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E-MailHao Liang is Assistant Professor of Finance at Singapore Management University and Luc Renneboog is Professor of Finance at Tilburg University. This post is based on their recent paper. Related research from the Program on Corporate Governance includes Reconciling Fiduciary Duty and Social Conscience: The Law and Economics of ESG Investing by a Trustee by Robert H. Sitkoff and Max M. Schanzenbach (discussed on the Forum here); Social Responsibility Resolutions by Scott Hirst (discussed on the Forum here); and Socially Responsible Firms by Alan Ferrell, Hao Liang, and Luc Renneboog (discussed on the Forum here).
Over the last 15 years and especially around the time of the financial crisis, interest in and attention to the investment policies of sovereign wealth funds (SWFs) have grown. 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. While SWFs have been in existence for many decades, it has attracted attention only until recent years, especially since the global financial crisis. The purchase of a $3 billion in equity in the Blackstone Group in 2007 by China Investment Corporation (CIC)—the SWF of China—sparked public interest. Several Asian and Persian Gulf-based SWFs bought $60 billion of newly issued equity in large American and European banks in 2008, thereby playing a critical stabilizing role in the aftermath of the crisis. 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. Examples of SWF who explicitly have a corporate social responsibility (CSR) perspective include the Norwegian Oil fund, as well as the SWFs of New-Zealand and France (United Nations Environment Programme, 2017). 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.
Since the global financial crisis of 2007-2008, more than 30 new SWFs have been established, such as the Turkey Wealth Fund in 2016 and the Japan Investment Corporation in 2018. Currently, SWFs are among the largest investors in the world, with Norway’s Government Pension Fund Global (or Norges Bank Investment Management) controlling more than $1 trillion in assets under management (AUM) (SWF Institute, 2019).
Do SWFs, which typically aim at accumulating national wealth for the future generations thus have a long-term investment horizon without short-term liabilities, have a stronger focus on stakeholder welfare rather than mere shareholder return orientation, compared to other institutional investors? Given their focus on the long-term and immunity from pursuing short-term financial returns, it is reasonable to expect that SWFs may be in a prime position to focus on long-term corporate and societal sustainability by taking environmental, social, and governance (ESG) issues into account in their investment decisions. Such a stakeholder-orientation does not necessarily mean a sacrifice to shareholder returns, as a modest positive relation between socially responsible investing (SRI) and corporate financial performance has on average been documented in academic research. 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.
This paper examines 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. Also, SWFs mainly use ESG score as a selection criterion to include or exclude target firms in their portfolio, but do not actively engage in target firms in order to improve their ESG policy.
With regard to the generalizability of our results, a caveat 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. Moreover, another limitation is that the execution of an event study to test for engagement of SWFs is not possible as the exact dates of the SWF investment and ESG rating are not available in the databased employed. Nevertheless, our findings highlight how SWFs, being among the most important global institutional investors, leave their ESG footprints across the world.
The full paper is available from download here.
