A shift towards sustainable investing among sovereign wealth funds could serve as a bellwether for national attitudes towards the energy transition
FOSSIL FUELED
Many large sovereign funds are flush with petro-dollars but are now looking for future-proof investments GREEN BACKING
The funds are increasingly diversifying into clean energy—but long after their private counterparts KEY QUOTE
Sovereign wealth funds are starting to emulate private sector investors in retreating from fossil fuel investments
Shadowy investors that have made their money from fossil fuels are now channelling cash into the energy transition. This is not the oil and gas industry, though but the sovereign wealth funds of countries such as the one you might be living in now. State-owned investment vehicles control an estimated $7 trillion in capital. This sounds substantial but is small in relation to the economic power wielded by pension funds and central banks. However, around 90% of that total is concentrated in the world’s top 15 or so sovereign wealth funds. This gives entities such as the Norway Government Pension Fund and China Investment Corporation—among the biggest—significant investment clout, which could be used to fund the energy transition but has been slow to do so until recently. The flow of money from these funds into climate-related equity investments soared from an estimated $2 billion in 2020 to $8 billion in 2021, according to Victoria Barbary of the International Forum of Sovereign Wealth Funds. At the same time, a body called One Planet Sovereign Wealth Funds (OPSWF), founded in 2018 to integrate climate change into investment decision making, is having an impact. The organisation has grown to 18 sovereign wealth funds, including four of the five largest funds in the world, plus 17 asset managers and eight private investment firms. The current collection of OPSWF members has a combined $36 trillion in assets under management. The funds have committed to supporting sustainable investments according to three principles, starting with aligning investment strategies with low-carbon objectives. The Public Investment Fund (PIF) of Saudi Arabia, the world’s fifth-largest sovereign wealth fund, plans to contribute $320 billion to the country’s non-oil-related gross domestic product by 2025. Similarly, the French public investment bank Bpifrance is setting aside €40 billion for climate-related action and the Ireland Strategic Investment Fund is investing €1 billion in climate projects over five years. CLEANTECH SPENDING The OPSWF’s second principle is ownership or addressing material climate change issues in governance, business strategy, risk management and public reporting. An example of this principle in action is the fact that more than 135 asset managers at the Kuwait Investment Authority, the world’s third-largest sovereign wealth fund, now report on the implementation of the OPSWF framework. Elsewhere, Saudi Arabia’s PIF has committed $500 million to a global impact investment platform called TPG Rise Climate and Spain’s Compañía Española de Financiación del Desarrollo has put €150 million into the United Nations’ Green Climate Fund. The OPSWF’s third principle calls on members to consider climate change-related risks and opportunities in investment management, to improve the resilience of long-term investment portfolios. This is seeing major sums being invested directly in climate and energy transition-related projects. Italy’s CDP Equity, for instance, pumped €6 billion into energy transition and climate change-related investments during 2019 and 2020, according to the OPSWF. In 2021, Bpifrance issued a €1.25 billion green bond dedicated to financing or refinancing wind and solar projects in France. “Bpifrance is asserting itself as a climate bank by deploying ever greater financial and human resources to accelerate the development of renewable energies,” said the organisation’s deputy chief executive Arnaud Caudoux at the time. RISK-AVERSE These moves reflect wider financial sector interest in sustainable investing but also mark an important shift in strategy for public companies in charge of national riches. “[These entities] are pretty conservative, with a small ‘c’,” says Barbary of the International Forum of Sovereign Wealth Funds. “That’s not a bad thing, because they are stewarding their citizen’s capital. They don’t want to take too much risk.” Until recently, she says, the funds were not even that interested in equity investments. “Sovereign wealth funds—particularly the top ten—have increased their exposure to private markets over the last five years, quite dramatically,” she says. DIRECT INVESTMENTS A 2021 survey of 98 sovereign wealth funds from 70 countries, conducted by Spain’s IE University and export-import organisation ICEX-Invest in Spain, found the amount of direct investment had increased 171% year on year. The exact level of the funds’ exposure to cleantech is hard to gauge because the organisations do not always disclose their holdings and often invest through green infrastructure funds as well as taking equity positions. Furthermore, the level of cleantech interest varies greatly between funds, since each has a distinct investment philosophy shaped by national priorities and culture. For now, green investing is still not as popular as technology, which was the focus of 42% of all sovereign wealth fund transactions in 2021, according to IE University and ICEX-Invest in Spain’s Sovereign Wealth Funds 2021 Report. However, “There’s a greater awareness that this is a potential opportunity,” Barbary says. BASIC ECONOMICS What is striking about this change in investment strategy is that many of the largest sovereign wealth funds have made their money from activities that directly contribute to climate change. Five of the world’s top ten sovereign wealth funds belong to Norway, Kuwait, Abu Dhabi, Saudi Arabia and Qatar, all countries that are major fossil fuel exporters. Norway and Kuwait have the largest and third-largest funds in the world, respectively. Historically, these funds’ interest in renewable infrastructure may have had less to do with climate change than with simple economics. For countries that derive significant revenues from fossil fuel exports, diversifying investments into other areas helps reduce risk and makes economic sense. WINDFALL PROFITS Increasingly, however, interest in clean energy investments may be driven by a growing awareness that sustainable assets could become more valuable as a result of climate change. This puts sovereign wealth fund managers from oil-exporting countries in something of a bind as oil and gas prices have climbed in recent months, says geo-economic and country risk expert Rachel Ziemba, of advisory firm Ziemba Insights. Having decided to follow mainstream money markets along the path to sustainable, low-carbon investing, they are now seeing massive profits from continued fossil fuel production as gas and oil prices hit record highs. “We have seen, with the sharp run-up of energy prices, significant windfalls to the energy-rich countries, and lots more surpluses that can go into sovereign funds,” Ziemba says. “What they are going to do with these surpluses will be important to watch.” DIVERSIFYING ECONOMIES There are signs that a fair proportion of revenues might go into energy transition projects as oil-rich countries ponder the long-term prospects for fossil fuels. In February 2022, for instance, Saudi Arabian Crown Prince Mohammed bin Salman ordered 4% of the shares in Saudi Aramco, the world’s largest oil exporter, to be transferred into the PIF. The transaction, worth $80 billion, was part of a move to endow the PIF with $1 trillion by the end of 2025, according to reports. In line with its membership of the OPSWF, the sovereign wealth fund is looking to diversify Saudi Arabia’s economy away from oil and towards renewable energy. A leading exponent of this strategy is Norway’s sovereign wealth fund, administered by Norges Bank Investment Management to ensure responsible and long-term management of revenue from Norwegian oil and gas resources. In January 2020, the fund earmarked up to 2% of the $1.3 trillion it has under management for investment in renewable energy infrastructure, with a focus on wind and solar projects in Europe and North America. After years of talk, its first renewables investment, in April 2021, was the acquisition of a 50% interest in the Borssele 1 and 2 offshore wind farms in the Netherlands, with an installed capacity of 752 megawatts. While other oil-rich countries ponder whether to follow the Norwegian model, current high fossil fuel prices might motivate sovereign funds in energy-importing countries to increase spending on the energy transition, Ziemba says. ACCELERATING CLEANTECH China and Singapore are both susceptible to oil and gas costs and have large bank balances. The China Investment Corporation is the world’s second-largest sovereign wealth fund with around $1.2 trillion under management, according to figures from the Sovereign Wealth Fund Institute. Another top ten Chinese entity, the National Council for Social Security Fund, adds more than $447 billion to the country’s sovereign reserves. Singapore also has two funds, GIC and Temasek Holdings, in the top ten. “Investing sustainably is core to our mandate as a long-term investor managing Singapore’s reserves,” says GIC on its website. The fund declined to answer queries but was the only one in the top ten to respond to FORESIGHT Climate & Energy. In July 2020, GIC launched a sustainable investment fund to identify and invest in sustainability-related opportunities that yield good financial returns. OVERTAKING OIL In time this kind of calculation may drive further investments in clean technology, even from sovereign wealth funds in oil-rich countries, says Ziemba. State-owned investors (SOIs), which include sovereign wealth and public pension funds, tripled green energy investments in 2021, according to a report by Global SWF, a financial consulting services and data platform provider. The flow of cash, amounting to an estimated $22.7 billion, far outpaced fossil fuel spending of $6.9 billion. “We are extremely happy to report that SOIs have, for the first time, invested more capital in renewable energy than in oil and gas,” said the report’s authors. “This milestone was a few years in the making and has concluded a trend that has been driven by social pressure and financial returns and accelerated by the Covid-19 pandemic.” ADDITIONAL RETURNS Commitments around net-zero portfolios were expected to ramp up in 2022, the authors said. A similar picture emerges from a 2021 global sovereign asset management study carried out by the investment firm Invesco. The research identified environmental, social and governance (ESG)-based investing as one of five major themes guiding sovereign wealth fund strategy. “Many respondents believe climate change is not fully factored into market prices, offering opportunities for additional returns,” said the report. “In just four years the proportion of respondents adopting an ESG policy at the organisational level has increased dramatically, rising from 46% to 64%.” This makes sense considering that the primary function of sovereign wealth funds is to administer riches for the long term, according to Javier Capapé of IE University’s Center for the Governance of Change. “Their long-term vision allows them to bet on… companies that are transforming the way we fight climate change, understand money and transactions, provide food security or accelerate a more circular economy,” he said at an event in March 2022. GENERATIONAL PERSPECTIVES Sovereign wealth funds typically have investment horizons of 20 years or longer, says Ziemba. “The big ones have very few liquidity needs, unlike a pension fund that has to give disbursements,” Ziemba adds. This allows—or indeed obliges—sovereign wealth fund managers to consider generational trends and invest in infrastructure and assets that will still be around for future generations. With the Intergovernmental Panel on Climate Change (IPCC) now warning carbon emissions must be nearly halved this decade to limit global warming to 1.5ºC above pre-industrial levels, fossil fuels no longer fit in that category. Rather, the clear warnings that the IPCC and others have issued on climate-related risks over the years beg the question of why sovereign funds, supposedly focused on long-term returns, have taken so long to invest in clean energy. Furthermore, sovereign wealth funds are only now starting to emulate private sector investors in retreating from fossil fuel investments. In January 2020, the Qatar Investment Authority announced it would no longer back fossil fuels. Gabon’s sovereign wealth fund, FGIS, has turned its back on coal investments and the National Investment Corporation of the National Bank of Kazakhstan is aiming to limit holdings in carbon-heavy industries such as crude oil production. SUSTAINABLE RICHES The Ireland Strategic Investment Fund, meanwhile, is banned by Ireland’s 2018 Fossil Fuel Divestment Act from investing in 246 companies that derive more than 20% of their revenues from fossil fuel exploration, extraction and refinement. For now, such moves may be challenging for entities such as the State Oil Fund of Azerbaijan or the Fondo Mexicano del Petroleo, which have an allegiance to fossil fuels embedded in their brands. Nor do all sovereign wealth funds need to move in this direction for now. “We have to recognise that a lot of sponsor governments with sovereign funds are not all [in] democratic countries,” Ziemba says. Nevertheless, the growing value of sustainable investments could tempt even the staunchest petrostates to go green. “These are not funds that are investing for political or altruistic reasons,” says Ziemba. “They are looking for investments that are going to give a return.” •
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Jason Deign