As almost $31 trillion has flowed into investment funds and strategies that emphasize good governance and socially responsible business practices, hedge funds have largely found themselves left out.

They’re starting to find a way in. Nearly 30% of hedge funds say they’re using ESG considerations to inform investment decisions, according to Preqin research released this month -- the first time the data provider put the question to hedge fund clients.

“The activity level relative to ESG within the hedge fund industry historically has been fairly low, but it’s going to increase significantly,” said Don Steinbrugge, chief executive officer of hedge fund consultant Agecroft Partners. “It’s an area that a lot of institutional investors are thinking about. It’s going to be a big growth area.”

Hedge fund investors -- particularly long-time pension fund clients -- are asking more detailed questions about climate change, diversity and other societal issues. For managers, that means figuring out whether and how they can adopt “ethical” or “sustainable” investment practices in an industry known for shorter-term and aggressive bets.

“There are a lot of different takes on what responsible investment means in practice in the hedge fund industry,” said Adam Jacobs-Dean, global head of markets, governance and innovation for industry group Alternative Investment Management Association. It’s just not “as apparent how to integrate ESG if you are a hedge fund trading interest-rate swaps, or an emerging-markets manager,” he said.

Some activist funds have started to figure it out. They already tend to take longer-term bets in a relatively concentrated number of companies, which makes adding a layer of ESG research easier. Jeff Ubben’s ValueAct Capital Management launched a fund last year focusing on social and environmental investments. Nelson Peltz’s Trian Fund Management has also pledged to back ESG issues.

“We’re absolutely convinced it is a way to both reduce risk and improve returns,” said Clifton S. Robbins, founder and chief executive officer of Greenwich, Connecticut-based Blue Harbour Group, which started adding ESG considerations to its investment strategy three years ago. “We’re at a tipping point where a lot of investors care about ESG.”

Blue Harbour, which manages $2.2 billion, this month released a report to clients detailing for the first time how often the firm has pushed companies to add wellness programs, increase diversity among senior officers and warned companies to reduce emissions. The firm’s analysts and principals have been trained to assess companies against a 20-page ESG diagnostic questionnaire and to incorporate this information into investment strategies.

Blue Harbour says ESG is increasingly critical to how companies are valued by future investors or acquirers. “I’m telling CEOs of public companies your valuation will be affected by this,” Robbins said. The firm typically takes 3% to 8% stakes in companies, which helps when asking for workplace safety improvements, for example, or more board diversity. The average ESG investor tends to hold less than 1% of a company.

Many hedge fund managers aren’t sure there’s any performance benefit to ESG considerations. Among more than 250 managers with $1.3 trillion of assets under management, 23% said they believed ESG strategies policies will help them outperform, according to a survey by JPMorgan Chase & Co.

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