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Carbon Credits Helping Macro Hedge Funds Tout ESG Credentials

Most of the coverage of the area where the rubber meets the road with regards to hedge funds and ESG primarily focuses on equities and therefore equity-based strategies. It shouldn’t be surprising; equity strategies dominate the hedge fund industry and there’s a plethora of data available to these firms to ensure they can screen out ‘bad’ ESG companies to help them tout their ESG credentials to ever-aware institutional investors.

Macro hedge funds have been behind the curve a little, but one ESG-friendly trade is becoming increasingly popular amongst these firms, according to Akshay Krishnan, Head of Macro and Trading Strategies at London-based alternative investment specialists Stenham Asset Management.

“Trading carbon emissions is becoming increasingly popular amongst macro managers,” he said. “It’s a long trade because they think prices could almost double in the next couple of years.”

Carbon emissions are exchange-traded products which have gained traction in recent years as companies pay to offset their carbon emissions. The price has been supported by governments and regulators making it more punitive to pollute, thus increasing demand for carbon offset products. It’s an opportunity that both discretionary and systematic macro managers are taking advantage of.

“The discretionary managers are taking the medium to long term view here, and the fundamentals are underpinning their view that the price will increase. The systematic managers’ view is generally based on trends around price movement,” says Krishnan.

Last weekend, Joe Biden became president-elect of the United States, according to the general consensus. Assuming that President Donald Trump’s legal challenges fail, he will take up his new job on January 20, 2021. Biden has pledged to take the US back into the Paris climate agreement on his very first day in office; Krishnan says that, if this happens, it should provide further impetus to the long carbon credits trade.

“European carbon emission prices rallied strongly on the back of the election results last week,” he said. Positive news of a potential vaccine for Covid-19 earlier this week has also led to continued performance as the market expects industrial activity to return to normalcy sooner.”

The long carbon credits trade has hit something of a roadblock in the past few months, however. The price of the EUA Futures November 2020 contract on the Intercontinental Exchange has been falling since mid-September; Krishnan says that the short-term trend of falling prices of carbon credit futures products like the EUA Futures contract is more of a blip, based on the economic shock of the lockdowns instigated by governments to stop or slow the spread of Covid-19, than a fundamental change in view.

“If industrial activity falls off a cliff because of the lockdowns, there is less demand for the certificates, which affects the price. The near-term outlook for carbon credits is definitely up in the air,” he said, but the news of a vaccine is clearly supportive. “That said, compared to where we were in March and April, macro managers, like most people, are much more sanguine because economic activity has resumed, markets have recovered and we’re closer to a vaccine. Discretionary macro managers still have a long-term fundamental view, and the CTAs will benefit from long positions because of the upwards price direction.”

The opportunity in carbon credits is just the tip of the iceberg for macro hedge funds. Krishnan says that he is seeing macro funds increasingly looking at ESG-related issues when putting on their trades.

“They are taking a much closer look at things like environmental factors. If hurricanes are becoming more frequent, would you really be long bonds in Puerto Rico? Would you be long banks in Florida? If there are droughts in South Africa and a limited ability for the state to respond, what does that mean for the currency or credit? Macro funds have realised that it’s been a mistake to not take this kind of data into account. These factors are having a real impact on countries and assets and therefore winners and losers from a trading perspective,” he said.

Institutional investors have traditionally looked at their hedge fund investments as either a source of alpha and/or as a way to mitigate downside risk. As they increasingly look at these products through an ESG-compliant lens, Krishnan says that macro funds are well-positioned to provide positive performance whilst being ESG-compliant.

“Frankly, it’s easier for a macro fund to deliver positive returns using an ESG-friendly strategy than an equity hedge fund because they have more freedom and less constraints across asset classes, e.g. they can trade single name equities if they want. Don’t forget, historically the classic macro managers always did that, it’s not just bonds or currencies. Another impact of ESG is macro funds now need to take into consideration whether they want to actually own, for instance, the sovereign credit of a sanctioned nation. They can trade carbon credits. Hedge funds can go beyond pure equity strategies to make money in an ESG-compliant way for their clients.”

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