Hedge funds have gotten into the green world through their energy and natural resource investments. Though a relatively new concept a decade ago, these types of funds have matured and proliferated. Increasingly, investors have become interested in environmental funds of funds (FoF), which are management companies that invest in multiple hedge funds. By doing so, FoF hope to capitalize on the upside potential of superior hedge funds without the substantial costs of developing in-house trading expertise.
Energy hedge funds came of age during the notorious collapse of Enron in 2002. Many successful funds shorted the market then and got rich. The problem then became how to employ resources in the energy investment sector without mirroring what everyone else was doing. Then in 2003-4, energy commodity hedge funds began to emerge. These small firms invested in crude oil futures and OTC contracts, and then went on to natural gas and petroleum investments. Hedge funds, being what they are, naturally sought to find arbitrage possibilities between commodities and equities. Funds that invested in emission credits resulted.
The meteoric rise and subsequent collapse of oil prices provided the volatility many hedge funds sought. To meet demand, exchange traded funds specializing in energy companies were established. The notional value of swaps and other contracts has ballooned. By creating FoF, managers sought to grab a piece of the environmental hedge fund upswing. These FoF diversify their investments using various asset classes, such as managed futures, commodities, and equities of energy service companies. To compete, these FoF must devote much time to due diligence in selecting the best hedge funds in which to invest.
Another offshoot of environmental hedge fund investing is so-called weather funds, which basically place bets on upcoming climatic events and their effects on commodities such as wheat and corn. A superior weather forecasting capability can catapult a hedge fund into a top tier investment. Good hedge fund performers know that markets for products such as oil and gas cannot be simply predicted by historical behavior. The growth of China and India has created a generic higher demand for natural resources, putting a steady upward pressure on prices, despite dips caused by the recent severe recession that hit most countries around the world. Any perception of disrupted supply can roil markets. This has been seen in recent years in such countries as Russia, Nigeria, Venezuela and Norway. The BP oil spill has placed new dynamics into the demand-supply equation that are still being sorted out. Small innovative green companies stand to benefit from hedge fund scrutiny, and a whole new generation of cleaner and more efficient technologies may result.