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Over the last 15 years and especially since the global financial crisis, investors around the world have been increasingly paying attention to the investment policies of sovereign wealth funds (SWFs). According to the SWF Institute, global assets under management by SWFs have exceeded $8 trillion, and the Norway Government Pension Fund Global manages over $1 trillion of wealth, making them among the largest investors in the world. While SWFs have been in existence for many decades, the public interest in it has only been mounted over recent years. Still, the lack of transparency and political motivations lead host country governments and firms to react cautiously to SWFs’ investments. As SWFs are government-owned, they do not need to exclusively focus on financial returns, but can also add a stakeholder perspective to their investment goals. It is challenging to investigate SWFs considering that many lack transparency and differ significantly in terms of their purpose, geographical focus, and funding source, etc.

Do SWFs, which typically aim at accumulating national wealth for the future generations thus have a long-term investment horizon without short-term liabilities, put a stronger focus on stakeholder welfare compared to other institutional investors? Given their long-term focus and immunity from pursuing short-term financial returns, it is reasonable to expect that SWFs may be more inclined to care about sustainability issues and take environmental, social, and governance (ESG) issues into account in their investment decisions. However, aside from some case studies on specific funds, extensive research on the tradeoff between ESG-focus and pursuit of financial returns by SWFs is still scarce.

Our paper examines the relationship between SWFs’ investments and the ESG practice at the ownership stake level. We distinguish between SWFs’ selection (i.e., whether the ESG performance of potential target firms affects SWF investment decisions) and engagement (i.e., whether SWF investment affects the ESG performance of target firms). To this end, we also distinguish between SWFs with an explicit ESG policy and those without.

In order to gain some insight into how SWFs leave sustainability footprints across the world, partially through their investment in public equity, we collect statements concerning SWFs’ ESG policy from their websites and reports. We also collect data on ESG ratings of their holdings in publicly listed companies. Using a global sample of 24 SWFs (representing over 80% of the total AUM by SWFs globally) that invest in 7,693 listed firms over the period of 2009 to 2018, we find that strikingly, SWFs are quite heterogeneous with regard to their size, organizational structure, funding sources, legal status, investment policies, number of equity investments and size of average equity investment. Also, the vast majority of the SWFs lack transparency and hardly disclose any information with regard to their operations and ESG policies. About half of the SWFs with a high level of transparency formally disclose their ESG policies in their annual statements, which are related to higher value-weighted ESG ratings of the public equity portion of their portfolio. At the portfolio company level, the ESG score of target firms is a strong predictor of its SWF ownership (both of the probability of being invested in and of the ownership stakes held). This relation holds not only for the aggregate ESG score but also for each component score. The ESG relation to SWF ownership is driven by SWFs originating from developed countries and civil law countries and by SWF that explicitly adopt an ESG policy. The positive relationship between SWF ownership and ESG scores of target firms is in line with the existing literature suggesting that the objective of SWFs is to maximize financial returns and minimize risk and losses while taking into account long-term development and stability, and taking ESG scores into account as investment determinant is positively related to corporate financial performance.

To disentangle the selection effect from the engagement effect, we exploit the occurrence of some exogenous shocks (namely, the Deepwater Horizon oil spill catastrophe and the Volkswagen diesel scandal) which primarily influence the incentive to engage rather than the selection. We then conduct a difference-in-difference analysis around those events. We do not find evidence that SWF ownership increases the ESG performance of the firms belonging to the industries concerned, even when we focus on the constituents of the E, S, and G subscores. Therefore, our results show no evidence of engagement of SWFs in the ESG policy of target firms, and instead suggest that SWFs seem to select companies with better ESG performance to invest. This is in line with the findings in the literature suggesting that SWFs primarily behave passively and monitor target firms, not to seek ways to force value-creating changes, but to prevent losses from mismanagement.

A caveat of interpreting our results is that even for the most transparent SWFs, we can only study SWFs’ equity investments and not the investments in other asset classes (such as private equity, bond investments, real estate etc.) which are not disclosed and most of which do not have an ESG rating. It should also be noted that the results are driven by some dominant funds. Nevertheless, our findings highlight how SWFs, being among the most important global institutional investors, leave their ESG footprints across the world. 

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