PRI DDQ Converting Hedge Funds, One Step at a Time

    Stockholm (NordSIP) – The PRI association held an event today (Tuesday, June 20) in Stockholm to promote the launch of a dedicated ESG due diligence questionnaire (DDQ) for hedge funds. PRI – in collaboration with the Alternative Investment Management Association (AIMA) and the Hedge Fund Standards Board (HFSB) – has developed this DDQ to improve transparency around ESG factors in the decision-making process, reduce the reporting burden, and enhance consistency and comparability of data across the industry.

    The program of the event today included two different panels with prominent actors in the field, who talked about the impact they believe the questionnaire will have on the industry. The panellists also unanimously emphasized the need for increased dialogue and collaboration between fund managers and asset owners on the theme of responsible investing. Several times, the question of fiduciary duty in the context of responsible investing came up as well.

    The first panel was focused on the question “State of the market – what asset owners are doing to integrate ESG in their portfolios?“ and was composed of Rebecka Elkert, Responsible Investment Specialist – SEB Life & Pension, Jarkko Matilainen, Director of Hedge Funds – Varma Mutual Pension Insurance Company, and Steven Desmyter, Chair, Responsible Investment Committee – Man Group. Bloomberg journalist Love Liman moderated the discussion.

    Multiple topics where covered and the panellists offered interesting insights, especially about the relationship between asset owners and hedge funds pertaining to ESG integration. Asset owners tend to present their own view of ESG integration to fund managers and make demands in accordance with their own policies. The issue all participants agreed on is often that the demands of asset owners can be very different and sometimes even opposed to each other.

    An example mentioned by Desmyter is the conflict between exclusion requests by some European pension funds and U.S. investors’ interpretation of fiduciary duty. A European investor may ask a manager to exclude, say, the tobacco industry, but a US endowment will come back and argue that this reduces their investment universe, hence limiting their opportunities to generate return. They will ask that managers stick to their fund’s guidelines, or they will not fulfil their fiduciary duty.

    In addition, Desmyter highlighted another aspect of fiduciary duty when it comes to meeting different demands from different investors: “We are regulated by the FCA and we need to treat all investors equally. We can’t make exceptions even if the demands come from the fifth largest asset owner in the world.” Some fund managers circumvent the issue by setting up managed accounts, he argues, and it is great for those asset owners who can place larger tickets with one strategy. This means that smaller investors are then at a disadvantage, even if it does not constitute a breach of fiduciary duty.

    An interesting solution that Man has implemented, Desmyter revealed, is to ask the independent fund directors (- those nominated by the fund, which are independent from the manager and represent the interest of the fund’s investors) to approve exclusions that were requested by asset owners in some cases. In practice, they were asked to determine whether the reduction of the investable universe would materially impact returns, and to take a position on that on behalf of all the fund’s investors. On the same topic, Eric Cockshutt, participant in the second panel, went further by asking the question: “Is fiduciary duty only about the bottom line profit or is it more than that?”

    Another issue brought up by Matilainen is that the added complexity of ESG requirements can be hard to bear for hedge fund managers. “Managers are puzzled if asset owners ask too many things. It represents huge amounts of work,” he says. With initiatives such as the new DDQ, the demands may become more uniform and simplify the work for managers. Desmyter observed that “most people on the asset management side are very receptive to ESG principles. It is very hard to argue that you are against them.” However, for regulated companies in today’s environment, a compliance office may be very reluctant to sign anything that will engage the company’s responsibility.

    As an example, Desmyter remembers an asset owner asking the fund to co-sign their code of ethics. “It pretty much described how to be a good person and no one will argue that they don’t want to be a good person.” But even if that’s true, for the head of compliance it was a big hurdle to sign the code. There are so many different parts in the regulation and compliance needs to be able to uphold all of them at the same time.

    A somewhat controversial point was brought up by Liman, the moderator: “Do you think that the PRI DDQ will be really effective in advancing ESG or will it be more of a box ticking exercise?” Very candidly, Desmyter admitted that he believes that it will rather be the latter at first. Simply put, the name of the game in the hedge fund industry is to raise assets. When hedge funds approach asset owners, it might go like this: “Please just invest. What do you want me to do?” Desmyter comments: “Don’t be naive. Is it box ticking? Yes, but then you get them hooked.”

    On the same topic, Elkert refers to her experience as part of the committee that prepared the new DDQ. “I agree with that,” she says, “It’s a start. At the beginning we were very ambitious with the PRI. We wanted to create different versions for each hedge fund strategy. But we realised that we needed to come up with something that we could start with. Still, the discussion and the work within PRI will continue. It’s an evolution, not a revolution.”

    The topic of the second panel was “Hedge Funds & ESG – Responsible Investing”. The Panellists were Ann-Sofie Odenberg, Head of Responsible Investment at Brummer & Partners, Ulrika Hasselgren, Global Head of Responsible Investment Strategy at ISS, Laura Merlini, Managing Director, EMEA at CAIA, and Eric Cockshutt, Director, Head of RFP & Responsible Investment Coordinator at Unigestion. One of the subjects panellists discussed was the need to tailor ESG requirements to different hedge fund strategies.

    Clearly, for Odenberg, implementing ESG at Brummer & Partners is about juggling between different investment philosophies and strategies spanning from long/short equity to CTAs. From the perspective of ISS, Hasselgren commented, it is about providing the right data and analytics to the different asset managers, whether fund or asset owners, where each one can then use them and integrate their conclusions in their own way. As an example, Odenberg mentions that at Brummer, ISS Ethix data is used for screenings, but flagged companies are not automatically excluded from their managers’ universes. The holdings are flagged and the managers are ultimately held accountable for their own decision when they decide to remain invested. Odenberg mentioned the example where a fund may be invested in a flagged company as the company is undergoing a turnaround.

    According to Cockshutt, hedge funds are in their infancy when it comes to ESG integration. “If you want to grow quickly, model yourself on your big brother and try to be like him,” he recommends. “Good practices out there are not fully being reaped.” One track is, for example, to get carbon data. It is still an imperfect science, he argues. Cockshutt suggests we compare the use of carbon footprint measurement to the way we would go on a scale if we wanted to start a diet. Even if the scale is 500 grams off, what we should do is compare whether we are losing weight between two measurements, not that the absolute number is inexact. Other steps he mentions are signing the Montreal pledge, and “putting your proxy where your mouth is.” At Unigestion, they use ISS for proxy voting and they write to management on different issues – when they will vote against certain points, for example. “All of these measures can be implemented quite quickly,” he concludes.

    For Merlini, Cockshutt’s analogy is appropriate, but she argued against the use of the scale as a first measure. “When you start a diet, using a scale directly is a bit harsh. What you want is to foster an environment that will make it possible for you to improve your heath.” Merlini works within CAIA, on the educational part of the industry.

    Among a good series of digressions and analogies, Cockshutt gave us the story of his grandmother’s good china. When he got married, Cockshutt received his grandmother’s china with the explicit recommendation to use it, and not only once a year on an important occasion. “I don’t care if you put it in the dishwasher,” she reportedly said. This should apply to the PRI DDQ, Cockshutt concludes: “It is worth spending a couple of days finding out how to answer the 14 PRI questions because these are questions you will have to answer quite often. Use the good china.”


    Picture (c) NordSIP

    Aline Reichenberg Gustafsson, CFA
    Aline Reichenberg Gustafsson, CFA
    Aline Reichenberg Gustafsson, CFA is Editor-in-Chief for NordSIP and Managing Director for Big Green Tree Media. She has 18 years of experience in the asset management industry in Stockholm, London and Geneva, including as a long/short equity hedge fund portfolio manager, and buy-side analyst, but also as CFO and COO in several asset management firms. Aline holds an MBA from Harvard Business School and a License in Economic Sciences from the University of Geneva.

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