Navigating the Polycrisis: Sovereign Wealth Funds’ Sustainable Investments in Turbulent Times

Bernardo Bortolotti, University of Turin and Transition Investment Lab, Stern at NYUAD
Abhinav Mangat, Transition Investment Lab, Stern at NYUAD

The opinions contained here are those of the authors and do not reflect the views of IFSWF or any of its members.

1. Introduction

The past four years have seen a simultaneous occurrence of multiple negative shocks: the COVID-19 pandemic and two devastating conflicts in Europe and the Middle East.

Geopolitical risk has disrupted global value chains, straining international trade and inflationary pressures that monetary policy tightening is struggling to contain. According to the IMF, trade flows between geopolitical blocs have declined by 2.4% since the start of the war in Ukraine compared with the growth of trade within blocs, an alarming sign of geoeconomic fragmentation. Globalisation seems strained today, with governments of all stripes grappling with security concerns on defence, energy, and technology that seemed improbable not long ago. Amid this backdrop of interconnected contingent issues, the looming challenges of climate change and income inequality persist.

Sovereign wealth funds have a fiduciary duty to generate robust returns on their investments. As universal investors, they also have the incentive and agency to address market failures and global externalities that could affect financial performance in the long run. Nonetheless, state ownership requires investors to consider policy issues in their strategies, which can limit the investable universe amid heightened geopolitical risk. Sovereign investing in these turbulent times thus requires a balancing act that combines vision and pragmatism.

How are sovereign wealth funds navigating the polycrisis? More specifically, what are the latest trends in their sustainable investments? Has the current turmoil led sovereign wealth funds to focus on short-term domestic challenges, or are they staying committed to investing for long-term sustainability?

Starting from the IFSWF database we classified sovereign wealth fund direct investments from 2020 to 2023 deals as “sustainable” (or aligned with the UN’s Sustainable Development Goals) when they were executed in sectors aligned with the IRIS+ taxonomy, a standard reference in the field. As in previous years, we decided to use the UN Environment Programme’s broad definition of “sustainability”, which contains both environmental and economic inclusivity dimensions.

2. Trends

Our database sample included 1,402 transactions totalling $286 billion. We classified 406 transactions (29%) as sustainable deals, representing a total value of $62 billion (21%). Although SDG transactions comprised a relatively small proportion of the total sovereign wealth fund activity during the timeframe, the latest trend indicates a significant increase in sustainable investment value in 2023, up about 50%, despite an 8% decline in deal count. This suggests that investment value has been gaining momentum over the past year, along with an increase in ticket size, signalling a consolidation of sustainable investment opportunities.

Source: IFSWF Database - IRIS+ Classification

A review of the sectoral distribution of sustainable investments over time appears to demonstrate that sovereign wealth funds’ strategies are becoming more influenced by domestic crises and can respond remarkably quickly in emergencies. For instance, the surge of investments in healthcare during the 2020-21 period contributed to the discovery and large-scale production of COVID-19 vaccines such as BioNTech and Moderna, showcasing sovereign wealth funds’ ability to support governments in the fight against the pandemic. Additionally, 2020 saw a record (albeit still small) number of agriculture investments, possibly reflecting a heightened concern about food security due to the COVID-19-related shock on supply chains.

With 40% of deals and 28% of value, healthcare remained a crucial pillar of sustainable investments throughout the period given the relevance of megatrends such as ageing populations, and the spread of related diseases. However, its prominence waned over the last two years in favour of clean energy as the most popular target industry for sovereign wealth funds. Sustainable energy deals—including renewables, energy access and efficiency —were valued at $12.8 billion, accounting for 62% of total SDG investment value in 2023. We have extended the IRIS+ category of clean energy to include energy transition resources, such as critical metals and minerals needed for the deployment of renewable energy technologies such as wind turbines, batteries and electric vehicles., For example, the largest deal in 2023 was the Saudi Arabian Public Investment Fund’s $2.8 billion acquisition of Vale Base Metals. The Brazilian conglomerate manages nickel mines in Canada and Indonesia, copper mines in Brazil, and with plans to in cobalt and platinum group metals.

The energy sector data shows that investments in green energy are not only increasing but also expanding their share in the energy mix. The sample period highlights that non-renewable energy resources such as oil and gas became less attractive to sovereign wealth funds as they continued their commitments to combatting climate change.

The sectoral analysis shows how sovereign wealth funds adapted to global challenges like climate change and investing in the energy transition. At the same time, over the past four years, they have also addressed the most pressing issues in their domestic economies.

The data on sovereign wealth fund sustainable investments reveals some geopolitical themes, although it is premature to draw any conclusions.

Source: IFSWF Database - IRIS+ Classification

As highlighted in an op-ed for IFSWF by Udaibir Das, “Buckle Up for the Ride: Sovereign Wealth Funds Grapple with Fragmentation and Conflict”, in times of heightened geopolitical tensions, sovereign wealth funds may seek to diversify their portfolios geographically and across asset classes to mitigate risks associated with specific regions or industries affected by geopolitical instability. This diversification strategy could lead to a shift in investment destinations, favouring economies or sectors less susceptible to geopolitical disruptions, and prioritising investments that align with broader national interests or diplomatic objectives.

In 2023, we observed a significant increase in the number of domestic and intra-regional sustainable investments, nearly two-thirds of the year's total sustainable investment activity. Regional deals stand out, doubling their share compared to the previous year to 42% of total sustainable deals in 2023. The share of genuinely global investments, namely overseas investments that crossed major macro-regions, has dwindled to a historic low of 27%. This trend is less pronounced in the data by value, where global deals still represent the lion’s share, as they tend to be in developed markets where ticket sizes tend to be higher. Indeed, there are no domestic investments among the 20 largest investments by value, a clear indication of the scarcity of sizable sustainable investment opportunities at home. The share of intra-regional deals, however, has grown considerably over 2023, reaching 22% of the total sustainable investments.

This data is broadly consistent with the view that as far as sustainable investments are concerned sovereign wealth fund strategies are affected by the "de-globalisation risk" induced by geopolitical crises. As global trade slows down, foreign direct investment follows suit, and it has implications for the pace of foreign asset accumulation by (once) large exporting countries. Transatlantic trade, particularly to North America, is the most negatively affected, leading to the US no longer being the main destination of sovereign wealth fund investments. The share of SWF investment in North America has more than halved over the past year, dropping to just 17%. Geopolitical risk appears to be reshaping global trade and investments, with a reallocation of trade capital flows aligning with the beginnings of a new economic order characterised by regional connectivity and interdependence within politically more homogenous coalitions of countries. The rise of regional deals and the increased attractiveness of destinations closer to the source of capital such as Europe are interesting developments to follow.

3. Conclusion

Sovereign wealth fund sustainable investments have been gaining considerable momentum in recent times, and 2023 serves as a clear illustration that sustainability-related themes are key. The ticket size of SDG-aligned deals is also rapidly converging with conventional investments, perhaps driven by large investments in clean energy projects.

Source: IFSWF Database - IRIS+ Classification

Yet, a growing concentration on clean energy and health underscores a recognition of climate change and health as the most pressing global challenges. Critical areas such as water and sanitation, food security, education, forestry and biodiversity conservation, have received less attention from sovereign wealth funds. This discrepancy highlights the importance of a more comprehensive approach to sustainable investing, ensuring that long-term investors can address a broader spectrum of societal and environmental needs.

Our analysis suggests that sovereign wealth funds are adapting their investment strategies to geopolitical events, leading to a significant reallocation towards domestic and regional investments. This underscores the significance of what are commonly referred to as "de-globalization risks". From this standpoint, emerging markets and developing economies of the Global South could represent interesting diversification opportunities. Overall, while geopolitical turmoil can pose challenges for all investors, it also presents opportunities for strategic adaptation and innovation in portfolio management approaches. Monitoring how sovereign wealth funds navigate these turbulent geopolitical waters could offer valuable insights into evolving investment trends and global economic dynamics.