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How Do ESG Hedge Funds Stack Up Against Their Non-ESG Counterparts?

The emergence of environmental, social and governance issues has shaken up the world of investments, including hedge funds. Investors have shown an increasing interest in ESG hedge funds, as demonstrated by a survey conducted by Barclays earlier this year.

The survey found that 22% of investors prioritize ESG when deciding which hedge funds to allocate to. That’s more than double the reading from the same survey a year ago. Barclays also found that investors with more assets under management tend to prioritize ESG products when choosing hedge funds.

Studies on whether or not ESG helps or hinders returns have varied almost as much as opinions on the subject have in recent years, but now there’s a new study to add to the pile. Eurekahedge found mixed results for ESG fund performance, although they generated alpha against their benchmark most of the time.

ESG hedge funds underperform non-ESG funds

On the surface, it looks like ESG hedge funds underperform their non-ESG counterparts, but not by much. The Eurekahedge ESG Fund Index was up 10.31% for the first half of the year, coming in just slightly behind the Eurekahedge Equity ex-ESG Fund Index, which returned 10.72% for the first six months. The ESG index underperformed its benchmark, the MSCI ACWI ESG Leaders Index, which returned 12.07% for the first half of the year.

However, looking back to 2007, non-ESG hedge funds stayed ahead of ESG funds, which outperformed the benchmark. Eurekahedge said the ESG fund managers it tracks generated an annualized return of 5.44% since 2007, compared to the MSCI ACWI ESG Leaders Index, which returned 4.94% per annum. Non-ESG funds using the long/ short equity strategy returned 6.09% per annum since 2007.

ESG funds outperform in longer time horizons

However, looking at the data from a different perspective brings different results. ESG funds outperformed non-ESG funds based on annualized returns over the last three-, five- and 10-year periods. ESG hedge funds returned 10.59% over the last three years, 10.03% over the last five years and 7.5% over the last 10 years.

ESG hedge funds also had lower annualized volatilities, so they outperformed their non-ESG counterparts and the underlying stock market in risk-adjusted returns. ESG funds’ Sharpe ratio was higher than that of non-ESG funds at 0.97 over three years, 1.15 over five years and 0.91 over 10 years.

Alpha comparison in ESG vs. non-ESG funds

Eurekahedge also looked at the 12-month rolling alpha of ESG funds against the benchmark MSCI ACWI ESG Leaders Index. It found that ESG funds generated alpha against their benchmark approximately 70% of the time, especially between August 2012 through August 2018. During that timeframe, ESG hedge funds delivered consistently positive alpha against the benchmark.

Eurekahedge also compared the 12-month rolling alpha of ESG hedge funds versus non-ESG funds, and it found something very interesting. In 2008, ESG funds were lagging equity non-ESG funds with a -1% alpha versus non-ESG funds’ 0.52% alpha. ESG funds stayed consistently behind non-ESG funds in 12-month rolling alpha for the year, but things started to change in 2009.

In that year, non-ESG funds started to lag ESG funds in terms of 12-month rolling alpha, although it wasn’t a permanent change. In 2011, ESG funds started to lag non-ESG funds in alpha again for about a year. However, there isn’t a big difference in alpha between ESG and non-ESG hedge funds, so some investors may feel that it makes sense to require their hedge fund allocations to target ESG investments.

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