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July 4, 2022updated 05 Jul 2022 10:22am

ESG: How sovereign wealth funds are sharpening their focus

With state funds under pressure to put their $11.3trn of assets to good use, there is evidence they are upping their ESG game.

By Joe Marsh

Sovereign wealth funds, ESG
Sovereign wealth funds are incorporating ESG into their investment plans, but are still behind other asset owners. (Photo by fcafotodigital via iStock)
  • Sovereign wealth funds are raising their focus on sustainability and climate issues, but more slowly than public pension funds, according to Global SWF.
  • More funds are incorporating ESG into their investment processes and implementing carbon footprinting, climate scenario analysis and stranded asset analysis, shows IFSWF research.
  • But regular ESG reporting is still lacking, and shifting away from hydrocarbon investments will not happen overnight.

Like most investors, sovereign wealth funds have suffered a torrid time this year with valuations falling across all major asset classes.

Thirteen major stock indices, from Asia to Europe to the US, slumped by an average 12.7% in the first half of 2022. Over the same period, bonds fell 13.8%, real estate 19.3%, private equity 28.2% and infrastructure 1.9%, according to their respective global S&P indices, while Eurekahedge’s hedge fund index is down 2.7%.

Little surprise, then, that sovereign wealth funds have posted losses on their investment portfolios in the first quarter, says US research house Global SWF in its 2022 report on the governance, sustainability and resilience (GSR) of state-owned institutions. Australia’s $187bn Future Fund saw a 1.5% drop, the New Zealand Superannuation Fund ($39bn) was down 3.7%, and Norges Bank Investment Management ($1.36trn) posted negative 4.9%.

Sustainability progress

So, despite pressure on government funds to use their long-term investment horizons and deep pockets for positive environmental and social impact, doing so may not be a priority for this year at least.

Nonetheless, sovereign wealth funds have made some progress, particularly in respect of its focus on climate, indicates Global SWF’s new research, published on Friday (1 July). Its findings are reinforced by separate data and insights from the London-based International Forum of Sovereign Wealth Funds (IFSWF), which tracks the activities of approximately 60 funds.

New York-based Global SWF assigns 100 sovereign wealth funds and 100 public pension funds (PPFs) a GSR percentage based on analysis of publicly available information and submissions from the institutions themselves. Each score comprises 25 elements: ten related to governance issues, ten to sustainability issues, and five to resilience issues (see first table below).

Certain sovereign wealth funds claim to have made big strides in the past year – for example, Abu Dhabi’s Mubadala posted a two-point increase in its sustainability score to 8, and a 28 percentage point rise in its overall GSR score to 84%, after it ticked seven new boxes on the list compared to last year.

Overall, these funds recorded a 0.6 point increase to 4.8 out of 10 for sustainability, helping to drive an overall 6 percentage point rise to 54%. But they are lagging behind PPFs in this area: only five of the 100 surveyed wealth funds received Global SWF’s top score of 10 for sustainability (see tables below), compared to 15 of the 100 public pension funds.

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Sovereign wealth funds are improving their sustainability focus, but are still slower than their PPF counterparts, Diego Lopez, founder and managing director of Global SWF, tells Capital Monitor.

The biggest improvement among the sustainability elements has been that both sovereign wealth funds and PPFs are increasingly recognising ESG as a risk they need to tackle, he says, but regular and detailed ESG reporting is still lacking.

Nonetheless, there is real momentum behind ESG among sovereign wealth funds, Victoria Barbary, director of strategy and communications at IFSWF, tells Capital Monitor. She cites insight from research conducted for a forthcoming report, the organisation’s third annual survey of the actions its members are taking to address climate change.

The latest research shows that all types of sovereign wealth funds are focusing on integrating ESG insights into their investment process, Barbary says. “They are also working on identifying relevant ESG data and the appropriate way to measure and benchmark their ESG strategies and impact.”

This continues the trend from last year’s IFSWF climate survey, the findings of which were published in November. They showed a significant uptick in the use of carbon footprinting or carbon intensity analysis, climate scenario analysis and stranded asset analysis, plus a sharp rise in investment into renewable energy (see two charts below).

ESG data challenges

But ESG measuring, benchmarking and reporting are challenging due to data availability and quality, and because finding and adopting appropriate targets and benchmarks is complex, Barbary says.

“However, each fund will adopt a different set of metrics and standards that most closely align with their mandate and their investment approach, as well as the available resources,” she adds.

What is also clear, though, is that sovereign wealth funds – like other financial institutions – will need holding to account for their climate commitments.

Take Malaysia’s Khazanah, which this month launched a sustainability framework and medium-term targets, with the aim of guiding the $30bn fund and its key investee companies “to integrate ESG considerations into their core business”. Yet it has reportedly ruled out divesting from carbon-intensive state companies such as Malaysia Airlines and power utility Tenaga Nasional, indicating it would be more responsible to support them in their transition away from fossil fuels.

This reflects a hard reality. Sovereigns wealth funds have invested in traditional natural resources for years, from natural gas pipelines to chemical facilities powered by coal, says the 2021 Sovereign Wealth Funds report published in April this year by the IE University Center for the Governance of Change in Madrid. Some $5.5trn of assets have come directly or indirectly from producing or transporting hydrocarbons, it adds.

That will not change overnight. But moves by state funds into renewables and climate change mitigation technologies, and increased focus on ESG-related risks is welcome – and not before time.

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