ESG Investing On The Rise: Two Thirds Of Middle East Sovereign Wealth Funds Now Have A Top Down ESG Policy

A major global study by Invesco has found environmental, social and governance (ESG) adoption rapidly gaining traction among global sovereign investors and Central Banks. The Invesco Global Sovereign Asset Management Study, which surveyed 139 global sovereign investors and Central Bank reserve managers, showed over half (60%) of sovereigns now incorporate a top-down ESG policy – up from 46% in 2017. Middle East sovereigns in particular have accelerated their pace of integrating ESG considerations into their investment processes. The study found that more than two-thirds (67%) of sovereign wealth funds in the Middle East have an ESG policy, up from 30% in 2017 (Figure 1).

The findings highlight a marked evolution in terms of both uptake and sophistication of ESG policies.  In 2017, the Invesco study highlighted the polarisation between sovereigns with regards to ESG, with supporters moving to further embed and integrate ESG in investment processes while non-supporters waited for evidence on investment implications. Two years on, ESG for many is now front of mind, with supporters becoming more focused in their approach, adding dedicated teams and deepening the integration of ESG into their investment processes.

SWF driving attention to responsible investing in the Middle East

Governments in the region are building a framework to drive sustainability through setting up national sustainability goals, revamping water security programs, launching diversity initiatives, introducing ESG financial disclosure standards, publishing ESG guidelines for exchange listing and more. Sovereign wealth funds are driving attention to core themes that have impact on sustainability and long-termism in the region. The most prominent examples of ESG adoption has been stewardship around the climate-focused One Planet initiative, which includes four of six founding members from the Middle East. Several funds have been investing in green energy and other oil-diversification initiatives.

Broad range of asset classes are viable for ESG implementation

The study revealed that there is a broad view among sovereign wealth funds globally that ESG can be integrated into most asset classes. While equities have been the initial starting point for ESG implementation, this year’s study found of the sovereign wealth funds in the Middle East that incorporate ESG at the asset class level, 100% are now applying ESG considerations into their alternative asset portfolios including real estate, infrastructure and private equity (Figure 2). This is in contrast to sovereigns in other regions where ESG investing has expanded more towards fixed income asset classes.

This disparity is in line with the efforts made by funds in the Middle East where many have intensified their focus on ESG by building extensive internal investment teams dedicated to real estate and infrastructure, where they can apply ESG principles more directly.

The long and winding road

There are numerous challenges that need to be addressed to fully integrate ESG into the investment process, according to the findings. The absence of quality ESG data remains a key issue, with 57% of Middle East sovereigns citing quality data and ratings as the main challenge in incorporating ESG. Monitoring is also seen as a big challenge, reflecting the limited resources and nascent reporting infrastructure (Figure 3).

Environmental concerns move into focus

A major trend highlighted by the 2019 study is the shift in focus toward “E” environment initiatives. Asset owners have, in the past, focused on “G” governance factors such as board composition and the ability to flag controversies. These are now relatively easier to measure and monitor. Middle East sovereigns in particular, are now looking to environmental concerns, with “pollution”, “resource efficiency” and “water scarcity” the top most important ESG issues (Figure 4).

Sovereigns are approaching environmental factors with an increased level of sophistication compared to 2017. The perceived increased frequency of physical climate risks such as hurricanes, heatwaves, earthquakes, and wildfires has precipitated some to pinpoint the risks of such events to assets such as infrastructure. These risks are now also being considered for assets located in emerging markets, which until recently was considered near impossible by many given a lack of information and transparency.

This leaves “S” social factors as the main remaining barrier requiring definition and measurement.  While some ESG leaders think of “S” as the risk of loss of social licence, for most sovereigns’ social factors have yet to become a practicable means of evaluating risk/return.

Josette Rizk, Client Director, Institutional Sales, Invesco Middle East and Africa, Invesco, commented:

“Over the past two years we have seen an uptick among sovereign investors towards adopting and integrating ESG factors into their overall investment policies.  The initial focus was on the improvement of governance practices such as better disclosure and transparency. Our latest study reveals that investors are broadening their ESG focus to environmental considerations, in response to an increased awareness to climate change and its impact on the environment. While the growing focus on ESG is a positive development in the Middle East, investors are still in the early stages of adoption.”