Investment Insights

Jeff Benjamin

Ethical investments could give hedge funds an edge

Sep 9, 2012 @ 12:01 am

By Jeff Benjamin

Hedge fund managers are usually thought of as cold, hard capitalists and not the types who are interested in socially conscious investing.

But if they are looking for investment money, they may want to consider strategies that offer social and environmental screens.

“There's a big opportunity for hedge funds to create these [socially conscious] share classes, and there's a lot of demand from the client side,” said Heather Jones, senior consultant with Cambridge Associates LLC, a global research and investment advisory firm for institutional investors.

Although Cambridge doesn't manage any assets, it is uniquely positioned between big-money investors and a wide variety of sophisticated products and strategies.

Having that advantage, Cambridge has homed in on the dearth of socially conscious or mission-related investment strategies in the alternative-investments arena.

According to Cambridge's analysis, institutional investors across the board are allocating as much as 20% of their portfolios to investment strategies that screen for various social and ethical causes.

But the hedge fund industry, Ms. Jones said, generally has ignored the opportunity.

“The money is definitely being channeled to other asset classes, because these institutional investors are finding other areas to invest in [for social and ethical causes] beyond hedge funds,” she said. “These investors are not going to hold that 20% in cash just because they can't find a socially conscious strategy in the hedge fund space.”

LIGHT DEMAND

More than $70 billion is held in 198 mutual funds applying some kind of ethical screen, according to Morningstar Inc. Five years ago, the category held $63 billion and 183 funds.

That is hardly a screaming demand.

However, Cambridge and others are anticipating a trend toward a more socially and environmentally conscious investor base.

Last week, First Affirmative Financial Network, as a preview of next month's 2012 Socially Responsible Investing Conference, released the results of a survey showing “wider institutional-investor acceptance” of these strategies, and calling 2013 “the year of impact investing.”

The survey of more than 200 professionals who manage assets in the category found that 62% expect acceptance of socially and ethically based strategies among institutional investors to increase over the next 12 months.

Keys to attracting institutional investors include having phrases such as “making a difference” in a fund's mission statement, and putting a greater emphasis on community investing.

“After the financial crisis, more and more investors have hungered for a way to have a more direct connection between their money and the impact it is having on the world,” First Affirmative president Steven Schueth said.

It sounds logical, but not everyone is sold on the idea that investors want their hedge funds to start screening out society's sinners.

“Hedge fund investors tend to be almost exclusively interested in return on investments,” said George Schwartz, president and chief executive of Schwartz Investment Counsel Inc., a $700 million asset management firm that screens out companies deemed to violate traditional Catholic values.

Until 2008, he also managed $50 million in two hedge funds that included the same screens as the mutual funds. The hedge funds were closed because of a lack of investor interest.

"GOOD RESULTS'

“Some investors look to our mutual funds because of our moral screens, but hedge fund investors don't usually think that way. They just want good results, right now,” Mr. Schwartz said. “It's not hard to put screens on a hedge fund, but I suspect hedge funds that go that route will be met with mixed reviews, because they're dealing with a different breed of investor that is not particularly philosophically driven.”

Phil Goldstein, a hedge fund manager at Bulldog Investors General Partnership, said that institutions, rather than individuals, would be more likely to request screens for socially responsible investments.

“Most of our investors are high-net-worth types, and they only care about returns,” he said. “But institutions might want to try and invest in more socially acceptable ways, because it's not their money.”

Mr. Goldstein said he wasn't sold on the strategy.

“I wouldn't feel comfortable with the constraints, and as to whether or not it could be successful, I just don't know,” he said. “It depends on how the screens are set up. You can become so politically correct that there's nothing to invest in. “

While one can certainly debate the need for social and ethical screens in the hedge fund space, there is nothing stopping more hedge funds from testing the waters.

“Hedge funds are going into every other area, why not this?” said Thomas Meyer, chief executive of Meyer Capital Group.

THE SHORT SIDE

It is even possible that hedge funds could go where most mutual funds can't, which is to the short side.

“I think it's an intriguing opportunity to make money by shorting bad companies,” Mr. Schueth said.

Questions, observations, stock tips? E-mail Jeff Benjamin at jbenjamin@investmentnews.com. Twitter: @jeff_benjamin

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