Arguably two of the most significant recent investment trends for institutional investors are the increased interest in responsible/sustainable investments and the growth of alternative asset classes.
In fact, the term ‘alternative assets’ is rather confusing in today’s environment, particularly when you consider that alternative assets have become a core element in institutional portfolios.
The reasons driving these trends are clear:
– As the majority of the world’s nations have signed on to the UN Sustainable Development Goals and the Paris climate agreement (COP-21), the pension and investment community has a mandate – and desire – do its part. This has led to an increased focus to fully understand the Environmental, Social and Governance (ESG) implications of investments.
– In a low interest rate world with high equity valuations, it is increasingly difficult to achieve attractive returns in traditional investments. This, in combination with an increasing correlation between the returns of various asset classes, has resulted in investors looking for new investment possibilities. In their quest for increased returns and better diversification, institutions are allocating substantial percentages of their portfolios into alternative asset classes such as property, infrastructure, hedge funds, private equity and private debt.
Institutional investors are also increasingly looking at the intersection of these two trends: incorporating ESG in alternative investing.
From a joint study LGT Capital Partners conducted with Mercer in 2015, it became clear that the majority (57%) of global asset owners (largely pension funds) were already convinced that incorporating ESG considerations in alternatives leads to more attractive risk-adjusted returns and only 9% believed it to be negative.
It was also clear that ESG analysis had moved beyond ethical concerns, but rather found its place as a risk management and a tool for generating alpha.
This view is now increasingly embraced by those who manage alternative investment portfolios. A recent study we carried out found that there has been steady progress among both private equity and hedge fund managers in incorporating ESG considerations.
Fifty-five percent of private equity managers now have ESG practices in place that we consider to be excellent or good, which is double that of such managers in 2014. Both small and large managers have made progress on ESG, and strong ESG integration practices are becoming the norm in Europe, with Asia rapidly catching up. In the US the picture is a bit different.
After some years of progress, we recently have observed a stagnation of ESG progress. This is, in part, a reflection of the fact that US managers have not historically been under much pressure to adopt ESG standards, as US asset owners have not pushed for ESG adoption in the same way as their European peers have.
Our discussions with our own managers suggest that this is changing, as US institutional investor appear to be taking a greater interest in the topic.
Meanwhile, there has been a continued improvement in the hedge fund space, with the majority of hedge fund managers making some efforts on ESG (78%); an increase of 6% since last year.
Overall, we clearly see a positive trend in ESG incorporation in alternatives.
The UN-supported organisation Principles for Responsible Investment (PRI) has played an important role in making this happen by publishing various influential documents and trying to standardise ESG due diligence procedures for hedge fund and private equity managers. It is only with widespread collaboration like this that ESG integration will continue its rapid expansion in absolutely all areas of investment.
At LGT Capital Partners, we are committed to turning ESG aspirations into reality, and I myself am running as a candidate for a PRI board position to help drive this change.
We ask all asset owners, alternative investment firms, advisors and regulators to help in realizing this ambition of true sustainability in the alternative investment space.
Tycho Sneyers (pictured) is managing partner and ESG committee chairman at LGT Capital Partners.