COVID-19 Forced Sovereign Wealth Funds to Prioritize Sustainability

Sovereign wealth funds are among the newest and most heterogenous class of institutional investors. The term was only coined in 2005, to characterize several already existing organizations that invested on behalf of governments.

Yet, because these organizations are accountable to the local populations they serve, they were quickly used as rainy-day funds during the early days of the pandemic. Three Latin American funds were completely exhausted, while others in different parts of the world were reformulated or merged. This dramatic shock to the sovereign wealth fund industry led to a change in how these organizations function, according to an academic paper by Diego López that was published this February.

“One can argue that 2020 has indeed marked the beginning of ‘SWF 3.0’, a period for a more mature industry that is focused on specific matters such as sustainability, resilience, and cooperation,” writes López.

The paper refers to SWF 3.0 as the post-pandemic era, SWF 2.0 as the era between 2005 and 2020, and SWF 1.0 as the early era of sovereign wealth funds before a name was coined.

“COVID-19 ended the opulence and excesses of SWFs and accelerated some of the trends occurring in the industry,” states the paper. These trends include “less and different real estate, more healthcare and technology, more partnerships, more ESG, and, especially, more venture capital.”

For example, sovereign wealth funds are now involved in startup investments all over the world.

“Funds are now able to enter earlier and smaller financing rounds, including seed and Series A, which was unthinkable a few years ago,” López writes.

The pandemic also pushed the funds to focus more on domestic investments, as SWFs were often relied upon to help with bailouts. Funds have also moved away from traditional real estate investing.

“Investments in brick and mortar, once favored by SWFs because of their alignment in risk and horizon, have decreased in volume from 34% of the total in 2012 to 18% in 2021,” states the paper.

Over the last decade, the amount of assets owned by sovereign wealth funds has increased dramatically. In 2008, global SWFs owned just $3.5 billion in total assets. In 2021, that number was $10.5 billion.

For the funds that survived the pandemic, long-term resilience has taken on greater importance. Now that the “rainy day” is passing, investors are starting to think further into the future. This has meant an increasing interest in long-term investing strategies. But sovereign wealth funds still trail behind many other institutional investors when it comes to ESG.

“Only 12 funds are signatory members of the UN Principles for Responsible Investing and only German quasi-SWF KENFO and NZ [New Zealand] Super Fund have committed to the objective of Net Zero by 2050,” states the paper.