Rising Nationalism, Inflation Create ‘Unique Risks’ for Sovereign Wealth Funds

The global trend of rising nationalism and populism is creating “unique risks for sovereign wealth funds,” according to a recent analysis from the International Forum of Sovereign Wealth Funds, a global network of approximately 50 sovereign wealth funds.

According to the analysis, written by IFSWF Senior Adviser Udaibir Das, the global economy is undergoing “structural challenges,” such as climate change and inequality, and that sovereign wealth funds must adapt to the new realities more than other investors.

“The rise of nationalism, populism, trade barriers, financial sanctions, and economic fragmentation has engendered a world that is inherently less stable and more brittle,” Das wrote. “The current global economic and capital market conditions necessitate reassessing conventional portfolio construction and risk management practices.”

Das writes that “resiliency risks” present sovereign wealth funds with significant challenges. He suggests funds consider working with venture capital firms to spot investment opportunities, as well as actively engaging with portfolio companies to improve their ESG practices and risk management. He noted that engagement should include regularly evaluating portfolio companies’ risk management capabilities, focusing on ESG, climate change, technology and AI, geopolitics, and other emerging risks.

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“Sovereign wealth funds must make their portfolios more resilient in this brittle and uncertain investment environment,” Das wrote. “They need to adopt more active and nuanced approaches to portfolio construction, investment themes, and strategies, using scenario analysis, stress testing, and enhancing risk management. They must also be vigilant to ensure that critical parts of the financial system remain functional when needed.”

Das also warns that inflation is another significant risk facing sovereign wealth funds. He notes that as a result of “complex macroeconomic factors” spurring short-term inflationary pressures, sovereign wealth funds have been seeking out so-called inflation-proof investments to “preserve their portfolios over time” as well as assets and investments that grow in value at least at the same pace as inflation, if not greater.

“A consensus view posits that inflation will remain elevated due to macroeconomic factors, including reflationary fiscal and monetary policies, industrial strategies to reshape supply chains, headwinds to globalization, conflict and war, and large-scale public investment to address climate change and meet sustainable development goals,” Das wrote. “These policies, expected to remain in place, add complexity to the inflation dynamics, reducing the purchasing power of unhedged assets.”

Sovereign wealth funds also need to take into account geopolitical risk, Das writes, particularly addressing funds that have larger investment stakes in volatile markets.

“Uncertainty surrounding the impact on trade flows, asset classes, transparency, and the enforceability of investment contracts in various parts of the global economic system has led to considerable apprehension,” Das wrote. “Geopolitical tensions may cause critical imports like energy, food, and minerals to be weaponised.”