Hedge funds: Green trimmings

CONCERN FOR THE environment is becoming the vogue, not just among politicians, film stars and musicians but also in the finance industry. It has led to a growth in the number of publicly listed companies providing solutions to environmental issues, and has created new markets in such areas as carbon emissions. It is fodder for hedge fund managers who are straining to find new opportunities to create alpha as traditional hedge fund strategies become increasingly crowded.

It is, however, still very much a nascent sector. There are a handful of funds of hedge funds that are running environmentally focused products but their choice of underlying managers is quite limited.

Kenmar launched its fund of environmental hedge funds at the beginning of July. It invests predominantly in absolute-return strategies but also looks at long-only and long-biased funds in alternative energy, clean energy, healthcare, environmental services finance, microfinance and water management.

Including long-only funds significantly opens up the universe of managers with which to invest. Kenmar estimates that there are between 30 and 40 environmental hedge funds, and about 100 to 120 environmental long-only funds. Kenmar’s co-chief executive, Marc Goodman, says that his fund is finding more hedge funds concentrating on environmental and sustainable themes in Asia and Europe. "Asia, due to the enormity of the environmental issues there, and Europe because of their long history in socially responsible investing," he says.

Goodman believes the number of environmental hedge funds will increase. "Many of these funds are taking advantage of new technologies, such as increased pollution control solutions, or markets, such as weather or carbon emissions trading, that previously were not available to them. The demand-driven new technologies will only increase in future." (See BioFinancial Corp profile.)

Across the spectrum of the small number of hedge funds looking at the sector there are a variety of approaches. The public markets remain the most opportunistic, and within that managers differ in how pure a play they wish to make. In some instances, managers are committing themselves to the environmental sector by investing only in companies that predominantly deal with green issues. Others, however, are investing in such companies as Toyota that have some green exposure – in the production of the hybrid-electric Prius car.

End investors are intrigued, sparked by a social conscience, but good returns are essential. Indeed, hedge fund managers need to prove that investing in the environmental sector can be profitable. Over the next two pages, Euromoney profiles four managers that have uncovered a way of producing uncorrelated attractive returns in environmental investment. While offering some help to reducing the effects of climate change or other environmental challenges, it is clearly business that takes precedence. It should. Returns and, in turn, profits will be necessary to encourage more hedge funds to the table. As more money flows in, the greater the likelihood that solutions to climate change and other environmental challenges will be found. As one environmental hedge fund manager says: "What the planet needs is to have 10,000 venture capitalists and hedge funds move into this space and we’ll have it cleaned up in no time."