Why SWFs and sustainability investments are a natural fit – and how to maximise the associated long-term value

The world’s sovereign wealth funds (SWFs) constitute an extremely varied group of investors with a wide diversity of mandates. But when it comes to investing for sustainable outcomes, they share some common features that set them apart from other investors. 

So far in this series of blogs on SWFs, we’ve looked at the broad landscape within which SWFs operate today, and then at how they can effectively apply governance and controls to manage risks in a volatile world. Now we dig deeper into how SWFs can integrate sustainability, such as climate transition investments, into their investment lifecycle, and as an integral pillar of their investment strategy and processes.  

Marrying returns and impact

As SWFs worldwide consider their approach to sustainability, they face a conundrum: how to do good by supporting the energy transition, while also doing well against their core objective to maximise financial returns on capital for their host nation? In answering this question, two characteristics of SWFs come to the fore. 

First, they’re responsible for delivering on their mandates through the long-term performance of their portfolios. As ‘patient investors’ free from tight investment horizons and geared to the stewardship of wealth for future generations, they’re well positioned to seize investment opportunities arising from climate change’s impact on asset pools – which likewise play out over lengthy timeframes. 

In assessing these opportunities, it’s important to recognise that SWFs can benefit from the simplicity that comes from having a single sovereign investor. This means they’re able to consider sustainability as a market opportunity focusing on value and long-term returns, without being subject to the growing pains of sustainable finance – such as issues around product labelling and alignment between international regulations.

Irrespective of such concerns, the reality is that global transition to a low-carbon economy is both unstoppable and the opportunity of a generation. As it gains scale and momentum, SWFs’ long-term investment lens can enable them to meet the twin goals of catalysing strategic industries (such as cleantech and climate change adaptation solutions), while simultaneously serving their core mandate – and even generating legacy, societal and environmental returns in the process.   

Managing exposures to climate impacts across portfolios

Second, as the managers of diverse investment portfolios across multiple companies, asset classes and markets – SWFs are inherently exposed to a wide range of risks from climate change-related impacts, including regulatory interventions. Since these impacts are inevitable and growing in scale, forward-looking SWF asset owners will focus on addressing them, thereby improving the health, viability and performance of the portfolio. 

Many are already doing so. The International Forum of Sovereign Wealth Funds¹ finds that 91% of the SWFs surveyed view climate change as consistent with their mandate. And 74% actively incorporate it into their objectives.

Four enablers to operationalise a focus on sustainability

Given the right intelligence and investment approach – SWFs can both fulfil their core mandate and capitalise on a diverse array of climate-related scenarios, including shifts in demand, technology innovation, and portfolio companies’ ability to scale solutions that cut emissions or enable climate adaptation. 

Here are four vital enablers that we’ve identified to help turn a focus on sustainability into a reality for SWFs.

1. Building internal capabilities and skillsets to embed sustainability into the investment process and manage the sustainability lifecycle of investments. This includes enhancing and integrating elements like sustainability due diligence, portfolio monitoring at both the portfolio and company level, and valuation through a sustainability lens, using financial quantification to put a monetary value on how climate could impact asset values over time. The effect is to marry the sustainability agenda with the day-to-day investment lifecycle and move away from sustainability being a siloed support function.
2. Showing the value of sustainability to investment teams. Today, funds’ investment professionals often regard sustainability as a hindrance to their core focus on finding deals, deploying capital and creating value. They shouldn’t. To change this perception, teams need to be provided with real-world examples of where sustainability has generated returns and secured strong exit valuations.
3. Learning from regulated companies to adopt leading practices in sustainability. In regulated industries, companies often move towards sustainability because they’re required to do so for compliance reasons. While SWFs don’t face this pressure, they nevertheless can absorb and emulate proven approaches that have worked for these companies.
4. Collaboration and information-sharing with other types of institutions that share common sustainability goals. Sovereign capital has a pivotal role to play in the energy transition. But it can’t achieve it on its own. An opportunity that’s currently largely untapped is working in partnership with Development Finance Institutes (DFIs) to magnify the positive impact of investments. These collaborations can shift the threshold on risk parameters and returns, enabling SWFs to invest higher amounts at lower risk. And supporting the adoption of common standards for climate disclosures and analysis can help to accelerate and scale up the energy transition across more markets.  

Bridging the climate finance gap is a top global priority – one to which SWFs are ideally placed to contribute. Their long-term investment horizons mean that they can lead on doing this profitably while also benefiting society – and our four-point action plan will help them step up to the plate.

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^{[1] https://www.ifswf.org/}