1 – Introduction
Call it the SWF paradox. Given the sheer size of their assets, sovereign wealth funds (SWFs) can move the needle in achieving SDGs and bridge the huge financing gap developing countries face. Furthermore, state sponsorship legitimizes them to address market failures in their investment strategies, accounting for externalities, and investing in public goods. The inter-generational nature of SWF’s business places them in a better position to assess the materiality of long-term risks, such as climate change, to their portfolios. At the same time, as universal owners with large stakes in companies across a huge range of sectors and markets, SWFs are uniquely placed to drive the transition across the investment cycle through active and responsible ownership.
Yet, SWFs are often referred to as “sustainability laggards”, and their participation in the responsible investing movement has remained lackluster relative to other institutional investors and private-sector counterparts. According to a recent survey, only 13% of SWF interviewed had published a sustainability report in 2019, while the share of pension funds doing so is 31% (UNCTAD, 2020). Another survey on global asset owners shows that SWFs record the highest percentage (52%) of respondents declaring that they do not include ESG in their investment approach (State Street Global Advisors, 2019). Turning to specific global challenges, most SWFs agree that climate change will affect economic growth and financial return, but 60% of respondents declare they are not taking climate-related risks and opportunities into consideration in the investment process in any systematic way (IFSWF, 2020).
This apparent reluctance to embrace sustainable investment can be traced back to several structural factors affecting the industry. SWFs are a very heterogeneous group, composed of institutions with different mandates stretching from fiscal revenues stabilization and inter-generational savings to national economic development. Within the category usually labeled Strategic Investment Funds (SIF), we find many examples of funds with a strong focus on sustainable development by adopting a “double bottom line” approach, targeting financial return and socio-economic impact.
A standard setter in this space is the Irish Strategic Investment Fund, but virtually all African SWFs, despite their smaller scale when compared with their global peers, have missions aligned with delivering on SDGs, focusing on sectors such as food and water security, energy generation, healthcare and digitalisation, that will have a material impact on their citizens’ lives (IFSWF, 2021). Amongst funds investing with the mandate of intergenerational savings, Norway’s GPFG, the largest savings SWF around the world with a portfolio of USD 1.3 trillion entirely invested abroad, has been a frontrunner in responsible investing. The fund has pioneered negative screening, a process which excludes stocks in sectors conflicting with the fund’s strict ethical standards and divests companies caught, for example, in human rights violations or causing severe environmental damage. Within the same echelon of savings funds, the New Zealand Superannuation Fund is recognized as a global leader among institutional investors for having developed one of the most sophisticated strategies towards combating climate change.
However, the above-mentioned cases are notable exceptions SWFs are generally isolated institutions, shielded from the external pressure to change investment policies and deliver on the SDGs. Asked whether their boards and beneficiaries ask about such issues, only 38% SWFs say that they do, compared to around two-thirds of central banks, foundations, and endowments, and just over half of pension funds who take environmental sustainability into consideration.
What prevents SWFs from changing their passive stance and actively engaging in sustainable investing? A possible explanation can be traced back to the recent history of SWFs. The largest institutions have successfully built their reputation on conducting purely financial investments to assuage the recipient countries’ concerns that they were acting as a foreign policy tool. This strategy was enshrined in the Santiago Principles, drafted in 2008 to promote transparency, good governance, accountability, and prudent investment practices, and signed by an increasing number of SWFs over the last decade (IFSWF, 2018). SDGs are ultimately policy goals, and any shift from conventional to sustainable investment would make SWF look more “political”, blurring the boundaries between government activity and sovereign investment that have been laboriously built over the years. These issues have more practical implications than one might think. They have spiced up the last national elections in Norway, where a debate was ignited over concerns about the political use of the fund in the pursuit of global challenges such as climate change. We can now better understand the initial paradox: among institutional investors SWFs tend to adhere more strictly to their fiduciary duty and avoid venturing out into deals (such as sustainable investments) that would make them appear politically motivated.
The COVID-19 pandemic might well play a key role in breaking the paradox. This crisis has painfully shown that neglecting environmental risks exposes both society and the economy to natural disasters, hurting the value of SWF assets and jeopardizing their obligations to their stakeholders. More generally, the realities of climate change, global financial crisis, populist regimes and the pandemic, to name a few phenomena since the turn of the century, have brought the risks of a globally interconnected world into sharper focus, and have highlighted the need for a shift from the conventional model focused on short-term profits, shareholder value, and the dilapidation of natural capital, to a new paradigm in which environmental sustainability, social inclusion and shared prosperity should become central in corporate and financial decision-making. A possible silver lining of the pandemic is thus to reconcile the fiduciary duty with the pursuit of SDGs, catalyzing a broader adoption of sustainable investment practices among private and state-sponsored financial institutions alike.
To better understand these trajectories, research has to set the record straight about sustainable investment by global SWFs, by providing updated and comprehensive data and information about their deal-making in this space. This article aims to fill this gap by tracking two decades of SDG investments by SWFs. Most of the information available on this topic (including the one reported above) is derived from surveys. We instead took a “revealed preference” approach, sifting SWF orientation (or lack thereof) towards sustainability by analyzing their overall investments over their recent history. We adopted UNEP’s broad definition of “sustainability”, which contains both environmental and economic inclusivity dimensions, and labels SWF deals as sustainable (SDG) when they are executed in the sectors aligned with the IRIS+ taxonomy, a standard reference in the field.
2 — Data description
The sample of the SWF investments originates from the SWF Global Transaction Database built by the Sovereign Investment Lab at Bocconi University and comprises 3,565 investment transactions made by 426 tracked SWFs or by their investment vehicles from 2000 to 2020, for a total aggregated deal value of just over USD 1 trillion. The data include investments in listed and unlisted equity, real estate and real estate funds, private equity and open-ended investment funds, platforms, and joint ventures in which a SWF (either directly or through its financial arms) is an investor.
Data collection was performed both with centralized sources (Zephyr, Refinitiv, Preqin, S&P Capital IQ, Bloomberg) and by manually collecting information from publicly available sources such as newspaper articles.
The sustainability dimension pertains to the core business of the investee company: each company reported in the database was classified based on its main field of activity according to categories and themes modeled on the IRIS+ taxonomy. Reclassification was based on information contained in the news articles related to the transaction and publicly available information on the investee company at the time of the SWF’s investment.
Each investee company was classified according to categories and themes (“subcategories”) based on the IRIS+ taxonomy:
The category “Non-SDG” was added to the original IRIS+ taxonomy in order to account for investee companies in the database whose core activities did not fit with any of the IRIS+ categories. For 51 companies (for a total deal value of USD 11.7 billion) it was not possible to find information to characterize their sustainability profile, and therefore we treat them separately as cases with missing data. If more than one IRIS category could be applied to a certain investee company, the one which fitted the largest share of the investee company’s core activities best (according to the information found) was adopted.
A few caveats are in order.
First, the focus of this report is SWF investments with a sustainability profile. This subset of transactions presents a very skewed distribution with respect to deal value: 10 investee companies account for more than 47% of total sustainable deal value recorded in the database. This may lead in some instances to incorrect conclusions, because the significant weight of certain categories would be driven not by a robust underlying trend, but instead by few large deals. As a remedy, for most of the analyses presented in this report, the “winsorization” method popular in economic and financial literature was applied to the variable “deal value”: the top and bottom 1% of the data was removed in order to exclude the largest and smallest outliers. In the top 1% of sustainable deals, four transactions were excluded: Qatar Railways Development Company (18% of total sustainable deal value), Bayer AG (5%), Nestle Skin Health SA (4%) and Allergan Plc (4%).
The sustainability classification of investee companies was performed following the detailed guidelines of IRIS+. Being a manual classification based on publicly available sources, a certain degree of subjectivity in the classification process was unavoidable. Some examples of borderline cases are:
— nuclear energy and natural gas: companies operating in these fields were not considered sustainable investments despite the important role they play in the transition from oil and carbon to more renewable sources of energy (natural gas is still a fossil fuel and nuclear energy is in many countries not socially accepted);
— telecom investments are generally considered sustainable investments: we tried to find out if the investment was done in underserved communities even if the definition of what an underserved community might be challenging. In many emerging markets telecom investments have generally led to vastly positive developmental outcomes in terms of financial inclusion, mobile money applications and generally beneficial innovation;
— “Social innovation” companies (those who promise to change the life of millions with artificial intelligence and the like) were not considered sustainable investments per se, unless there was a clear and proven connection with one of the IRIS+ categories.
3 — General trends
Out of the total 3,565 transactions recorded in our database, we were able to flag 564 transactions representing a total of USD 73.5 billion of aggregated transaction value as ‘sustainable (SDG) investments’. This represented 16% of the total deal count and 7% of the total deal value of the SWF transactions. The distribution of deal value within SDG investments is skewed (even after performing winsorization, as described in the previous section) but this is simply a function of the highly heterogeneous nature of the SWF community, with a considerable diversity in mandates, as mentioned in the introduction.
For those who espouse the normative belief that SWFs should engage deeply in making sustainable investments, these are, in an absolute sense, not overly impressive numbers.
Perhaps not surprisingly, we do see an increasing appetite by SWFs making sustainable investments over time. The growth in SDG deal count from 2010 onward may well have benefitted from the spike in overall deal making, both in deal count and deal value. In the aftermath of the Global Financial Crisis (GFC), several SWFs made large value-driven investments in alternative assets such as private equity and real estate. After reaching a plateau of around 27 deals a year in the 2012-2016 timeframe, we see total sustainable deal count (the total number of SDG deals) accelerate to 59 in 2017 and progress strongly to almost 100 in 2020.
The total sustainable deal value (the total USD amount of SDG investments) is also keeping pace in these later years. We see a spike in total sustainable deal value in 2017 to around USD 6.3 billion, a brief dip in 2018 and then a steady increase by 2020 back to 2017 levels.
4 – Sectoral analysis
When we perform a sectoral analysis across the two decades covered by the database, what immediately stands out is that SWFs’ sustainable investments are predominantly in the sectors of healthcare, energy, financial services, and infrastructure. The healthcare sector makes up 44% of the sustainable deal count and 38% of sustainable deal value, making it the leading sector by some distance.
Energy follows, representing 14% of the SDG deal count and 27% of the deal value, respectively. Financial services and infrastructure vie for third and fourth place, with both 9% in SDG deal count, and 5% and 11% in sustainable deal value. Energy, financial services, and infrastructure are all considered sectors with highly investable business and revenue models that are generally well-tested and understood. Other more niche or nascent investment sectors, with more challenging business and revenue models for mainstream institutional investors, including water, education, agriculture, climate, and biodiversity & ecosystems, individually represent 4% or less.
Looking at the proportion of the four leading investment sectors in sustainable deals across three different time spans – the pre-GFC years, the GFC itself from 2008-2010, and the post-GFC era – some interesting shifts through the two decades become visible.
Pre-GFC the healthcare sector was even more dominant in terms of sustainable deal value, at a whopping 73%, and sustainable deal count at 57%. Infrastructure followed, with 16% and 23% respectively. However, we should caution that these early years are statistically not very meaningful due to the low SWF activity in sustainable investments in general.
During the GFC SWFs shifted their sustainable investments significantly into infrastructure (45% of deal value, and 29% of deal count) and energy (45% of total deal value and 29% of deal count). The healthcare sector bore the brunt of the re-direction of investment flows and fell to just 3% in sustainable deal value and 22% in deal count during this period. Sustainable financial services received scant attention during these same years as most investment in the industry was targeted toward the rescue of US battered banks.
The probable cause of this shift during the GFC may well have been that in times of severe economic stress, SWFs, by their own design or by the request of their political masters, elect to commit capital to capital-intensive hard assets like infrastructure and energy projects that stimulate the economy and create employment. This allows investors to enjoy predictable long-term cash flows over a long investment horizon.
What happened next may lend credibility to this possible explanation. After the GFC, investment in the infrastructure sector fell precipitously from 45% to just 4% in sustainable deal value, and from 29% to 5% in sustainable deal count, even below pre-GFC levels. Energy experienced a less hefty decline, from 45% to 27% in sustainable deal value, and from 29% to 14% in sustainable deal count. It is plausible that after the investment spike during the GFC in infrastructure projects, the number of available ‘spade-ready’ infrastructure projects had been exhausted. Energy projects specifically, however, have a longer design, engineering, procurement, and construction phase, and hence the ‘rise and fall’ effect may be less pronounced.
The graphs above confirm the leading investments sectors, both by deal count and deal value: overall healthcare is by far the biggest beneficiary of SWFs’ sustainable investments, followed by energy, infrastructure and financial services.
5 – Geographic analysis
Changing our vantage point to a geographic analysis of sustainable investments made by SWFs over the two decades covered, Europe and North America received the largest SDG deal value, with 26% and 25% respectively, followed by Asia-Pacific with 20%, and Southern Asia with 18%. Middle East, Latin America, and Africa trail with a modest 7%, 3% and 1% respectively.
Interestingly, the deal count shows a slightly different distribution. Here, the lead goes to North America and Southern Asia, both with 24%, followed by Asia Pacific with 21%, and Europe with 18%. Middle East and Africa with a combined 10% and Non-Pacific Asia together with Latin America (with 2% and 1% respectively) close the ranks.
This pattern is not surprising, though. Europe and North America are lower-risk OECD economies with many significant and mature public and privately held companies. Europe may well be receiving the largest dollar share of sustainable investments since it is more dialed into sustainability than North America.
Given TIL’s special focus on MEASA (the combination of Middle East, Africa, and Southern Asia) the data of this macro-region are treated separately, and results are particularly interesting: MEASA gets the larger share of deal value (26%), and deal count (34%) due to the contribution of Southern Asia (particularly driven by India and Singapore), while the other two sub-regions fall behind, and spectacularly so. MEASA combines the highest long-term growth potential, thanks to demographic dividends of Southern Asia, with the most acute socio-economic problems of the less developed nations. We claim that transition investments in the MEASA region by international and domestic SWFs will be a key challenge in the years to come.
Regional data do not show a lot of variation from the overall trends, and hence we left it unreported here. The healthcare sector shows the largest sustainable deal count in all target regions except for Africa, where energy and infrastructure play the biggest role as investment sectors – this is to be expected in a continent where electrification is still the single largest development need – followed by investments in agriculture and real estate.
When it comes to sustainable deal value, we see the healthcare sector again take the lion’s share in Europe (aging population), Latin America (rising middle classes, and fragile healthcare systems), Middle East (rising middle classes, catered to by nascent healthcare systems), and North America (aging population, and healthcare represent a disproportional 19.7% of GDP in 2020 ). In the Asia-Pacific region too, healthcare takes the runner-up position, after energy and infrastructure in the leading positions, in a region that sees its energy needs double in the next decade due to high economic growth projections.
A final noteworthy geographical perspective is to be found in the two graphs above which report the share of SDG investments in domestic vs. foreign deals. Interestingly, deal count, and deal value tell two different stories. By deal count, SWFs seem more prone to make SDG investments at home, which is consistent with a mandate of socio-economic development. By deal value, however, we see the opposite: in most years, and markedly since 2017, the share of SDG investments abroad has outpaced the share made at home. By taking a closer look at transaction data across deal types, we discover that domestic SDG investments are significantly smaller than international ones. Indeed, the mean (median) size of domestic SDG deals is USD 81 (21) million, while it rises to USD 122 (34) for SDG investment abroad. A working hypothesis is that this may be attributable to a “firm size” effect. While chasing SDG opportunities at home, SWFs are willing to take an early-stage venture capital approach, by investing in innovative startups with a high potential to generate spillover effects in the local economy. When they invest abroad, SWFs pick instead larger, more established, and consequently less risky companies, seeking primarily financial returns rather than impact.
6–Funds
An interesting question is whether there is a relationship between the degree to which a SWF makes sustainable investments and the source of a SWF’s funds, whether its origin be commodity-related wealth or non-commodity related wealth?
The above graph shows that over the past five years, both commodity SWFs and non-commodity SWFs have begun to make more sustainable investments, both in terms of deal count and deal value.
In terms of sectoral investment focus, the two types of funds behave largely the same, with a strong focus generally on the healthcare, energy, infrastructure, and climate sectors, albeit that the non-commodity SWFs relatively invest more in healthcare (45% of deal value) and relatively less in energy (22%) compared to their commodity peers (27% for healthcare, and 35% for energy). The larger value of investments made by the commodity SWFs in energy and climate (together representing 45% of deal value), relative to their non-commodity peers (23%), would suggest there is a focus on diversifying their portfolios into clean and renewable energy away from the hydrocarbons that predominantly form the source of their wealth.
When we disaggregate the data further down to the level of individual SWFs, we see some sustainable investing champions in the field emerge.
The two generally forward-looking Singaporean SWFs, GIC Pte Ltd. (GIC) and Temasek Holdings Inc. (Temasek) lead the ranking with USD 11.6 billion (7% of their total deal value), spread over 86 deals (12% of their total deal count), and USD 9.7 billion (9% of deal value), distributed over 213 deals (26% of their deal count), respectively.
There are other noteworthy players in this echelon. Qatar investment Authority invested more than USD 8 billion (6% of total deal value) in SDG investments spread over 28 deals (10% of deal count), whereas Mubadala Investment Corporation PJSC invested almost USD 6 billion (5% of total deal value) across 50 deals (15% of total deal count). China Investment Corporation (CIC) invested USD 3.8 billion (2% of total deal value) across 21 deals (8% of total deal count), and Abu Dhabi Investment Authority (ADIA) is not far behind, with USD 3.2 billion in SDG deals (6% of total deal value) invested across 19 deals (11% of deal count).
The league tables would thus be led by the largest Middle Eastern SWFs, the Singaporean, and Chinese SWFs.
In the next echelon we find three more SWFs investing at least USD 1 billion in the aggregate in SDG deals over the period. Khazanah Nasional Bhd of Malaysia invested USD 2.2 billion (14% of total deal value) across 33 deals (30% of deal count). The New Zealand Superannuation fund represented USD 1.3 billion of investments (45% of deal value) in 12 deals (26% of their deal count), and, last but not least in this category, the quickly growing Saudi Public Investment Fund (PIF) invested USD 1.1 billion (2% of total deal value) in eight deals (20% of total deal count).
Another interesting way of looking at this data is the prevalence of sustainable investing as applied to investment decisions (expressed as a percentage of deal value and deal count) in some select SWFs, suggesting a more consistent integration of sustainability considerations in their investment operations. For example, 52% of Bahrain Mumtalakat Holding Company’s deal value was sustainability-driven, representing a total of USD 215 million across five investments. The New Zealand Superannuation Fund, which, as highlighted earlier, has developed a sophisticated strategy against climate change, had a sustainability-driven deal value of 45%, representing USD 1.3 billion invested in 12 deals.
7–Conclusions
This article represents the first systematic attempt to quantitatively document the evolution of SWF sustainable investments over the last two decades. Our evidence – albeit purely descriptive – is broadly consistent with the consensus view of SWF as “sustainability laggards”: since the turn of the century they aligned only 16% of their deal count and 7% of their deal value with the SDGs. This record is hardly impressive, supporting the hypothesis that SWFs stick to a narrow interpretation of their fiduciary duty, eschewing deals (such as sustainable investments) that would make them appear politically motivated.
But things are changing. Our data analysis reveals that over the last five years there has been a noticeable uptick in SDG investing by SWFs. From 2018 onwards, we see momentum building in climate and energy, especially in terms of deal value. We also see agriculture come to the fore in 2020, and to a lesser degree, investments in education, as the SWFs appear to slowly but surely extend their investment remits into other long-term investment themes.
While SWFs’ overall engagement in SDGs has been so far quite limited, the efforts displayed in the health industry are truly remarkable. With 249 deals worth almost USD 29 billion (altogether, without taking into account the winsorization), healthcare has been consistently over the period the SDG target sector of choice. Having backed the R&D efforts of many pharmaceutical firms that eventually developed COVID-19 vaccines, we can conclude that SWFs have played a key role in slowing down the spread of the pandemic.
Geographically, we see the deal value as well as the deal count of sustainable investments affected in MEASA, Europe, North America, and Asia Pacific, in that order. While Europe and North America are attractive lower-risk OECD destinations, MEASA is a highly diverse region, exhibiting both high growth potential and socio-economic and environmental challenges and associated investment opportunities.
As it is often the case in SWF research, aggregate data mask important differences. Drilling further down to the level of individual SWFs, despite the documented reluctance at the industry level, we see a few emerging champions in sustainable investing. QIA, GIC, Temasek, ADIA, CIC and Mubadala have each invested between USD 21.6 billion to USD 3.7 billion (not taking into account winsorization) aligned with SDGs. The healthcare sector is their predominant target of investments, invariably followed by a combination of energy, financial services, and infrastructure. All four sectors taken together typically make up around three quarters of their total deal count. Some smaller SWFs, such as Bahrain Mumtalakat and the New Zealand Superannuation Fund, report higher percentage of sustainable investments of their total investment activity, suggesting a consistent integration of sustainability in their investment operations.
The COVID-19 pandemic might well play a key role in breaking the SWF paradox, but is too early to tell in light of the pandemic’s disruptive effects on risk management and deal making practices. However, as overarching themes such as sustainability, ESG, climate change mitigation and adaptation, and SDG-aligned investing become more and more prevalent in the investment world, one might reasonably expect the SWFs, from their boards to their investment committees and officers, to not only say the right thing but also to do the right thing, aligning their investment approaches more and more with the SDGs. We expect their position shifting from passivity and a degree of institutional isolation from external pressures, to the acknowledgement of global responsibilities towards sustainable development. The SWFs continue to be uniquely placed to foster and hasten this transition.