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Why is there an alternative ESG fund drought?

Some fund managers fear that market inefficiencies and transparency troubles make the application of ESG criteria to alternative assets difficult

Why is there an alternative ESG fund drought?

Environmental, social and governance (ESG) criteria are now being integrated in investments across the board, but for alternative assets, some fund selectors argue there is a shortage of opportunities due to transparency issues and market inefficiencies.

Gary Waite (below), a portfolio manager at Walker Crips, said there is a difficulty in proving that existing ESG funds are wholly ethical.

He said: ‘I think there is a shortage. It’s hard if you’re an alternative fund to get that granular information to satisfy ethical investors. That standard of assets is difficult to come by because it’s hard to prove it’s ethical. The issue with many funds is they wouldn’t pass standard normal investment process metrics related to size and liquidity.’

Biggest challenges

In a recent Citywire Selector article, Carole Tanguy-Lepy (below), a fund selector at Edmond de Rothschild, highlighted integrating ESG criteria in alternative strategies as one of the biggest challenges facing sustainable investors.

She said: ‘In essence, long/short strategies or intensive users of derivatives are not really compatible with sustainable investments, but maybe we have to evolve on that.’

Donald Pepper, managing director at Trium Capital, agrees with Waite that there is a shortage, pointing out that markets are struggling to adapt to ever-changing ESG criteria adopted by companies.

He said: ‘There is a shortage. Hedge fund managers have historically not been willing to provide the kind of transparency investors expect. They believe the old myth that if you make it ESG you’ll sacrifice performance.’

However, this does not mean there are no alternative funds to invest in that employ an ESG screen.

Pepper’s company, for example, runs the Trium Morphic fund which shorts unethical stocks using a fundamental stock-picking approach. It goes long on companies that are making material ESG improvements.

‘At the core of the Trium Morphic investment process is the belief that markets are unable to adapt to price changes in the real world. This, the team believes, extends to changes in ESG factors for individual companies,’ he said.

‘There’s no reason why an ESG-compliant approach won’t give sufficient opportunities.’

Another company, Fulcrum Asset Management, has a framework for assessing alternative assets through an ESG lens.

What to look for

Mark Horne, the firm’s director of alternative strategies, explained: ‘We look at the actual investment opportunity and then we look at the ways you can implement that through external managers in the form of a veto, for example.

‘We look at four key things: expected return, diversity themes, such as opportunities/decision making profiles of the manager or team, sustainability and terms and conditions relating to the investment.’

He highlighted clean energy as a theme that the team can get enough detail on to meet the thematic criteria of its Diversified Liquid Alternative fund.

He said: ‘Our Diversified Liquid Alternative fund exposes investors to under-represented investments, that’s alternative investments to us. We have a basket of securities under the banner of clean energy. Companies we’ve chosen in the past include Verbund, an Austrian firm investing in hydro power.

‘If you look at core equities and bonds then energy would be a good illustration of something that’s under-represented. The investment case for clean energy is exciting, there’s lots of ways to capture that alternative energy.’

One company that has stood out for Horne is Sky Harbor, which applies ESG criteria to alternative asset selection.

The business, which is majority-owned and run by women, specialises in funds of US high yield bonds and leveraged loans for global institutional investors.

‘If you do traditional bond research you’d look at profit and outgoings. Over time, people add ESG to that analysis. Some asset managers, like those at Sky Harbor, do that thoughtfully.’

He notes that the team at Sky Harbor also removed traditional energy companies from its portfolios, instead focusing on renewables.

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