Hedge funds ignore value opportunities in the ESG narrative constellation

Published: Dec 10th, 2019

Updated: Jan 23rd, 2023

However embedded or impenetrable a specific narrative seems to be, understanding its structure means its trajectory can be changed. Hedge fund managers and their investor relations teams must analyse and understand how the narratives surrounding their businesses and investments are constructed, how they mutate and how they can enter them most productively. If they don’t, they will miss the opportunities those narratives hold for communicating competitive advantage and demonstrating their real value.

Responsible investing and ESG is a narrative in which most asset managers now find themselves. And many of them struggle blindly to position their firms within it, missing opportunities to signal their value. They are forced to react to the latest news rather than work with media productively, and thus leave so much value untapped and unseen. Particularly for hedge funds, the ESG narrative contains significant potential. It can be used both to differentiate themselves as individual firms and to shift wider embedded and inaccurate preconceptions around short selling and activist investing.

Hedge funds should be developing communications strategies that explain why they are actually very well-equipped to deal with ESG investing, why the contents of their unique investing tool-box, like short selling or, for some firms, activism, should be acknowledged by allocators and why, within this narrative, they are more relevant than anyone else who manages money today.

This is because they can take action beyond the traditional ‘screening-out’ of companies who perform poorly on ESG factors. Hedge funds can take active short positions on businesses which are failing to meet ESG standards. Activist strategies can also call for and affect management change at specific companies for the same purpose. These are very powerful tools that traditional investors simply do not have.

As an example, it’s not hard to argue that fossil fuel companies will underperform renewables in the long-run. As such, a sensible approach to constructing a portfolio might include not merely being long renewables, but also being short fossil fuel stocks. Of course that’s a gross oversimplification. It doesn’t address the true breadth and depth of short selling activity across markets, nor its use in various strategies and portfolios. But it’s an intuitive illustration of how adding the short component to a portfolio in the ESG context could improve returns and might also raise pressure on companies that are not meeting ESG standards.

The same can be said of activist fund managers calling for better corporate disclosures or action on climate change. One recent example is Sir Christopher Hohn, founder of TCI Fund Management, who has sent letters to large international companies such as Google and Airbus, warning that he will take action against companies that do not do enough to tackle the climate emergency.

These last points also offer the hedge fund industry as a whole the potential to change how short selling and activism are perceived. It is unexpected, for example, that it has taken until now for activist funds to use their unique platform as financial, investing and corporate experts. And it is even more surprising they have not identified the opportunities for differentiation and powerful communication this narrative affords them.

But some investors are still wary. As such, some hedge fund firms may worry it’s a step too far for allocators in the ESG space. Pension funds already have to go to their boards and explain why they are invested in hedge funds. They are already on the backfoot. Indeed, if they have to explain that a fund is short a stock rather than just excluding it, things may become even harder.

Communications strategies must therefore articulate the potential of short selling and activism in the ESG context. This can be achieved by signalling their value as tools for positive change through the ESG narrative, and that’s where an understanding of its construction is so important. Possessed of a clear map of the ESG narrative, hedge fund firms will be much better able to shift its constituent topics and even insert new ones into that theme constellation, offering both awareness but, also, the opportunity to address finally the misunderstandings around what they actually do.

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