As state-owned funds with large shareholdings in companies across a broad range of sectors and markets, sovereign wealth funds (SWFs) are in a unique position to advance the global environmental, social and governance (ESG) agenda.

But studies indicate that many SWFs lag behind their institutional peers in this area. According to a 2020 Unctad study, only four of the world’s 30 largest SWFs published a sustainable or responsible investment report in 2019. This compared with 16 out of the 50 largest public pension funds. 

Meanwhile, another survey of 98 SWFs conducted by alternatives data provider Preqin found that just 19% had dedicated ESG policies. 

“If you ask an SWF whether ESG is taken into account in their investment decision process, most of them will say yes,” says Diego Lopez, managing director of industry data provider Global SWF. “But if you dig deeper, you won’t find anything that refers to it in their books, criteria or public materials.”

Growing influence

SWFs are long-term global investors that are mainly driven by financial returns, encompassing a diverse set of institutions — by investment mandates, sources of capital, geography and culture. While some SWFs may invest domestically to support local development and others invest overseas for diversification, their collective influence has grown.

Over the decade to end-2020, the value of assets managed by SWFs almost doubled to $7.84tn, according to Preqin. However, only 54% of those assets ($4.24tn) were managed by funds with stated ESG policies.

Dave Lowery, the head of research insights at Preqin, says that the move among investors of all stripes to view opportunities through an ESG-focused lens is pushing some sovereign investors to accelerate the shift. “SWFs have got to keep pace with [this ESG focus], as they cannot keep operating outside of that sphere forever,” he adds. 

This shift to ESG was precipitated by a rise in global partnerships between SWFs and other investors too.

“When they are making direct investments, SWFs are increasingly partnering with private-equity firms, their peers and asset managers, which all have an ESG policy,” says Victoria Barbary, director of strategy and communications at the International Forum of Sovereign Wealth Funds (IFSWF), a non-profit network of more than 30 SWFs. “Even though SWFs may have been slow in their ESG uptake, they understand its importance and are pushing in that direction.”

While a change of attitude is coming, there remains some scepticism. More than half (58%) of the 84 SWFs surveyed by Preqin in November 2020 believed that ESG policies had a positive or significantly positive impact on returns, while a fifth thought ESG had a negative impact. 

Shifting returns

A 2021 Global SWF study found that Norway’s NBIM, one of the world’s largest funds, missed out on $125.8bn in potential returns over a three-year period by investing in fossil fuels rather than green stocks. 

“Whether it is Norway or [Singapore’s] Temasek, these investors are concerned about profits and a strong portfolio that allows them to diversify and generate a cash flow,” says Mr Lopez. “Funds are realising that both in the public and private markets, they need to get on the train of sustainability.” 

Aside from the fact that Norway’s SWF sources its wealth from oil and gas, Mr Lowery notes that it is a great example of a fund that is transparent with its ESG policies. Other funds recognised for their ESG policies include Australia’s Future Fund and New Zealand’s Superannuation Fund (NZSF).

While it difficult to generalise about a group as diverse as SWFs, experts say the divergence in ESG policies is due in part to the national governments they serve.

“Funds coming from democratic countries tend to be more transparent, accountable, sustainable, responsible and resilient than funds coming from autocratic countries, including in the Middle East and Asia,” says Mr Lopez, adding that there are notable exceptions, such as Singapore’s Temasek and Abu Dhabi’s Mubadala.

Environmental focus

Ms Barbary says that most of the ESG focus at funds is put on addressing climate change.

“The ‘E’, or environment, is very much the easier piece for funds to start on,” she explains, noting that renewable energy investments can go a long way to increase their green exposure. “There is a degree to which SWFs as large institutional investors can engage with their portfolio companies and convince them to go greener.” 

There are signs that things are moving in the right direction too. The value of SWF investments into sectors combating climate change, including agritech, forestry and renewables, increased almost four-fold from $781m in 2016 to $2.25bn in 2020, according to IFSWF data.

Some funds are leading the way, such as New Zealand’s NZSF, which cut its exposure to fossil fuels by 40% between 2016 and 2020. It has set a new target of cutting its fossil fuel exposure by 80% by the end of 2025.

Global initiatives have been launched to further this transition too. For instance, the One Planet SWF working group — which comprises 33 of the world’s largest institutional investors, including 14 SWFs — aims to accelerate capital allocation for a low-carbon economy.

But Mr Lopez questions whether these types of initiatives are more about greenwashing, than fomenting real change. “If funds are not really incorporating ESG factors into their investment decision process, joining an international organisation is not going to change that,” he explains. 

Another IFSWF report found that only eight SWFs from a group of 34 have more than 10% of their portfolios invested in climate-related strategies. 

The ‘S’ and ‘G’

Beyond the need to fight climate change, Covid-19 has also given new impetus to SWFs to invest into societal good.

“The pandemic has made governments much more focused on societal impacts,” says Mr Lowery, adding that SWFs can play an important role in developing social infrastructure. “As long as governments can provide investment mechanisms for these types of investors, they can make money and promote social good as well.”

Other global initiatives intend to improve governance too. More than 30 SWFs follow the Santiago Principles, a voluntary set of principles that promote good governance, accountability, transparency and prudence.

“There is an understanding that governance is very important and is getting better understood at SWFs,” says Ms Barbary, who points out that increased private market exposure has made this more prominent. 

Ms Barbary continues that despite there being room for improvement, the difference between the EGS conversation at state-backed funds now, compared with 10 years ago, is like “night and day”.

“While there are laggards, there is progress being made by SWFs. I don’t think that SWFs as a diverse group are any worse than other institutional investors,” she says.

This article first appeared in the October/November print edition of fDi Intelligence.