Are ESG Markets Still as Important as They Once Were for Hedge Funds?

The 2020s have so far been a tumultuous decade for environmental, social, and governance (ESG) investing. While sustainable investing took center stage during the post-pandemic recovery, hedge funds appear to have cooled on ESG initiatives of late. Has conscious investing lost its shine? Or will we see a comeback gather steam? 

According to a Barclays Strategic Consulting team survey in 2021, 22% of respondents suggested that they’re placing a ‘high priority’ on ESG in their hedge fund allocation decisions–doubling in size over the year prior. 

Additionally, 40% of investors in Europe, the Middle East, and Africa claimed to be looking to integrate ESG into their hedge fund holdings. 

While the COVID-19 pandemic appeared to intensify investor interest in ESG initiatives, there’s evidence that appetite for environmental, social, and governance was growing throughout the landscape before the health crisis, with one 2019 report suggesting that 65% of hedge fund investors believed ESG investing will become more important in the next five years. 

At the same time, 40% of hedge fund managers in the same survey confirmed that they were practicing responsible investment. 

ESG’s Sentiment Reversal

While optimism was high for ESG investing, the years that followed saw more hedge funds take up short positions in various stocks. 

This sentiment reversal came as an initial flurry of interest in stocks with reported environmental, social, and governance credentials bloated their values and left them sitting in ‘overbought’ territory. 

Additionally, it became clear that some firms had been mounting bogus green claims in a bid to attract more investor interest without having sufficient fundamentals in place. 

In 2023, Larry Fink, CEO at BlackRock, announced that he would no longer be using the term ‘ESG’ in a trend that appears to be sweeping through the institutional landscape. 

According to RBC Capital Markets data, 56% of sustainable-fund debuts have been re-labeled as ‘thematic’ as opposed to ‘ESG’, with some key industry players suggesting that the term has become too politicized of late. 

However, leaders in the sustainability sector have been quick to dismiss any anti-ESG movements as anything more than hot air. "There's a lot of attention and noise but nobody supports this stuff," explained Heidi Welsh, executive director at the Sustainable Investments Institute.

Navigating the Return of Trump

With the prospect of a Donald Trump-led Republican presidency becoming a highly plausible prospect in 2025, it’s certain that a change of president will carry major ramifications over ESG investing, or will it? 

Crucially, Trump has already expressed fierce opposition to ESG principles in workplace retirement plans and his withdrawal from the Paris Agreement underlines the Republican nominee’s strong pro-fossil fuel stance. 

There’s no doubt that a Trump victory will prompt hedge funds to think twice about exposure to ESG investments, but the underlying statistics from the previous Trump presidency between 2016 and 2020 could be seen as deceptively positive. 

During Trump’s time in office, data shows a 110% growth occurred in US solar panel production, a doubling of US installed wind capacity from 4.6% to 9%, and an 89% decline in the cost of battery pack production which helped to pave the way for growth in the solar and wind sector. 

While it should be added that these ESG tailwinds occurred despite, rather than because of, Trump’s presidency, it illustrates the growing level of technology within the ESG landscape and its power to facilitate exponential growth. 

“The green transition will plough ahead from November 2024, whether we have the IRA or not, whether we have Trump in the Oval Office or not,” explained Rahul Bhushan, managing director at ARK Europe.

Whether this means that hedge funds will find more opportunities in the United States or throughout global markets remains to be seen. 

Outside of the US, China recently announced new sustainability reporting guidelines that require companies to begin reporting by 2026, making the use of more globally-focused trading institutions with direct market access to dozens of international exchanges more advantageous for ESG-focused institutions moving forward. 

Readying for an ESG Revival?

Following widespread ESG short positions taken up by hedge funds in 2023, it appears that many institutions are readying for an environmental, social, and governance revival this year, according to research at UBS Group AG. 

“Hedge funds have continued to step up sustainability integration into investment strategies,” explained a note published by the Global Wealth Management arm of UBS in January 2024. 

The note also acknowledged “a subset pursuing dedicated sustainable investment deployment via equity long/short and credit strategies, mostly within thematic equities and green, social and sustainable bonds.”

This outlook is supported by a recent survey conducted by Ortec Finance, which suggests that institutions are readying to increase their allocations to green bonds and specialist climate-focused funds over the next two years. 

With 62% of survey respondents claiming that they’re intent on boosting allocations to green bonds, and 75% have planned to increase investments in specialist climate-focused funds, it’s becoming clear that the sentiment reversal towards ESG investing may have been short-lived. 

Where will ESG Sentiment Go? 

The cooling market conditions for institutional ESG investing last year may have been the result of mounting economic headwinds impacting the decisions of hedge funds. As rising inflation and the distraction of a generative AI boom took center stage, it can be easy for sustainability-focused options to fall down the priority list for institutions. 

One key case for the relevance of ESG investing stems from an intensifying climate emergency. With PwC data suggesting that almost one-third of CFOs are looking into the potential impacts of climate change scenarios on financial outcomes in 2023, the topic of sustainability will become increasingly important throughout the institutional landscape. 

While political factors, bogus claims, and an uneven post-pandemic recovery have caused some market volatility for ESG stocks in recent years, climate change remains the specter at the feast as far as hedge funds are concerned. With the topic of the environment at the forefront of minds, it’s likely that appetite for ESG markets will only grow over time. 

This article is from an unpaid external contributor. It does not represent Benzinga's reporting and has not been edited for content or accuracy.