Sovereign Wealth Funds’ Social Focus

Ana Nacvalovaite, Research Fellow at the University of Oxford, explains how investing in employee-owned businesses can help sovereign funds create prosperity for future generations.

Sovereign wealth funds’ (SWFs) assets under management (AUM) hit an all-time high of US$11.2 trillion globally in 2023, according to the Global SWF Annual Report 2024. But they invested less, and less often, than in 2022.

The challenging macro environment – including geopolitical conflicts and volatile markets – led to SWFs’ investments falling by 20% to US$124.7 billion compared to 2022. They participated in 324 deals – a 24% year-on-year decline.

While SWFs have continued to operate cautiously in 2024, they have displayed growing interest in sectors such as technology, healthcare and infrastructure, and have move away from traditional investments such as real estate – previously the backbone of their portfolios.

Renewable energy and green technologies have also been a focus point, largely due to the global push towards sustainability and decarbonisation, according to Ana Nacvalovaite, Research Fellow at the University of Oxford.

“SWFs are also participating more in venture capital, seeking high returns from start-ups and innovative businesses,” she told ESG Investor. “In addition, regional preferences are shifting, with a strong focus on emerging markets such as Asia and Africa, which offer substantial growth potential despite perceived higher risks.”

While SWFs have historically been very conservative, they now have a greater appetite for going into places where the growth potential is higher, Nacvalovaite added.

Many African nations have developed strategic road maps for growing and supporting domestic businesses, and implemented policy reforms to encourage foreign investment. “Governments are now engaging in stewardship of companies, as well as creating innovation hubs where the younger generation can be more experimental and launch new companies,” she said.

In Rwanda, for example, the government and SWF Agaciro Development Fund (ADF) are supporting several innovation hubs.

Importantly, having the backing of an SWF opens up the potential for an enterprise to access blended finance. “If a company can get 10% of its financing from a SWF and 30% from a development bank, then it becomes much easier for the business to attract the rest of the financing from a private capital source,” said Nacvalovaite. “The private investor feels more comfortable when going into partnership with such institutions.”

Portfolio diversification

The change in SWF risk appetite has also been driven by the desire to diversify their investments. By maintaining a varied portfolio that balances risk and returns across different classes and geographies, a sovereign investor can afford to enter riskier investment areas.

According to Nacvalovaite, SWFs have also been building out strong investment teams equipped with knowledge on how to support greater diversification.

“While the mandate of every SWF is return first and foremost, we are living in times when it is not guaranteed and capital preservation is often difficult enough,” she explained. “As such, SWFs have become more accustomed to [being bolder] over the years.”

For example, Saudi Arabia’s Public Investment Fund (PIF), with US$700 billion AUM, is the main catalyst for the country’s Vision 2030. As such, it is investing in projects aligned with the goal of increased economic, social and cultural diversification. Similar to the ADF, the PIF is investing in the innovation economy.

“The PIF has created innovation hubs in almost every industry and has the financial foundations to attract the best globally,” said Nacvalovaite. “It is also financing the construction of the world’s largest hydrogen production plant in Neom Oxagon City. Such projects support both environmental sustainability and economic diversification goals.”

Double impact

Nacvalovaite has gleaned insights into SWF trends during her three-year research project at Oxford University’s Kellogg’s Centre for Mutual & Co-owned Business. She is investigating whether such funds would focus investments on local cooperatives, mutual societies and co-owned businesses as a way of enhancing social and environmental sustainability.

The research positions SWFs as pivotal players in the drive towards sustainable development. “As an entity with extensive access and vast funds, a SWF has the tools to make an impact,” said Nacvalovaite. “These are long-term patient investors who can leverage their capital for driving positive outcomes.”

She argued that SWFs can create wealth for future generations by maintaining a diversified investment portfolio through a balance of risk and return across different asset classes and geographies, as well as investing in sustainable and innovative sectors for long-term growth. They can also lead in the adoption of best practices, such as governance, transparency and ethical investment.

However, investing in social sustainability has several challenges, including difficult geopolitical environment in many countries, as well as a perceived lower rate of return and higher risk.

“There is a common misconception that social sustainability investments yield lower financial returns compared to traditional investments, despite evidence that they are profitable in the long term,” she said. “However, it is difficult to measure social impact and there is a lack of standardised metrics. Data is a huge problem, which makes it challenging to assess the effectiveness of social investments.

“In addition, social sustainability projects are often viewed as higher risk because, in terms of scalability and financial performance, we haven’t enough data to counter that view as yet.”

The research fellow believes greater collaboration between the private and public sectors, as well as academics, is needed to address social sustainability investments. “When everyone sits around the table and discusses the issues that they’re facing, SWFs can take the lead on helping solve these issues,” she said.

“However, they can also be secretive – or at least not entirely transparent,” she continued. “There are some exceptions, such as the Norges Bank Investment Management (NBIM) and the New Zealand Superannuation Fund, but many others don’t want to share information. Until we find a healthy balance, it will be difficult for us to make a united impact.”

Yet many SWFs, particularly those aligned with national development goals or Sustainable Development Goals (SDGs), are already making a difference. The key conversations are around integrated strategies and understanding how combining environmental and social goals can lead to better outcomes, Nacvalovaite explained.

“This is about improving community health, as well as diversifying the options at our disposal to enhance our wellbeing,” she said. “Active stewardship conversations should revolve around what we want as a community, so that in each of them we’re building our capacity to look after our assets and create new, innovative jobs.”

Employee-owned enterprises

While Nacvalovaite believes SWFs are waking up to the ‘S’ in ESG, she described the tension with the ‘E’ as a sensitive topic. How far each institution is on that continuum varies from country to country, she said.

NBIM, for example, incorporates both an environmental and a social focus, with a strong commitment to ESG principles overall. However, under its current mandate the Norwegian SWF is not allowed to invest in domestic cooperatives or employee-owned businesses.

Rwanda’s ADF, on the other hand, is able to make inward investment in local enterprises. As such, it works with the Pink House, which is both a workers’ cooperative and charity supporting women suffering from breast cancer. The cooperative has 15 workers involved in its loofah exfoliating sponge manufacturing project and its revenue is shared between workers, with a percentage allocated to the charity.

“Women coming from all over Rwanda to undergo chemotherapy receive free room and board,” said Nacvalovaite. “It is an interesting, blended format in investment aid and it would be great to see [other similar] initiatives. These social initiatives are commercially viable, but we need to inform investors who are not familiar with the model.”

SWFs have generally shown varying degrees of enthusiasm towards investments in co-owned businesses – though funds with mandates aligned with national development goals are more proactive in this space, she said.

“Many say that they may be willing to look into employee-owned enterprises because they want to support economic diversification, local entrepreneurship and community development,” said Nacvalovaite. “But the main concerns are around governance, scalability and financial performance. Also the fact that the legal definition of a cooperative or mutual differs between jurisdictions.”

Conducting due diligence on both cooperatives and mutuals is challenging, and therefore costly.

“With the data that I have now, it is clear that cooperatives are particularly tricky,” she said. “However, mutuals are something that SWFs may be willing to learn more about, provided that the employee-ownership structure is not more than 10% or 20%. Otherwise, the math does not quite add up for them.”

Nacvalovaite is hopeful that with more data and conversations that help SWFs understand the structure and benefits of ESG and SDGs, it will be possible to develop a mechanism enabling them to focus on investments into employee-run social enterprises.

“That would make a huge difference for communities and future generations,” she added, pointing to the work of Pete Stavros, Partner and Co-head of Global Private Equity at investment firm KKR, who has evaluated how the legal framework can be changed to take the fear out of employee-owned businesses.

In 2021, he launched Ownership Works – a non-profit focused on broadening corporate ownership and enhancing workforce financial resilience.

“Through his seminal work, Stavros is educating the SWF community and wider society about the benefits of such investments,” said Nacvalovaite. “He also makes the case that not only is it profitable for the investor – it’s also life-changing for the employee.”

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