operation is challenge of our age.
Hence, in their role as allocators of vital. But markets are viewed as the
finance, capital markets are viewed strongest link in a mutually reinforcing Leaders can make a
as an essential bridgehead to a more chain involving three other sets of huge difference.
purposive capitalism, as institutional partners: governments, using their
investors seek to future-proof their own supportive tax and trade policies; A Canadian asset manager
portfolios against the looming risks in technology, delivering innovations
the separate areas of environment, in cost‑effective green energy; and
social and governance. The fiduciary
responsibility currently enshrined in
their articles of memorandum tend to
consumers, favoring pro-sustainability
products.
1
Executive
summary
Case study 3A:

Sustainability is a leadership issue
Our sustainability initiative their own sustainability, so as competencies, our business

started some 15 years ago, to deliver decent risk-adjusted behaviors, our talent pool, and
with a sole focus on ethics: returns. our systems and processes.
We screened out shares in
Our initial forays into ethical Our sustainability DNA has
companies associated with
funds were not successful reoriented our business to ‘do
activities deemed undesirable
because dumping ‘sin’ stocks good and do well’ by continuous
2
like weapons, fossil fuels,
yielded handsome profits to improvements in our capabilities
tobacco and human
those who bought them. All that and track record over time.
rights abuses.
happened was a change in share
Around 80 percent of our assets
Not only were these activities ownership. The rise of ESG
now cover sustainability funds of in the hedge
morally wrong in themselves,
Markets had not woken up to one variety or another. Of these, fund industry
but they also imposed negative
the fact that investors were around a third rely on specific
externalities — uncompensated
expressing their personal values ESG themes that target financial
costs — on the whole of society,
via investment choices. and nonfinancial outcomes. Our
hurting future growth and
total assets under management
prosperity. As CEO of the company, I
has doubled in the last 5 years.
persuaded my colleagues that,
Our belief was that the rise
as a mid-sized player, we could Our people are excited to work
of sustainability would, over
only differentiate ourselves by for us because they believe in
time, change the ecosystem
pioneering sustainability at the our core value that finance has to
of markets that had long relied
heart of our business model. give something back to society
3
primarily on financial metrics to
as well as making a profit.
value individual companies. We have evolved a culture that
links it to our core business A Benelux asset manager
Hence, we focused on
values, our leadership
companies that were enhancing The rise of
sustainable
investing

c. Setting the tone at the top Leaders must question the purpose of governance can also translate into lower
This laudable aim marks a sea change a modern corporation in order to give it overall corporate risk, as governance
from the traditional way of investing, better social expression. They must set can set standards for environmental and
which has long targeted risk-adjusted the tone and lead by example, as they social goals. This is especially the case in
returns, assessed mostly on financial face what is veritably a new foundational emerging markets (case study 3B).
criteria. trend that is reshaping investing as we
There, transparency is a big slow
know it today.
For individual asset managers, the burn issue because of the unique
implied shift has huge implications in But, as case study 3A shows, it’s concentration of corporate ownership
a number of areas in the value chain: the long haul that requires vision, in the hands of individual families or
research, investment process, stock passion and persistence. Transition government bodies; further complicated
selection, portfolio construction, talent to a low‑carbon future is likely to have by a myriad of cross-shareholdings
pool, staff incentives, fund pricing, a jagged trajectory owing to various that often compromise the interests of
barriers. minority shareholders.
1
distribution, client engagement, and
performance reporting. Second, sustainability investing
It all adds up to combining the best is primarily driven by institutional
of old and new in order to re‑anchor investors. Worldwide, total sustainable
markets in the transition to a investing assets under management Executive
low‑carbon future. was more than US$30 trillion in summary
2018, representing around a third of
In this context, our discussion with the investment universe, according
early adopters identified two related to recent estimates10. It has been
salient points. influenced by a large body of trans-
First, sustainable investing is essentially Atlantic research that shows that
a leadership issue. It requires a strong sustainable investing works2. Rising short-termism
belief that the old ways of investing that As for emerging markets, data are has turned investing
ignore negative externalities are self- sparse. But significant changes are
defeating: they will increasingly harm afoot on the corporate governance side, into a game of chasing
shareholders and society over time, which is vital for the efficient allocation the next rainbow.
while undermining the role of markets in of capital that delivers long-term growth
2
the efficient allocation of capital. and sustainability. Good corporate A UK asset manager
The rise of ESG

in the hedge
fund industry
3
The rise of
sustainable
investing

Case study 3B:
Emerging markets face a stiff test
Over the past 40 years, breakneck Internal systems and controls To reinforce these requirements,
industrialization has lifted over that help the board to effectively index providers are also
750 million people out of poverty incentivize and monitor increasingly demanding
in emerging markets (EMs). management in the best accessibility, efficiency and
interests of shareholders and transparency of capital markets
But as an unintended
wider society are not so well in emerging economies, all
consequence, environmental,
developed — as of yet. of which requires a robust
governance and social issues
1
regulatory framework.
have been seen as the Lately, however, with the
responsibility of governments, worldwide rise in passive Such efforts reinforce what
not companies. investing, a big positive push many regulators worldwide
has come from many large listed are trying to do in earnest: Executive
However, corporate governance
companies, as they up their reorient markets towards summary
has come under the spotlight,
governance game to qualify for sustainability risks.
especially as EMs' share
entry into major EMs' indexes.
of global stock market As in developed markets, so
capitalization has more than A majority-independent board, in EMs, all the moving parts in
doubled so far in this century to
meritocratic executive incentives, the sustainability revolution are
around 30 percent in 2019. robust capital allocation criteria pulling in the same direction.
and an engagement mechanism Progress is slow but the
Our experience shows that
that focuses on reducing financial direction of travel is clear.
checks and balances between
and nonfinancial risks — these
a company’s board, its A global US asset manager
imperatives have come to the
management and its shareholders
2
fore, as index funds have taken off.
are weak in most EMs.
The rise of ESG

in the hedge
fund industry
3
The rise of
sustainable
investing

2. Factors slowing progress
Guidelines on how to
Three sets of barriers were most Climate Action 100+ and the Impact
assess what is ‘good’
frequently cited by early adopters in Management Project are just two of the and ‘bad’ are rare.
general and institutional investors most prominent examples. That apart,
in particular. individual pension plans have been
There are no agreed
discouraging activities that promote a definitions.
a. Coping with shorter quick-buck mentality. Other asset owners
investment horizon have been petitioning regulators to codify A US asset manager
Over the past 20 years, what has passed rules on sustainability disclosure to
1
for active asset management has promote long-term investing.
largely been the second-order trading The foundational short-term problem is
of existing assets, the main focus being not that stock market pressure dislodges
trying to anticipate the behaviors of firms from the right technological path,
other investors. but that it forces faster and deeper Executive
change than before, which induces summary
Under this argument, some institutional
investors suggest that financial markets a negative reaction in corporate,
are no longer a conduit between savers employment, judicial, and political circles.
planning for a decent retirement nest More people feel vulnerable. Sharper
egg and borrowers deploying their technological shifts and enhanced global
savings to create wealth, jobs, skills competition are the cause; stock markets
and prosperity. are the messenger.
i. Trading vs. investing ii. Regulators flexing their muscles
The result of this, as per the view of For their part, regulators, too, have been
some investors, has been shorter time responding.
horizons, unrealistic expectations, more The EU’s Second Shareholder Rights
2
momentum trading, a higher velocity Directive, effective from June 2019,
of trades and the constant search for sets out to remedy the situation by
hot products. Long-term investing has strengthening the role of shareholders,
come to be full of opacity, such that enjoining them to act like active
commitment to it exists at the outset owners, rather than distant holders The rise of ESG
until investors resolve is tested by time of paper assets; and demanding in the hedge
and events. commitment to sustainability in fund industry
A decade of zero-bound interest rates reporting requirements. Similar aims
has enabled companies on both sides are deeply embedded in the latest
of the Atlantic to inflate their share governance codes in Japan and the UK.
prices via borrowings that have mostly Indeed, the regulatory tempo has
gone into stock buy-backs and outsized increased. Over 500 separate measures
dividends. As per the view of some have been enacted worldwide in the last
investors, companies seem to have decade, according to the PRI responsible
been under pressure to distribute cash investment regulation database.
to shareholders rather than invest it
to improve their long-term prospects, Among others, these rules and
3
resulting in lower growth in the future. regulations seek to escalate new
disclosure requirements from
Such practices haven’t gone unnoticed. companies, securities issuers, asset
Large institutional investors with owners and asset managers. They also
liabilities stretching out over decades enhance the definition of the fiduciary
have been their most vocal critics. They The rise of
duty of a pension plan to include societal
are forming coalitions that promote sustainable
considerations. In the past, its focus
climate action and better sustainability investing
was solely to maximize the financial
methodology by, amongst other things, gains that can provide a regular decent
fostering long-term investing. retirement income for their members.

b. Climbing a steep learning Learning-by-doing remains the principal
curve vehicle for climbing what looks like a steep
learning curve.
Another key barrier is data challenges. Materiality is
At the heart of sustainability sit three i. Heart of the matter
foundational concepts that have proved hard to ascertain
The crux of the problem is that there
hard to quantify: materiality, intentionality
is no universal acceptance of what a with the current
and additionality (case study 3C).
‘good’ company is in practice. With rare generation of data.
Respectively, they seek to assess how exceptions, therefore, governments do
material sustainability factors are to a not mandate companies to provide data We are forced to
company’s financial performance and the on the aspects that matter for sustainable make judgment
risks that can affect it; does the company investing.
really intend to act on them and ‘do good’ calls.
Article 173 in the French 2017 transition
1
via its products, services and interactions
with wider society; and does it generate law broke the mold by requiring A Dutch asset manager
societal benefits in addition to financial mandatory carbon reporting for listed
benefits? companies as well as pension investors.
Other EU jurisdictions have followed suit.
So far, each of these areas have relied on Executive
blending existing data with judgment calls. summary
Case study 3C:

The Achilles' heel of sustainability
Far and away the biggest barrier typically have better disclosure selection. The data are updated
to sustainability investing so far procedures than the rest. The rise annually so it is hard to assess
has been the lack of a robust of big data has been a major boost progress on sustainability scores
2
template with consistent for all data vendors. more frequently.
definitions and reliable data on
But information challenges persist For now, we are making do
how companies score on various
on three of the most pertinent with what data we have. Our
sustainability factors. The rise of ESG
issues for investors: materiality, experience shows that it is not the
Worldwide, there are over 150 intentionality and additionality. sustainability scores themselves, in the hedge
fund industry
major data vendors, each with but the rate of change in them — in
It is hard to ascertain these issues
their own proprietary definitions either direction — that moves their
because most of the data are
and data sources. share prices.
self‑reported, raising questions
The result is that companies in about reliability and consistency. Markets seem to have rewarded
the same investment universe The implied volunteerism has given those who have improved their
end up with radically different rise to whitewashing on the part of game the most, including carbon
scores from different vendors. corporates: selective focus on good polluters.
scores and ignoring the rest.
But we are a long way from A key contributory factor is the
having real-time reliable data that Their coverage is mostly limited media publicity generated by
can enhance market depth in
sustainable funds.
Data coverage, on the whole, is
far better for larger companies that
to this decade such that their
time series are not long enough
to facilitate statistical modeling
that typically underpins asset
shareholder engagement with
the companies involved.
A Dutch pension plan
3
The rise of
sustainable
investing

Even so, four problems persist in all Similarly, when it comes to ESG
fund jurisdictions. investing, it is unclear how much weight
should be accorded to each of the three
First, currently, there is no universally
disparate components, without invoking Engagement will
agreed upon terminology that can help
to create a common language and
value judgments. become the alpha
mental models about sustainability at Finally, in the area of climate change, behind alpha.
a statistical level. Trade associations two data challenges have proved
and advocacy groups worldwide are daunting. One is having to factor in A German asset manager
collaborating extensively to bridge the physical risks like forest fires and rising
gap. sea levels that are hard to predict.
The other challenge is to measure a
Climate change, being an inexact
company's carbon footprint, which
science from an investor perspective,
is defined to include emissions
1
presents formidable challenges in
from its own operations as much as
measuring the carbon footprints of
emissions from its supply chain at the
companies. The task of establishing
upstream end and its customers at the
a clear line of sight between climate
downstream end.
change and investment outcomes is Executive
fraught with as many unknowables as Yet, these problems have not detracted summary
unknowns. from two parallel developments,
according to the participants in our
Second, getting consistent data on
interview survey.
sustainability scores and performance
measures remains a difficult task ii. Winds of change
even with the presence of more than
The first one is that we are indeed
150 major data vendors, each with
witnessing the emergence of a new
their own proprietary definitions
infrastructure of data, skills and
and methodologies on materiality,
technology on the ground. Data vendors
intentionality and additionality. In the
are experiencing rapid consolidation. The
absence of a standardized format,
rise of big data and machine learning
the result is often a radically different
is improving the quality and timeliness
2
assessment of the same company
of the information. Progress may not
from different sources. The problem is
be enough but it remains exponential.
compounded by the fact that most of the
For example, the Impact Management
required data is self-reported, selectively
Project alone has involved over 2,000
focusing on good news and filtering out The rise of ESG
investment practitioners globally on
bad. As a result, many asset owners in the hedge
how to measure, report, compare and
prefer to pursue sustainability via passive fund industry
improve impact performance.
funds that require least governance
oversight and data demands on them. Second, for smart investors, the
identified problems give rise to all
Third, when it comes to avoiding ‘sin’
manner of informational inefficiencies
stocks, it is unclear at what threshold a
in financial markets. As such, they
company is to be classified as ‘bad’. For
are nothing more than concealed
example, many conglomerates have a
opportunities to generate alpha for those
small exposure to defense weapons.
who are progressing fast up the learning
Any ceiling is bound to be arbitrary11.
curve.
3
The rise of
sustainable
investing

c. Partial evidence of success factor in Europe but probably less so in
With ever more money flowing into America or Asia Pacific (case study 3D).
sustainable investing, a big question has Regionally, the environmental aspect
come to the fore: Is sustainability a risk was most evident in asset valuation in
factor? Our interviews identified two the US during 2014–17 but has since
groups: believers and pragmatists. turned negligible12.
i. Believers
Believers argued that it is — but with
one difference. It is a compensated
Case study 3D:

Is sustainability a risk factor?
1
Executive
summary
The rise of sustainability has more data have emerged to century as well as related high-
naturally raised the question: Is confirm their validity. profile corporate disasters — like
it a risk factor — on top of the the recent abrupt bankruptcy
In contrast, being a relatively
traditional ones like value, quality, of Pacific Gas and Electric
new phenomenon, sustainability
low variance, size and momentum? Company.
lacks the database to underpin
The main problem is that most risk its status as a risk factor. But that So, sustainability is gradually
factors are not readily observable. does not make it unimportant. transitioning from being an
So, our portfolio managers are uncompensated risk factor to a
First, there is a concerted
forced to use their proxies. compensated one.
regulatory push towards
2
For example, value factor is sustainability, as investors have Third, our own research shows
associated with cheap stocks. earmarked some US$30 trillion that sustainability is correlated
But the evaluation of ‘cheap’ worldwide towards sustainable with the traditional quality factor
relies on metrics such as investments. It is hard to believe that relies on proxies that are
The rise of ESG
book‑to-price or PE ratios. markets will not take note. broadly similar.
in the hedge
In contrast, as yet, there is no Second, the history of other Even so, we use sustainability fund industry
agreement on the proxy metrics risk factors shows that, once as a factor to deliver — at the
for environment, social and discovered, they remain very least — a more defensive
governance; nor on what weights uncompensated until they have portfolio by taking account
to assign to each of them. been tried and tested by events. of long horizon risks that are
statistically hard to model.
Traditional risk factors have We have been witnessing
gained credence over time as dramatic climate events in this A global French asset manager
3
The rise of
sustainable
investing

Overall, governments and consumers downside protection and much lower Hence, they need evidence that
in Europe have become stronger drawdowns in the pronounced risk‑on/ something has worked well in the
supporters of sustainability, especially risk-off cycles of the last decade. past within a replicable investment
after the 2015 Paris conference, which In other words, sustainability has process, backed by a clear thesis.
attracted widespread attention in the so far already proved a good capital For many of them, sustainability is a
mass media. conservation strategy in periods of nascent phenomenon. They remain to
volatility. be convinced about its upsides. After
Unsurprisingly, five European
all, their own incentives favor consistent
countries have made most progress in ii. Pragmatists
returns year on year.
implementing carbon pricing, according
On the other hand, pragmatists argued
to the latest OECD data. They are
that, for any return driver to be treated as
Switzerland, France, the UK, Italy and
a risk factor, it needs a long performance
Germany. Capital markets have duly
history over multiple cycles in multiple
noted.
1
regions. So far, data on sustainability
Believers cited two other arguments. To have been sparse, covered a short Unless asset
start with, their own analysis shows that time horizon and been beset by various managers act like
sustainability has been a factor overall caveats. This relative sparsity of data
in this decade. But the time period for creates problems for many among the active owners on our Executive
environmental, social and governance current generation of research analysts behalf, sustainable summary
components has varied: they have not and portfolio managers. They are trained
moved in tandem. This argues for a skeptics: Their craft blends data with investing will not meet
more granular approach when assessing personal judgment — cultivated over our expectations.
sustainability as a risk factor. years of chasing financial returns via in-
depth research. For them, investing is a A Hong Kong institutional
Furthermore, together, these three
bet on an unknown future. investor
components have served to provide
2
The rise of ESG
in the hedge
fund industry
3
The rise of
sustainable
investing

3. Developing best practice
The challenges outlined above — namely, data about a company from a diverse set
short-termism, data shortcomings and of sources with information emerging
lack of robust impact evidence — have from direct engagement with it as
only intensified efforts to develop shown in Figure 3.2. Our neglect of
practical solutions. Two areas have been
Notably, some pension plans see socio-environmental
prioritized: active ownership and smarter
implementation, as described separately
engagement as a source of what they issues will shock
call ‘structural capital’: knowledge about
below.
how sustainability is playing out on the future generations,
1
a. Active Ownership 2.0
ground and where alpha opportunities just as our
are likely to arise, as companies improve
It is now widely accepted that their sustainability credentials. After predecessors’
sustainability best practice involves all, it is widely accepted that it is the neglect of slavery
enriching the current infrastructure increase in sustainability score — rather Executive
of data, skills and technology with than absolute levels — that drives shocks us today. summary
shareholder activism that targets real- performance. The aim is to identify
world outcomes at scale. companies, via engagement, with a A French institutional investor
Its principal instrument is direct virtuous trajectory, as opposed to those
engagement with investee companies exposed to controversy.
that seeks to understand the reality on i. Pragmatism presides
the ground and be a change agent in
reshaping it for the better. More than In this context, investors face two choices:
that, it’s about gaining an informational divest or engage.
edge via positive feedback loops in The former is appealingly simple: Cut off
which ideas beget ideas and information the flow of funds to society’s corporate
begets information. Such loops blend ‘villains’ and they will collapse from capital
Figure 3.2 Active ESG
advanced an
2
The rise of ESG
in the hedge
ta al y
da tic
s
fund industry
ig
B
Di
rec
a
arty dat
t
engagement
Company
ird-p
Th
Benefits from
e
Co ur
rporate disclos
Evolving methodology
3
The rise of
sustainable
Portfolio
investing
Source: Neuberger Berman, 2019

starvation and sacrifice the diversification engagement with investee companies —
benefits as a trade-off. often in collaboration with other investors
to exercise maximum leverage. It is based
Instead, there is growing preference for
on the belief that those who are part of the The days when
a pragmatic ‘carrot and stick’ approach.
Selling ‘sin’ stocks, for example, to others
problem can also be part of the solution. stewardship was a
without similar concerns often ends up Engagement can be an intensive box-ticking exercise
with the latter buying shares at less than drawn‑out process. But if all else fails,
the prevailing market price and pocketing then our interviewees have been unafraid using a boilerplate
the profits; while the business models of to exercise the nuclear option: divestment. narrative are gone. We
the villains remain unchanged.
In sum, data provide the breadth of are mandated to be
Besides, when it comes to fossil fuel information, engagement provides the
companies, voting with your feet does depth. Together, they make a powerful agents of change.
1
not work, since most of them now sit on combination as investors and their asset
a large free cash flow, with much less managers progress up the learning curve, A UK pension plan
reliance on capital markets. via collaboration with their peers within
various global networks (case study 3E).
Hence, the more effective channel for
Executive
changing corporate behaviors is direct
summary
Case study 3E:

An owner, not a trader
Engagement is not a ‘once and We are also demanding Standards Board, and Climate
done’ exercise but a long haul. regular reporting on various Action 100+.
It seeks to wean investors off governance aspects such as
The UK Stewardship Code, hailed
a deeply ingrained addiction to board independence, executive
as one of the best globally, is
quarterly numbers. compensation, risk dashboard,
being refined this year.
2
employment practices, gender
Our research shows that, on a
diversity and community-related The previous one asked for
5-year view, companies with poor
activities. policies, procedures and basic
sustainability scores have higher
disclosures from institutional
idiosyncratic risks and higher We vote at AGMs and back that up The rise of ESG
investors. In contrast, the new
beta. We have such companies in with year-round conversations with in the hedge
one requires evidence-based fund industry
our portfolio. top executives, in order to deepen
disclosures from us as to how
our relationships in the targeted
That leaves us with two choices: these policies are actually
companies. In 2019, we engaged
One is to dump them; another implemented on the ground.
with over 800 major companies,
is to encourage these laggards
via face‑to‑face meetings, More notably, it also enjoins our
to up their game. We have done
conference calls and emails. board and C-suite executives
both.
to receive and approve the
We enhance our leverage
Principally, we require them to stewardship reports and put their
by subscribing to the UK
use the reporting framework of money where their mouth is.
Stewardship Code, the Japanese
the Task Force on Climate-related
The new code has shifted
3
Stewardship Code, the US
Financial Disclosures, with a
Forum for Sustainable and the burden of proof to us by
strong focus on carbon footprint
Responsible Investment, the mandating us as the agents of
and the actions taken to reduce it.
Carbon Disclosure Project, change.
the Sustainability Accounting The rise of
A UK pension plan sustainable
investing

ii. Progress is slow Its own research shows that, for
pension plans, sustainability capabilities
In general, though, positive investor
are the most important factor in
action is the exception rather than the
manager selection because the majority Sustainability will have
rule so far, according to a recent report
from the PRI13. Many investors do
of plans do not as yet have the requisite its own version of the
resources. Hence, they tend to rely on
not — as yet — have policy advocacy
their asset managers to make all the key core-satellite model.
functions that could move the needle on
decisions on sustainability.
some of these issues. A UK asset manger
So, asset managers should concentrate
To cynics, therefore, engagement may
on four areas to achieve best practices in
smack of box-ticking. Not so, according
implementation: data, integration, clarity
to a previous paper from the PRI14.
and articulation.
Its research shows that engagement
1
i. Data
can and does promote a constructive
dialogue that facilitates the exchange of Taking them in turn, the ability to
information, sets expectations, seeks measure sustainability impact is central
specific actions and builds trusting to its reporting. As regulators in the
Executive
relationships on the ground. West step up their efforts towards
summary
disclosure guidance in line with the
It promotes new learning in the belief
Task Force on Climate-related Financial
that ideas breed ideas and collaboration
Disclosure recommendations, asset
can devise solutions that meet the
managers should step up pressure for
requirements of both parties.
quality improvements in their data supply
Finally, it navigates internal politics within chains.
both parties that have often promoted
Lack of requisite data remains a
the box-ticking that has long undermined
major impediment — what cannot be
genuine catalysts for change.
measured cannot be reported. The
current situation provides ample scope
b. Smarter implementation
for greenwashing — repurposing of
Templates for improving the funds to give them a green label as a
2
effectiveness of sustainability have marketing gimmick. It also gives rise to
been produced by various national and whitewashing at the investee company
international bodies. end — massaging the data to overstate
One that was widely used among improvements. Both are detrimental to
the sustainability brand. Investors are
The rise of ESG
our interview survey participants in the hedge
was from mallowstreet Insights, a especially keen to know how reliable
sustainability scores are, how they are
fund industry
research center providing pivotal inputs
to pension trustees and their asset changing over time and whether they are
managers15. reflected in the value of assets they hold.
3
The rise of
sustainable
investing

ii. Integration iii. Clarity
The second area is integration. Asset Asset managers should provide
managers need to have an integrated explanations at a more granular level Actions on climate
approach to sustainable investing, on how implementation is done at the
embracing at least one of two levels fund or mandate level. This includes change are no
that are meaningful to investors: seven components: the statement longer equated to
core and specialist (Figure 3.3). Data of its investment policy; its link with
problems dictate pragmatism in the international standards; the data tree-hugging and
core portfolio by including only those sources used; their real-time tracking; back-door socialism.
securities that rate high on both their the definitional templates used;
alpha potential and their sustainability corporate engagement policy; and A Swiss institutional investor
potential in the short and medium term. resources dedicated to engagement
That way, poor data will not undermine practices and their outcomes.
performance, nor will the investment
time horizon — if the portfolio includes
securities currently underpriced on
both criteria.
On the other hand, investors who wish
Investors are especially keen to know
that there is a direct line of sight between
sustainability policy and the practices
that deliver its impact on the ground.
1
Executive
summary
iv. Articulation
to pursue specific sustainable themes
should have access to thematic funds, Asset managers should provide
with longer time horizons and variable better sustainability articulation in the
performance. In other words, the core fixed‑income space. Currently, attention
portfolio should embrace Levels 2 and is centered on equities where data
3 in the Spectrum of Capital (Figure 3.1) availability is less constrained and
and the specialist should cover engagement is a lot easier via proxy
Levels 4–6. Investors are especially voting, attendance at the AGM and
keen to see sustainability investing year-round conversations. In contrast,
evolve along this dual line. fixed-income instruments are perceived
as overly quantitative, relying on interest
rates, inflation, credit quality and
Figure 3.3 How ESG is evolving

liquidity risks.
2
The rise of ESG
in the hedge
Core ESG Core–specialist ESG Specialist ESG fund industry
(e.g. Impact, Thematic, Activist, etc.)
— Seeks stable — Stronger focus

outperformance on ESG
— Controlled ESG — Typically longer

exposure CORE ESG term focus
— Risk controlled, — More variable

diversified performance
Sp
Source: QMA, 2019

e ci a li s t E S G
3
The rise of
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investing

There is a perception that lenders do not As more assets go into sustainability
have the right to engage because their funds, a meritocratic fee structure will
investments come with protections at have to be the norm in the active space.
the expense of voting rights. Hence, In contrast, in passive investing, where
investors are especially keen to know price wars have been fierce lately,
how effective sustainability criteria are stewardship has to be a key point of
currently exercised at two stages: the competition.
initial screening when the investment
Furthermore, alignment is no longer just
is first made and the refinancing stage
about having fees that offer equitable
when a bond matures.
sharing of gain and pain with clients.
Some asset managers already do this It is also about having alignment of
by adopting the approach set out in investment beliefs and time horizons
Figure 1.9 in the Executive summary. over which investment goals can
And the pace is set to accelerate as
more sustainability funds flow into the
fixed income space.
In addition to the above four areas,
institutional investors in our interview
materialize.
The current approach — often
influenced by herding and past
performance — is fraught with ‘wrong
time’ risk and ‘regret’ risk: Investors buy
1
Executive
summary
survey also identified a fifth one where high and sell low, only to lament later on.
the needle needs to shift significantly. Many of them have not been too clear
about beliefs on which their investments
v. Financial and nonfinancial
are based; nor about the time horizon
alignment of interests
over which their goals are expected to
Worldwide, fee compression is the materialize.
norm in the asset industry. It is most
Accordingly, an essential element of
evident in new mandates, while
engagement between asset managers
legacy assets remain locked into the
and their clients is to align beliefs
age-old fixed percentage fee linked
and time horizons when it comes to
to assets under management. While
sustainable investing. Fee structures
encouraging asset gathering, this
2
are moving in the right direction as
asymmetric structure rewards asset
alignment deepens.
managers irrespective of outcomes. It
also generates windfall gains in rising
markets as the icing on the cake.
The rise of ESG
in the hedge
fund industry
To conclude, therefore, the challenges identified in this section are
the teething problems of a better form of investing.
Sustainability is set to morph into the new gold standard, as our
societies seek to overcome the side effects of the turbocharged
capitalism of the past 40 years.
Before then, sustainability is beset by its own challenges. But early
movers see it as no more than a concealed opportunity to create
businesses of enduring value — and profit from them.
Institutional factors are fast driving change. Pragmatism has been
3
all too evident, with concerted action now in progress. There is an
increasing realization that finance must give something back to
society as well as making profit. Early results are encouraging.
Only responsible ownership and savvy implementation will deliver The rise of
sustainability.They will also differentiate the winners from the losers. sustainable
investing

References
1. Edelman: An overwhelming majority of investors expect companies to implement
effective envirownmental, social-impact and governance (ESG) practices,
December 2019.
2. Gunnar Friede, Timo Busch and Alexander Bassen: ESG and financial performance:
aggregated evidence from more than 2000 empirical studies, 2015.
3. PRI: What is the inevitable policy response?, 2019.
4. Carbon tracker initiative: 2 degrees of separation — transition risk for oil and gas in
a low carbon world, 2017.
5. Barron’s: ESG investing suffers a setback in California, 2018.
6. PRI: Responsible investment due diligence questionnaire for hedge funds, 2019.
1
Executive
summary
7. Preqin: Will hedge funds ever truly embrace ESG principles? 2019.
8. Impact Management Project: The rise of impact: five steps towards an inclusive
and sustainable economy, 2017.
9. Aviva investors: Rights and responsibility — Our global responsible investment
approach, annual review 2018.
10. The global sustainable investment alliance: 2018 global sustainable investment
review.
11. Man group: ESG integration — No silver bullet, June 2019.
12. The Financial Times: Active investing and ESG are a perfect match, November 12,
2
2019.
13. PRI: Active ownership 2.0: The evolution stewardship urgently needs,
November 2019.
14. PRI: How ESG engagement creates value for investors and companies, 2018. The rise of ESG
in the hedge
15. mallowstreet Insights: ESG report, 2019. fund industry
3
The rise of
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investing

Contacts
Regional contacts:
Andrew Weir Bonn Liu David Neuenhaus
Global Head of Head of Asset Management Global Leader
Asset Management ASPAC Region Asset Management Tax
E: andrew.weir@kpmg.com E: bonn.liu@kpmg.com E: dneuenhaus@kpmg.com
Greg Williams Tomas Otterström John Cho
Head of Asset Management Global Leader
1
Global Leader
North America Region Sustainable Finance Services Institutional Investors Group
E: gregorylwilliams@kpmg.com E: tomas.otterstrom@kpmg.fi E: johncho@kpmg.ca
Darina Barrett Jon Mills
Head of Asset Management Global Leader Executive
EMEA Region Asset Management Audit summary
E: darina.barrett@kpmg.ie E: jon.mills@kpmg.co.uk
Linda Elkins Vivian Chui David Capocci

KPMG Australia KPMG China KPMG in Luxembourg
E: lindaelkins@kpmg.com.au E: vivian.chui@kpmg.com E: david.capocci@kpmg.lu
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KPMG in the Bahamas KPMG in Denmark KPMG in the Netherlands
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2
Mahesh Balasubramanian Gerard Gaultry Andrew Thompson
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KPMG in Bermuda KPMG in Germany KPMG in Spain The rise of ESG
E: garypickering@kpmg.bm E: hvolckens@kpmg.com E: jmunozneira@kpmg.es in the hedge
fund industry
Lino Junior Frank Gannon Markus Schunk
KPMG in Brazil KPMG in Ireland KPMG in Switzerland
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3
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KPMG in the Channel Islands KPMG in Japan
E: stevenhunt@kpmg.com E: ryuichi.murasawa@jp.kpmg.com
The rise of
sustainable
investing

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Publication name: Sustainable investing: fast forwarding its evolution
Publication number: 136641-G
Publication date: February 2020

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Sustainable Investing (KPMG)

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Sustainable

Anthony Cowell Amin Rajan

The rise of ESG

i Sustainable investing: fast-forwarding its evolution

Hong Kong (SAR), China

ii Sustainable investing: fast forwarding its evolution

The rise of ESG in the hedge

iii Sustainable investing: fast-forwarding its evolution

1 Sustainable investing: fast-forwarding its evolution

2 Sustainable investing: fast-forwarding its evolution

85% 55% 15% 63%

Institutional investors’ survey — Key data points

44% 34% 75% 49%

Early adopters’ narrative — Key messages

Markets are slow to A new infrastructure Active Ownership Savvy

3 Sustainable investing: fast-forwarding its evolution

1 Institutional investors are driving the ESG agenda

Having established a good track record Thus, the traditional risk–return

Institutional investors 85%

Institutional consultants 39%

Internal stakeholders 30%

HNW investors 19%

Industry trade bodies 6%

Source: KPMG–CAIA–AIMA–CREATE Survey 2020

4 Sustainable investing: fast-forwarding its evolution

Figure 1.2 How are ESG factors being used?

Source: KPMG–CAIA–AIMA–CREATE Survey 2020

5 Sustainable investing: fast-forwarding

Figure 1.3 Where is your organization currently in the ESG-implementation life-cycle?

Source: KPMG–CAIA–AIMA–CREATE Survey 2020

6 Sustainable investing: fast-forwarding its evolution

Source: KPMG–CAIA–AIMA–CREATE Survey 2020

7 Sustainable investing: fast-forwarding its evolution

8 Sustainable investing: fast-forwarding its evolution

Hedge fund managers' survey Institutional investors' survey

Source: KPMG–CAIA–AIMA–CREATE Survey 2020

9 Sustainable investing: fast-forwarding its evolution

Best practice in the ESG space is a a. Guard against greenwashing

The rise of ESG

10 Sustainable investing: fast-forwarding its evolution

11 Sustainable investing: fast-forwarding its evolution

To conclude this subsection, therefore, the overriding message

12 Sustainable investing: fast-forwarding its evolution

Sustainable investing is about creating businesses of

13 Sustainable investing: fast-forwarding its evolution

Figure 1.8 Creating sustainability DNA in business models

Source: KPMG–CAIA–AIMA–CREATE Interview Survey 2020

14 Sustainable investing: fast-forwarding its evolution

15 Sustainable investing: fast-forwarding its evolution

16 Sustainable investing: fast-forwarding its evolution

Figure 1.9 Engagement that goes beyond the hype of sustainability

Source: KPMG–CAIA–AIMA–CREATE Survey 2020

17 Sustainable investing: fast-forwarding its evolution

To conclude, therefore, early adopters see sustainable investing as

The rise of ESG

18 Sustainable investing: fast-forwarding its evolution

19 Sustainable investing: fast-forwarding its evolution

Information in this section is based on fund managers can offer ESG-oriented

20 Sustainable investing: fast-forwarding its evolution

It is clear that there is growing interest ‘no change‘ in interest. Not a single

Source: KPMG–CAIA–AIMA–CREATE Survey 2020

21 Sustainable investing: fast-forwarding its evolution

Hedge fund managers' survey

Growing institutional investor and/or consultant demand

Figure 1.3 Where is your organization currently in the ESG-implementation life-cycle?

c. Other challenges slowing These costs can easily pile up and