No net zero without nature

Financing nature

Shyam Gharial

Senior Investment Consultant

Biodiversity loss is a systemic risk which is inextricably linked with climate change. And both need tackling together. They are also likely to have significant negative impacts on investment returns if left unchecked.

Thankfully, many investors are targeting net zero with the aim of protecting the value of their investments, along with wider society, from the physical impacts of climate change (see David Wrigley and Laasya Shekaran's article for examples of physical impacts).

But achieving net zero can't only be about encouraging companies to use forms of energy with lower carbon. We also need to invest in climate solutions to help achieve the goal.

Climate mitigation solutions are goods and services that contribute to a reduction in greenhouse gas emissions.

A healthy natural environment underpins everything we do

And while focus has rightly been on reducing emissions, thought will also be needed on the negative emissions side of the zero in “net zero”. How will investors approach that?

Carbon offsets are often mentioned as an option, and described further in Nikki Matthews's blog. We are comfortable with funds generating carbon credits and selling them to generate returns but if an investor buys offsets it is questionable whether this meets current interpretations of the fiduciary duty to invest with the objective of achieving the best possible returns (although not directly related to offsets a re-interpretation of fiduciary duty is something our CEO has been advocating recently).
Novel carbon capture and sequestration technologies are unproven at scale and could result in some seriously damaging unintended consequences. The risks are massive. Novel methods require a phenomenal level of scaling, they are not receiving the required policy support, and there are cavernous information gaps in scientific literature.
For now, nature should be our focus – we know that works. A major contributor to negative emissions needs to come from investment in the natural world – soil, trees, mangroves, peatlands, etc.

$bn

There is a $700bn pa funding gap to reverse the biodiversity crisis.

Source: Financing Nature: Closing the global biodiversity financing gap. The Paulson Institute, The Nature Conservancy, and the Cornell Atkinson Center for Sustainability

Solutions based on nature are important because, as bodies like the World Resource Institute and the Confederation of British Industry have pointed out:

We can’t meet the goals of the Paris Agreement to limit global warming without investing in nature-based solutions and reversing the loss of biodiversity!

Net zero aside, there are other compelling reasons for investing to reverse biodiversity loss. The World Economic Forum assessed in 2020 that over half of global GDP is moderately or highly dependent on nature, which I, personally, don’t think does nature justice. EVERYTHING we do is dependent on a healthy natural environment. Our whole civilisation is underpinned by nature – the air we breathe, the water we drink, the food we eat, etc. All these basic things we have poisoned and they will bite back financially – yes, focusing on the money aspect is very narrow and short-sighted, but that’s how many interpret fiduciary duty!

Investing in nature is becoming much easier

So, how can investors invest in nature-based solutions that address biodiversity loss and, indirectly, climate change?

There are private-market asset classes like regenerative agriculture, sustainable forestry, and carbon sequestration through improving the health of land (where the returns are predominantly from the sale of carbon credits). Regenerative agriculture is to biodiversity loss what renewable energy is to the climate crisis. It aims to improve soil health, which should allow it to store more carbon dioxide and reduce the ever-expanding reliance on fertilisers. It includes various techniques. For example, drilling seeds into the soil, rather than ploughing it, minimises the disturbance of the soil, allowing it to retain nutrients which means less fertiliser is required. Another method is to plant “cover crops” after the main harvests, which can reduce the loss of soil nutrients or naturally control crop pests.

On the more liquid side, there are listed biodiversity equity funds – generally actively-managed, low-turnover funds with an unconstrained global allocation to 35-80 names. They are often biased to small/mid-caps and the materials and industrials sectors. Companies in the portfolios will do a range of things from water treatment to producing equipment that applies fertiliser/pesticides to plants with precision. Corporate bond funds focused on biodiversity loss are not yet on the horizon, but some broader sustainability bond funds can take account of it.

The investment thesis for the listed equity funds we researched relies on the array of nature related laws, regulations, consumer/public demand, the TNFD reporting framework (see Tom Fieldsend’s blog on TNFD) and other initiatives providing a strong tailwind for companies addressing the issue through their products or their operations.

The main positive impact from a listed equity investment relies on strong and effective stewardship to encourage corporates to reduce their impact on nature.

The main positive impact from a listed equity investment relies on strong and effective stewardship to encourage corporates to reduce their impact on nature. We were impressed by the fund managers’ strong links with reputable environmental non-governmental organizations, who provided research and advice, access to data, oversight and were willing to assist in stewardship exercises.

Some of the equity funds invested solely in companies providing biodiversity solutions in the form of products/services, whereas others invested in a mix of these solutions providers and companies transitioning their operations to have a lower negative impact on biodiversity. I believe companies providing solutions are likely to have the greater positive impact, and engagement can encourage these companies to make these business lines more prominent within a firm, but there is also a need for other companies to transition too, and fund managers that include those open up a wider investment universe.

The twin crises of climate change and biodiversity loss both require investment in nature solutions. These can potentially be accessed together through a single fund that covers multiple aspects of sustainability – both environmental and social. Biodiversity solutions make up a small proportion of those funds though. I believe the complexities of nature are best approached with specialist knowledge. For those investors with the ability to allocate to more than one fund, I believe it is optimal to use a specialist biodiversity fund in combination with either a climate solutions fund or a broader sustainability fund. And the sector concentrations within climate solutions funds are likely to be complementary to the sectors that biodiversity funds focus on.

So, we’ve got the tools to help address the climate and biodiversity crises. They just need your capital! Simple!

Conclusion

Any investor that wants to protect their portfolio from the worst impacts of climate change needs to fund the solutions required to reach net zero. Nature is a proven ally in that respect, and there is a strong tailwind behind investing in nature-based solutions. We are ready and able to help explore these options - speak to us about the options available.