Diverse, evolving and growing: the increasing importance of Sovereign Capital

The world's 179 Sovereign Wealth Funds (SWFs), managing an aggregate of more than $12 trillion¹, are often bracketed together for descriptive purposes. Whilst there are some commonalities, for example they mostly all act as conduits for the investments of surplus state funds, the reality is that SWFs are a hugely diverse grouping, ranging in size² from Norway’s Norges Bank Investment Management (NBIM) with $1.379 trillion assets under management (AUM) to Djibouti’s Fonds Souverain de Djibouti (FSD) with $170 million AUM. SWFs span the world, pursuing objectives and strategies that can diverge as much as they converge.

In some cases, a SWF’s primary goal is to drive economic growth and development in its home country, serving the national interest by catalysing strategically important industries of the future like AI, food production and renewable power generation. For others, the objective is simply to protect and grow the nation's wealth, preserving it for future generations.

While strategies and mandates vary widely, SWFs share a number of common traits and face many of the same challenges, including navigating macro-economic and geopolitical changes, continually evolving relationships with private equity, not to mention, investment risk and governance, and sustainability. 

Increasing AUM…

Off the back of a tough 2022 from a performance perspective, followed by a modest improvement during 2023, SWFs now appear to be moving back to a more solid growth trajectory. In virtually every case, the direction of travel is towards continued growth in AUM – via surplus capital contributions, asset transfers, a recycling of invested capital, and of course performance income and asset appreciation – and further diversification of the capital they in turn deploy.

Industry estimates³ point to AUM continuing to grow from $12 trillion today to $18 trillion by 2030, a 50% increase. This growth in AUM is set to be further fuelled by continuing launches of new funds around the world; since the beginning of this decade, 13 new funds have already launched and recent press commentary has even extended to new funds in both the UK and the US.

…but growing challenges in a volatile global environment

However, like all investors, SWFs face headwinds. Whilst inflation appears to be coming under control in most parts of the world and the interest rate cycle seems to have turned, economic issues have now been replaced at the top of the risk register with continued geopolitical uncertainty. A fractured, more turbulent world poses risks for any global investor, but as mostly government-related entities, SWFs need to navigate an even more careful course. A heightened degree of caution remains the order of the day with some funds reporting net divestments in 2023 and only relatively modest (albeit improving) deployments of capital in the first half of 2024.

In response, sovereign investors have also been actioning a range of responses⁴ – including increasing their allocations to fixed income, private credit and infrastructure. They continue to be significant investors in all forms of private equity, extending to secondary deals and General Partner (GP) stake investing.

SWFs can also take advantage of potentially longer-term investment horizons; unless they are in joint ventures with other general partners, they are not restricted by traditional fund timelines. Investing strategically in the right opportunities, they can be flexible over both how they deploy and the timelines over which they invest.

Geographical priorities are shifting

SWFs’ ability to deploy capital at scale arguably means they are better placed than some to shift geographical focus. Whilst Sovereign investors’ US portfolios continue to grow, Japan and India are increasingly popular destinations for investment.

Conversely, we have seen interest and investments into Europe and China somewhat wane, with ‘China plus one’ strategies seeing the focus expand to the likes of Indonesia, the Philippines and Vietnam. Interestingly, as US funds have decoupled from China, some of the Asia region’s biggest SWFs have moved in to pick up Chinese assets, especially in non-tech sectors such as domestic consumer businesses and the green economy.

Looking to 2025 and beyond

In a fund-raising market that’s set to remain tough, SWFs’ unique combination of capital at scale, flexibility in approach and a long-term perspective means they are now arguably more important and influential as potential direct investors, Limited Partners and co-investors than ever before. They will inevitably gravitate to higher-quality managers. This selective approach, mirrored by gradual and ongoing consolidation of GPs, will help SWFs meet their return expectations – a matter of public interest and occasional political scrutiny.

Given the recent period of subdued M&A activity, there’s pent-up demand for deals, which may be amplified by falling financing costs. While these factors don’t directly drive activity by SWFs, they may trigger more deal activity by the co-investors that SWFs partner with, creating opportunities for them to step in, deploy capital and generate good and sustainable returns.

Absent unforeseen shocks, the broad expectation continues to be for a steady increase in activity as we move into 2025 and beyond.

Stay tuned…

In the environment we’ve described, we think SWFs need to focus particularly on two key areas, both of which we’ll explore in forthcoming blogs.

The first is risk and controls – increasingly business critical as SWFs move between asset classes and geographies and expand their operating footprint. Ever more complex tax systems also call for rigorous and quickly adaptable governance, risk and control frameworks. And in a world where investors can no longer rely on buying low and selling high, actively managing the assets they hold (if not directly then via their partners), brings focus to the need to be able to truly understand and manage performance, through the cycle.

The second area is sustainability, a growing consideration across almost all investment decisions, including those made by SWFs. SWFs as a collective have a major role to play in the energy transition (a topic we will examine in a separate and new piece of thought leadership we will release shortly). When investing for the long term, it’s vital to establish that the investments will stand up to scrutiny in five or ten years’ time, even more so where an SWF’s host country has made commitments to foster a sustainable future.

We’ll be publishing these follow-on blogs soon, so watch this space. In the meantime, please learn more about Sovereign Wealth Investment Funds by clicking on the link below.

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_{^[1]Financial Times, Britain is building a new sovereign wealth fund - what can it learn from the others?, 10 September 2024
^[2]https://globalswf.com/ranking
^[3]https://globalswf.com/reports/2024annual#the-world-in-2024-3
^[4]Global SWF 2024 Annual Report, August 2024}