R. Scott Arnell is Founding Partner of Geneva Capital S.A. in Geneva, Switzerland and host of the SRI 360º Podcast.
In global markets, few themes have generated as much capital, and controversy, as environmental, social and governance (ESG) investing. Hedge funds, once among its loudest skeptics, are now some of its most vocal champions. With more than 5,200 signatories representing over $139 trillion in assets as of the end of March, the Principles for Responsible Investment (PRI) ecosystem suggests a wholesale embrace of sustainability across the industry.
The Rise Of ESG In Alternatives
The growth of ESG strategies has been remarkable. In 2021, Bloomberg Intelligence projected that ESG-related assets could exceed $50 trillion by 2025, accounting for over third of global assets under management. This momentum is not confined to mutual funds or pensions. For hedge funds, known for their flexibility and appetite for risk, ESG can present both a defensive shield and a growth opportunity.
In practice, that has meant two parallel realities. On one hand, many managers now incorporate carbon intensity analysis, renewable infrastructure allocations and stewardship frameworks into their processes. On the other, research shows outcomes lag the rhetoric: A 2023 analysis found that EU “sustainable” funds still invested roughly $18 billion in the world’s 200 biggest polluters.
The ESG Paradox
Academic research has added an important layer of skepticism. A study examining hedge funds found that PRI signatories underperformed non-signatories by an average of 2.45% annually after risk adjustments. For allocators, that is a meaningful shortfall.
Yet paradoxically, these same funds attracted more capital, launched more products and charged higher fees than peers outside the PRI network, in the three years post-signing. As The Economist observed, ESG has in some cases become less about performance and more about perception. I’m seeing PRI affiliation increasingly being treated as a badge of legitimacy. But a badge alone does not guarantee alignment with investor goals.
When ESG Becomes A Marketing Tool
The credibility challenge grows sharper when one examines fund-level behavior. The same study revealed that so-called “low ESG” signatories, funds that signed PRI but showed little evidence of ESG integration, underperformed non-signatories by 7.72% annually.
Many had no records of voting on ESG resolutions or engaging with companies, yet highlighted ESG prominently in their marketing. Some displayed signs of higher operational risk or return manipulation, suggesting that ESG branding was being used as reputational arbitrage. Morningstar has flagged over 400 U.K. funds using ESG terms in their names, warning that labeling often outpaces substance and strengthening the case for tighter standards.
What Authentic ESG Looks Like
Not all funds fall into that trap. When governance and incentives are aligned, outcomes look very different. An analysis of 27 firms in Sweden found those that tie executive compensation to ESG metrics are more likely to improve ESG outcomes and reduce risk exposure, even if consistent outperformance is not yet proven.
A good example is Osmosis Investment Management. On my podcast, I spoke with CEO Ben Dear, who explained how the firm built a $17 billion platform using a resource-efficiency model, embedding sustainability directly into portfolio construction rather than relying on exclusion lists or marketing.
New Models At The Frontier
I’ve spoken on my podcast with several managers who are experimenting with approaches that stretch the boundaries of ESG in alternatives. These new models include:
• Shorting for accountability: François Bourdon of Nordis Capital has built a strategy that shorts companies with weak sustainability practices, creating financial consequences for laggards instead of only rewarding leaders.
• Quantitative ESG in emerging markets: Asha Mehta of Global Delta Capital tackles emerging markets where ESG data is scarce, using proprietary signals to capture underappreciated risks and inefficiencies, blending quantitative rigor with contextual ESG insights.
• Impact frameworks at scale: At TPG’s Rise Fund, Maya Chorengel has highlighted the firm’s use of the “Impact Multiple of Money” framework, designed to quantify the social and environmental value created per dollar invested.
These examples demonstrate that hedge funds can serve as laboratories for ESG innovation when they prioritize measurable outcomes over branding.
Why Regulation And Oversight Matter
If hedge funds are the new frontier for ESG, regulators and allocators are the border guards. Stronger oversight can narrow the gap between rhetoric and reality.
Mandatory disclosure requirements, stewardship codes and performance-based reforms have already shown promise. The Securities and Exchange Commission’s climate disclosure rules, for instance, require companies to report climate-related risks in a standardized way. In Europe, initiatives such as the Sustainable Finance Disclosure Regulation (SFDR) are pushing asset managers toward greater accountability.
Evidence suggests these reforms do move the needle. Funds subject to stricter governance requirements have demonstrated stronger ESG performance over time. For allocators, the real test is not whether a fund claims ESG, but whether governance, incentives and measurable outcomes back that claim.
In Markets Demanding Accountability, ESG Needs Oversight
For hedge funds to move from signaling to substance, investors must push harder. While some allocators still view sustainability mainly as risk management, others are retrenching. In Europe, regulators are tightening disclosure standards and channeling capital toward transition finance, whereas in the U.S., political backlash and skepticism are prompting fund rebranding and retreat. This growing transatlantic divide underscores the need for credible global frameworks such as TCFD and ISSB to ensure ESG reporting is both comparable and enforceable.
Conclusion
Hedge funds have always thrived on exploiting inefficiencies. Today, ESG is one of the biggest inefficiencies in capital markets, not in opportunity, but in credibility.
The PRI badge is not a substitute for due diligence, and a glossy brochure is not a substitute for governance. Investors should stop asking, “Are you ESG?” and start asking, “How exactly is ESG embedded in your strategy, your team and your compensation model?”
Responsible investing will only have meaning if investors and managers stop treating marketing as a substitute for measurable outcomes. Applying the same scrutiny to ESG claims that hedge funds apply to markets themselves may be the way forward. And if hedge funds can’t tell the difference, it may be time for investors to remind them.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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