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ESG from a Risk Management and Investment Perspective

Nov 18, 2021

In this episode of Engaging Alternatives Spotlight, Elana Margulies-Snyderman, Senior Manager, Publications, EisnerAmper, speaks with Patrick Ghali, Managing Partner of Sussex Partners, who shares his outlook for the alternative investment industry, including strategies he sees most attractive and ones that face the biggest challenges. In addition, he shares his outlook for ESG, which has become more prominent in the alternative investment space.


Elana Margulies-Snyderman: Hello, and welcome to the EisnerAmper podcast theories. I'm your host, Elana Margulies-Snyderman and with me today is Patrick Ghali, managing partner of Sussex Partners, a London based firm that advises many of the most sophisticated global investing institutions on their allocation to hedge funds. Today, Patrick will share with us his outlook for the alternative investment industry, including strategies he sees most attractive, and ones that face the biggest challenges, along with his outlook for emerging managers. In addition, were ESG is top of mind for the alternative investment industry, he will also share insight on that topic. Hi Patrick, thanks for being with me today.
Patrick Ghali: Thanks for having me Elana.

EMS: Patrick, tell us a little about Sussex Partners and how you got to where you are today.
PG: Yeah, so a friend and I started Sussex Partners almost 18 years ago now. We're a hedge fund advisor, outsourced alternative CIO to institutional investors globally, and we have an office in London and Zurich and staff in the US and Japan. Our focus is on hedge funds, funds of hedge funds, alternative risk premium strategies, and we've also become involved with impact investments recently. We're completely agnostic as to investment vehicles and jurisdictions. (UCITs, Cayman, managed accounts, etc).

I'm really solely focused on the content then I create bespoke solutions that fit our plans and specific requirements. Almost all of the work we do is bespoke and very often we act as an extension of our clients and general capabilities. We can advise them in just a few positions or we can sit on their investment committee. And I think what's important is that our approach is completely flexible and really customized to match our client's needs. Over time, we've been asked to do more and more work for our clients, and of course we enjoy working with them as closely as possible. And we really see ourselves as an extension of our clients, and that's very much how we work with them on a day to day basis.
EMS: And Patrick, as an advisor on alternative investments, what's your overall outlook for the industry?
PG:So, we've seen a lot of growth in the 18 years since we started. And to me it was always somewhat baffling that there's such a start distinction between alternative investments and traditional investments. I mean the distinction is a little bit artificial and created by regulators. So it's a bit akin to having two sets of carpenters. And imagine that you tell one of them that he can only use a hammer and the other ones allowed to use a full toolbox, the same... So of course for the alternative investment industry. So I fully understand the desire and the need to protect investors, but there are plenty of alternative investments that are actually less risky than traditional ones. Our clients for example want to preserve capital, not get rich quick from their investments. And much of our time is actually spent on risk management conversations, which is really the most important thing for most of our clients.

The current level of global asset prices, all these years of on our orthodox monetary policy and distortions and capital markets have made it very challenging for investors to achieve the types of returns they require to meet our liabilities without having to accept significant risks, if they go about it purely with traditional investments. And, there's plenty of return free risk available in markets at the moment or at least it feels like that. So alternative investments provide a much broader set of techniques and opportunities to try and achieve to require the levels of return in a more controlled fashion. For example, right now we're working on fixed income replacement options for our clients, which have large bump positions ruling off and are now faced very low or negative yields. We also think that if you look at ESG and SDG, so the UN's sustainable development goals for investing active management will become a lot more important again.

I recently read a note by Natixis which I found quite striping and it stated that index investing equates with a four and a half to five degrees celsius increase in global temperatures. And that clearly isn't sustainable and much higher than where we need to get to. And the point of the report really was that current indices are far too skewed to an economy based on pollution and carbon. And again I think this is where active management can really add value both on the long and short side, because with the amount of money going into these markets you will all also see excesses, and projects that aren't going to work out. Look, it's dangerous to generalize, but I'm quite sanguine about the outlook for the industry. Investors need to be very careful which for stay in trust capital to and strategy selection, risk management remain key, and I think that's where we can help.
EMS: Great, and Patrick which strategies specifically will present the greatest opportunities going forward and why?
PG:So philosophically as a firm, we like strategies which don't rely on getting a mark and macro call rights, but rather identify market efficiencies which require specific set of skills to be able to monetize these. These can either be specific geographies such as Japan or China or specific parts of capital markets. We think that alpha strategies which completely demonstrate and added value and low correlation continuity of greatest interest. We also think that the low yield conundrum not go away that soon, and therefore any strategy that can provide a reasonable return at a reasonable level of risk and with decent liquidity, which I think is quite important behind demand.

Going back to the prior point, we also think that ESG and SDG will become more and more important, ultimately just being integrated completely into the investment process. But in the short term it's going to be important both from a risk management and from an investment opportunity standpoint. If you just look at the U, they have committed 470 billion euros for hydrogen alone over next 30 years. So this is a huge global trend that isn't going to go away anytime soon investors need to take advantage of this.
EMS: And Patrick, on the other hand, what strategies do you feel will present some obstacles going forward and why?
PG:So I think there's a few that are currently facing challenges, with the current market conditions being what they are fundamentally driven equity strategies, including market neutral, have been having a very tough time, as markets are not reacting to fundamentals at the moment. We have seen some normalization though recently which is somewhat encouraging. But we typically try and steer clients away from crowded markets and to think more creatively about where alpha opportunities can be generated. An example of a crowded market would be US where you have lot of smart capital, but they're all change- chasing the same ideas. So geographically we prefer markets such as Japan which are very efficient and with much less capital going into active management. We also often hear managers in the US complain of crowded trades and we've seen very high correlations between US long short managers when we actually analyzed their returns, and you've seen this as well with the mean stocks this year, and people getting squeezed in crowded shorts.

We did a study last year for an annual Japan hedge fund industry survey that we do, which by the way is still only one of its kind. And we compared long short managers in the US, Japan and Europe going back to December 2007, so really before the crisis happened. And what we found was that US equity hedge funds as a group had underperformed equities, so long only a decease over that period. So there was really no reason and to invest with them. Whereas European, and to an even greater extent Japanese hedge funds had significantly outperformed. And to us this demonstrates the importance of picking inefficient markets rather than highly efficient uncrowded markets. Right? If you can do that, then it's much easier to generate returns. And of course Japan is not the only market of interest to us, but it's just, I think a great example. The other strategies that we find challenging are the myriad of private and direct lending funds that have popped up.

This is clearly direct result of the dearth of yielding assets available. And while some managers are doing a great job, we were around in 2008 and 2009, and I really remember what would happen to many of those funds. So this isn't the first time that people came up with these ideas. And there's just a lot of room for people to play with valuations, liquidity, and so on, and there's a lot of gap risk in these strategies, which we think investors just very much underestimate.

So we're very cautious when it comes to those types of funds. And then, lastly, going back again to ESG and SDG, as I said I think that's going to be very important. But it's also an area which poses some real challenges because there's no clear industry standards at the moment. So even the European union has only really provided guidance on two of their goals. So if the countries don't even give you guidance, it's very difficult for investors to know what to do. And the lack of standards makes it incredibly difficult to properly measure these ESG factors and then if you try and consolidate the portfolio level, the challenge becomes even bigger and there's a very big risk that either you will participate or you'll be accused of greenwashing.
EMS: Patrick, I know we've already discussed a lot about ESG, which has obviously been top of mind for the alternative investment industry. So I wanted to ask you, what are you doing to embrace it both at Sussex Partners, and what do you think the industry needs to do as a whole?
PG:Yeah, so we had our first ESG mandate as a company in 2013 albeit at the time it was a very basic filtering exercise, trying to avoid certain sectors and companies for investor behalf. We're also signatory of the UN principles for responsible investing, and we're in the process of creating a series of dedicated ESG SDG products for some of our clients. It's becoming a very important topic in conversations with our clients, for a number reasons, regulatory, tax etc. What we also find very helpful is to look at the UN sustainable development goals because they're much more specific and precise, they're 17 of them and they offer much more focused set of criteria by which to measure ESG investing. In addition to that we're also currently evaluating number of external advisors to help us with making sure that our framework is sound and robust when it comes to ESG and SDG investing, because it's not something that you can easily just set up by yourself.

We're constantly engaging with our managers on this topic, and we also started to approve a number of impact investment funds more than private equity side for clients who want more direct exposure to this part of the market. We're generally quite excited about the developments and the opportunities that are coming out of that part of the market, and I think that's going to be a great opportunity for active managers to not only generate alpha but also mitigate risk and ultimately do the right thing. Our industry is somewhat abstract and it's quite nice to see that we can have a more direct impact that we can actually measure that, other than just looking at the fact sheet.
EMS: Patrick you said a lot of exciting things about what Sussex Partners is doing, but I wanted to see if you wanted to mention anything else with respect to your future plans.
PG: Look, next year will be our nineteenth year. It's gone quite quickly. I think in that period, we've seen a couple of significant global crises and we somehow managed that when growing. I think we just want to continue to grow the business and add more like minded clients. We like what we're doing, it's intellectually stimulating, we always learn something new, ESG SDG is a big topic now, that wasn't a topic when we first started. And so I just think we just want to continue doing what we have, add more clients and add value to them and find ways to, to help them.
EMS: Patrick we covered a lot of ground today, I just wanted to see if there are any final thoughts you would like to share with us.
PG:Yeah, so I think we're in a extraordinary period at the moment. It's very easy to get seduced by shiny new ideas, even though they may not make any economic expense. And I think there's a great danger that the fear of missing out this driving investment decisions and to be fair, suspending this belief in just buying the dip has been a very profitable strategy for now. But to quote our CIO, the world is currently full of naked emperors as he sees it and investors need to be careful that they want to come to a naked emperor attack on their portfolios. So I think we're in very uncharted territory at the moment.
EMS: Absolutely. And Patrick, thank you for sharing your perspective with our listeners.
PG:Thanks for having me Elana.
EMS: And thank you for listening to the EisnerAmper podcast series. Visit for more information on this and a host of other topics. And join us for our next EisnerAmper podcast, when we get down to business.

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Elana Margulies-Snyderman

Elana Margulies-Snyderman is an investment industry reporter and writer who develops articles, opinion pieces and original research designed to help illuminate the most challenging issues confronting fund managers and executives.

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