(Bloomberg) -- As money managers adapt to a new reality in which their oil policies risk losing them business, hedge funds are finding they’re also being dragged into the fray.
Pension funds in northern Europe are currently reviewing US mandates amid concerns over climate risk. In London, meanwhile, lawyers advising hedge funds say their clients are dropping oil exclusions in order to hold on to US clients.
The “concern is that oil screens may cause redemptions by oil-state investors,” said Lucian Firth, a partner at London-based law firm Simmons & Simmons who advises hedge funds with as much as $20 billion of assets under management. And oil states “are big investors in hedge funds.”
It’s a split-screen moment which has fund managers struggling to strike the right balance. State Street Global Advisors has already lost mandates from pension funds in the UK and Scandinavia after retreating from its climate commitments. And PME is currently reviewing a €5 billion mandate with BlackRock Inc., which the Dutch pension fund says is at risk due to “BlackRock’s diminishing ambitions in responsible and sustainable investing.”
At the same time, the state pension plan in Republican-led Indiana recently replaced BlackRock with State Street, based on an assessment that BlackRock was too focused on an environmental, social and governance agenda. And the Texas Comptroller of Public Accounts is targeting financial firms it says are “boycotting” the oil and gas industry.
Firth says he has hedge fund clients who are worried that an oil screen on just one fund can be enough to lose US clients, “even if they have other funds which do potentially invest in oil.”
The developments have sent a chill through the wider investment management industry, with many opting to remove clear references from public documents that might place them in one camp or another. But it’s a strategy that may backfire, according to Lucie Pinson, executive director of Reclaim Finance, a French nonprofit.
“Financial institutions will need to pick a side,” she said.
Anders Schelde, the chief investment officer at AkademikerPension — a Danish pension fund known for its focus on sustainability — said it’s important for the fund that external asset managers are “aligned to some degree with how we think and how we see the world.” And in the current climate, Schelde said “the odds of a US manager getting to our portfolio going forward have become lower.” The $20 billion fund just pulled a $480 million mandate from State Street.
State Street has said that as AkademikerPension does more investment management inhouse, it looks forward to continued discussions about future opportunities. BlackRock has said that it’s a “global leader” in sustainable and transition investing, and that it offers climate-focused clients in Europe a choice of products that deliver performance in line with their preferences.
The ‘Woke’ Factor
As US asset managers risk losing more European contracts, they remain under pressure from a newly emboldened Republican Party that’s made fighting climate policies a battle cry. Money managers face lawsuits and bans if they’re suspected of embracing environmentally friendly investments vilified by the GOP as “woke” and financially unsound.
Those political threats have coincided with a selloff in green stocks, which by one measure have lost about two-thirds of their value since the end of the pandemic. In the same period, big oil, big tech and the wider market have all rallied.
To be sure, clean-energy stocks have outperformed both big tech and the wider market so far this year, as they prove more resilient to the global selloff that just sent the S&P 500 Index into a correction.
At the same time, there’s an awareness in Europe that pulling large mandates from the biggest US firms is far from risk-free. In Switzerland, lawmakers just voted to keep State Street as the custodian of a 46-billion-franc ($52 billion) pension hoard. The bill had been brought forward by a parliamentary committee in January, due to fears that the Trump administration might suddenly order State Street to freeze funds amid growing tensions between Europe and the US.
In the event, Interior Minister Elisabeth Baume-Schneider said the bill would have “damaged the reputation of Switzerland as a financial center,” while Kathrin Bertschy of the Green Liberals said annulling State Street’s contract would hurt the perception of legal certainty.
US money managers are now navigating a political landscape in which they can be blacklisted from either side of the ESG debate. Late last year, BlackRock, Vanguard Group Inc. and State Street were all sued by a group of states led by Texas for allegedly breaking antitrust law by adopting environmental strategies that hurt the supply of coal. The suit alleges that those investment policies drove up electricity prices.
For hedge funds, such developments have coincided with a clear decline in enthusiasm for ESG strategies. For example, a once-popular fund class under the European Union’s Sustainable Finance Disclosure Regulation, known as Article 8, has now fallen out of favor, Firth at Simmons & Simmons said. At the same time, the industry is lobbying hard to ensure hedge funds are exempt from a variety of EU ESG rules.
While insisting that “ESG is far from dead,” Firth said hedge funds now find it more convenient to keep segregated accounts for such holdings.
Separately managed accounts (SMAs), which are an “entirely private” vehicle between an asset allocator and a fund manager, “are an increasingly common way for hedge fund mangers to deliver strategies to allocators,” he said.
(Adds reference to hedge fund lobbying efforts in third-to-last paragraph.)
