Responsible Hedge Funds

Can hedge funds be responsible?

The study Responsible Hedge Funds by Hao Liang, Lin Sun, and Melvyn Teo examines the performance and behaviour of hedge funds that endorse the UN PRI.

They use event study methodology and regression analysis to measure abnormal returns and identify factors associated with underperformance. Their conclusions include:

• Hedge funds that endorse the PRI underperform other hedge funds by 2.45% annually after adjusting for risk factors.
• Despite underperformance, PRI signatory hedge funds attract greater investor flows, accumulate more assets, and generate higher fee revenues.
• The underperformance of signatory hedge funds is driven by those with low ESG scores, according to Refinitiv data.
• The underperformance is also more significant in hedge funds with poor incentive alignment, suggesting some of them may endorse PRI to attract investor flows without genuinely integrating ESG factors into their investment processes.
• Regulatory reforms that enhance stewardship improve the ESG exposure and relative performance of PRI signatory funds.
• While 65% of hedge fund investors believe ESG will become more important, only 37% of hedge fund managers share this view.

These results suggest investors are willing to accept lower returns in exchange for perceived responsible investment practices and that external pressures can mitigate agency problems and enhance the effectiveness of responsible investment practices.

The study highlights the need for stronger regulatory frameworks and stewardship codes to ensure hedge funds genuinely integrate ESG factors into their investment processes.

Additionally, investors should be cautious of potential greenwashing by hedge funds that endorse PRI and scrutinise their actual ESG practices and performance.