Sovereign wealth funds (SWFs) are increasingly taking into account environmental, social, and governance (ESG) factors when making investments, according to the latest Sovereign Wealth Funds 2023 report from Preqin.
“In Asia, where climate risks are particularly significant, SWFs still prioritize environmental factors to mitigate climate change risks and support investments in renewable energy projects and decarbonization technologies to achieve their net-zero goals by 2050,” Harsha Narayan, one of the authors of the report, told AsianInvestor.
Preqin's data shows that Asian SWFs with an ESG policy have $3.3 trillion of total assets under management (AUM), which is significantly more than Europe's $1.3 trillion, the Middle East's $1 trillion, and North America's $68.5 billion.
THE CHINA EQUATION
In Asia, this trend has been predominantly driven by the China Investment Corporation (CIC) and the Government of Singapore Investment Corporation (GIC).
The inclusion of CIC's $1.4 trillion AUM is the main reason for the significant increase (126%) in SWF assets managed with an ESG policy in Asia from December 2020 to March 2023.
The report highlights the growing importance of ESG principles in some of the world's largest funds.
“SWFs in Asia, like their global counterparts, are also increasingly focusing on labour practices, including fair wages and workers' rights, and favouring companies that prioritise diversity and inclusion in their workforce,” said Narayan.
However, the percentage of SWFs with an ESG policy in each region paints a slightly different picture, with Asia at 47%; Europe at 46%; the Middle East at 18%; and North America at 13%.
Private capital funds in Europe and North America have made significant progress in integrating ESG into their investment strategies, with 91% and 75% of private capital AUM, respectively, in funds that have an investment policy that includes ESG issues.
In contrast, Asian and Middle Eastern private funds lag well behind, with only 30% and 27% respectively of private capital AUM with an investment policy that includes ESG issues.
Leveraging their substantial size and influence, SWFs actively engage and influence private capital funds on ESG adoption, said Narayan.
“When they invest in funds that demonstrate good ESG practices, they signal to the industry their preference for funds that integrate ESG into their investments. According to our global investor survey, 82% of the LPs felt that fund managers established ESG policies to meet investor demand.”
The growth of ESG investing is being led by Asia's SWFs, according to Preqin’s report.
CIC, in particular, has made significant strides in ESG adoption since 2021.
In response to China's goal of achieving net-zero carbon emissions by 2060, CIC established its first ESG policy framework in 2021, which integrated ESG into its investment processes.
“CIC adopted a formal ESG policy in 2021, a year after China announced its net-zero goal. GIC has also experienced significant growth, with AUM increasing by 76% from $453 billion in 2020 to $799 billion in 2023,” said Narayan.
Singapore’s GIC and Temasek Holdings, which jointly manage $1.1 trillion in AUM, have also made impressive strides in ESG practices. Their combined ESG AUM represents approximately 26% of Asia's total AUM, coming in close to China's 32%.
Temasek has been recognised as the top state-owned investment fund with exemplary governance, sustainability, and resilience practices, according to Global SWF's 2022 GSR Scoreboard.
Temasek launched GenZero, an investment platform company, with an initial capital injection of $3.75 billion to deploy in decarbonisation technologies.
GIC, on the other hand, established a dedicated sustainability office in the summer of 2022, tapping into its Sustainable Investment Fund launched in 2020. These efforts aim to drive investments toward climate-related opportunities such as renewable energy, sustainable infrastructure, and green bonds, thereby supporting the transition to a low-carbon economy, said Narayan.
Several countries, including South Korea, Taiwan, Malaysia, and Vietnam, announced their commitments to achieve net-zero carbon emissions by 2050 at the COP26 UN climate change meeting in 2021.
Although they are taking a step in the right direction, these goals alone may not be enough for Asian countries to achieve net-zero emissions by 2050, due to structural obstacles and the need for significant investments.
However, Asian SWFs have demonstrated that they are more willing to invest in green initiatives and technologies due to their large AUM, which allows them to respond to the urgency of decarbonisation and avoid the worst effects of global warming, according to Preqin.
“Given current macroeconomic and geopolitical headwinds, financial performance remains the primary priority of SWFs in Asia. There is a growing acceptance that good ESG does not necessitate a return sacrifice, and they see ESG as an added component, underpinning robust risk management,” Valerie Mantot-Groene, regional managing director of APAC at the Apex Group, told AsianInvestor.
Increasingly, Mantot-Groene has observed SWFs following the lead of other institutional investors, by requiring detailed ESG reporting for any GPs or Portfolio Companies they are investing into.
“In addition, we are seeing Asian SWFs who may invest in EU markets, funds, and assets, seeking to ‘get ahead’ of the future introduction of regulation, by aligning themselves with ESG best practices, despite there being no current regulatory obligation to do so,” she said.
When confronting systemic ESG risks like climate change, threats to shareholder value at individual companies are critically important, according to Michael Herskovich, global head of stewardship at BNP Paribas Asset Management.
“By integrating ESG priorities, we are not asking companies to act against their own best interests. We are asking them to confront the reality of ESG priorities and act accordingly. And by integrating material ESG priorities, we will achieve long-term sustainable returns for our clients, by placing sustainability at the heart of our strategy and investment philosophy,” Herskovich told AsianInvestor.
Understanding and supporting the transition to a sustainable economy is key, and it requires adopting a single-minded sustainability approach.
“Sustainability is a long-term driver of investment risks and returns. We believe sustainability is imperfectly understood, under-researched, and inefficiently priced, with inconsistent levels of disclosure in Asia,” he said.
In short, managing ESG risks will help promote greater market stability and more sustainable long-term growth while delivering the same, or better, financial returns.