Hedge fund managers are largely ignoring environmental, social and governance (ESG) factors in their investments despite overwhelming demand from their clients, a new report has found.

A study published on Monday by Cerulli found that ESG hedge funds account for 2% of the total assets under management held in alternative investments.

The lack of alternative ESG funds contrasts with increasing demand for sustainable strategies from hedge fund clients, particularly those in Europe.

Some 73% of respondents to the Cerulli research said they would like ESG incorporated in the hedge fund investment process and 60% see ESG factors as a competitive advantage for alternative investment managers.

Justina Deveikyte, director in Cerulli’s European institutional research team, said on Monday: “Although dedicated ESG liquid alternative fund AUM remains limited, representing only 2% of total industry AUM, Cerulli anticipates growth. We expect managers’ negative screening approaches to gain most traction.”

Cerulli believes ESG hedge funds will become more prominent as institutional investors expand their responsible investment policies to cover the whole of their portfolios.

The study cited the disparity between ESG supply and demand as an example of hedge funds needing to work more closely with their clients

More than half (58%) of the managers Cerulli surveyed said partnerships will be a top priority over the next 24 months when distributing their hedge fund strategies.

“Although providing additional services will be challenging for smaller managers, mid-sized and larger managers should aim to build holistic partnerships with their clients; this can improve investor retention even during downturns in performance,” said Deveikyte.

These partnerships might cover reporting, access to investment teams and digital content as well as ESG investments, Cerulli concluded.  

The Alternative Investment Management Association published a report in July that suggested 80% of hedge fund clients are happy with the performance of their alternative investments.

The US Securities and Exchange Commission announced in June a plan to increase market transparency with the introduction of new regime surrounding short sale disclosure, a move that would have implications for short-selling hedge funds.