Private equity firms and hedge funds are under growing pressure to set ESG policies and integrate sustainability factors into their investment portfolios, according to a new study released by global professional services firm EY.

For the new “2022 EY Global Alternative Fund Survey,” built in collaboration with Coalition Greenwich, interviews were conducted with 114 hedge funds representing more than US$1.7 trillion  in AUM, 112 private equity firms representing more than US$2.8trillion in AUM, and 61 institutional investors with around $1.3 trillion in assets under management. The survey covered topics ranging from industry trends, long-term positioning, talent management, investment products, the regulatory climate and strategic priorities.

The report found that the alternative asset managers are under increasing scrutiny on ESG matters, with 26% of investors reporting that they decided not to invest with a manager this year due to inadequate ESG policies, up from 20% a year ago.

Only 11% of investors said that managers’ corporate ESG policies do not have an impact on their decisions to invest or remain invested, while 36% reported that these factors are “important” or “critically important” to these decisions.

While managers may face pressure to improve their ESG policies, they may also have opportunities to provide ESG-focused solutions for their clients. While only 14% of investors reported that they are currently required to invest in socially responsible products, another 29% anticipate being required to invest in these products within the next 2 to 3 years. Over a third of the investors said that they currently invest, or plan to invest, in ESG-dedicated funds.

The report also explored the top ESG characteristics considered by the investors in their investment decision making, with governance and climate risk being the top areas of interest, reported by 63% and 61% of investors, respectively, followed by human rights practices and DEI, each at 41%.

While the alternative asset managers appear to be responding to investors’ ESG demands, significant room for improvement remains, with the report finding that just over half of managers (53%) are currently embedding ESG risks and considerations into their investment decision-making, and 18% have yet to set a formal ESG policy.

In the report, EY wrote:

“Meeting investor ESG policy and reporting requirements is becoming increasingly important, as 26% of investors decided in 2022 not to invest with a manager because of inadequate ESG policies, a five-point gain from 2021. This increase should serve as a warning for managers to take investors’ demands for appropriate ESG policies and reporting seriously. Managers who neglect this trend may lose out on investor interest and capital allocations.”

Click here to access the report.

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