Investing in biodiversity crucial to combating climate crisis

Healthy ecosystems create a natural barrier against extreme weather and absorb huge amounts of greenhouse gases, but are being destroyed by human activity. What can investors do to reverse this trend?

While still in its infancy, biodiversity may soon become a significant investment megatrend, as investors, corporates and policy-makers become increasingly aware of the impact of economic activities on nature. New methodologies and tools are also being developed by scientists, think-tanks and investment houses.

More than half of the world's economic production, valued at $44tn, is moderately or heavily dependent on nature, according to the World Economic Forum.

Biodiversity, the variety of life on Earth, is the basis of food systems, the source of raw materials and medicines, and is crucial to advancing the sustainable transition and combating the climate crisis. Healthy ecosystems form a barrier against extreme weather, such as storms, wildfires and landslides, with land and oceans absorbing almost half of global greenhouse gas emissions.

But human activity is destroying biodiversity and natural ecosystems faster than ever before, accelerating global warming, posing a serious threat to business and financial stability.

Between 1970 and 2018, global wildlife populations fell by an average of 70 per cent, according to the World Wide Fund for Nature (see chart). Almost one million species face extinction, essential crops are under threat and our oceans are overfished. Humanity has become a “weapon of mass extinction”, according to UN secretary-general António Guterres.

While 2023 was the hottest year on record, the 1.5-degree global warming “safe landing” pathway established by the 2015 Paris Agreement is increasingly under threat, as it assumes nature will continue to be a healthy provider of carbon sinks and ecosystem services for humanity. “We are undermining the planet exactly when we need a healthy planet more than ever,” says Jenn-Hui Tan, Fidelity International’s chief sustainability officer, explaining biodiversity and climate are intrinsically linked and must be addressed together.

Biodiversity loss can result in lost jobs, mass famine, new diseases, and less medical discoveries, as 70 per cent of cancer drugs are natural or synthetic products inspired by plants. The Global Biodiversity Framework estimates the ‘biodiversity finance gap’ is $700bn a year between now and 2030, along with an additional $117tn total cost for climate change-focused solutions. This may translate into both significant investment opportunities, and risks to existing business models. But investment in conservation and remediation lags far behind annual needs.

Following the UN’s COP15 Biodiversity Conference in December 2022, which underscored the urgency of addressing biodiversity loss and the advent of the Taskforce on Nature-related Financial Disclosures (TNFD), a wave of biodiversity funds has sprung up to address this issue.

Last September, MSCI identified 149 funds globally that were thematically linked to biodiversity based on the fund name and investment strategy. These funds collectively held around $60bn, or around 2 per cent, of the estimated $3tn invested in sustainable funds. Most of the 15 pure-play biodiversity-labelled funds were mutual funds launched in 2022 and managed slightly more than $1bn in assets.

Investing in biodiversity is vital, considering “the financial industry is one of the main conduits to nature destruction, as it finances many sectors harming nature”, says Ingrid Kukuljan, head of impact and sustainability Investing at Federated Hermes.

Investing in biodiversity

Investors can invest across asset classes, in public equities, fixed income, including ‘blue’ and ‘green’ bonds, and private markets.

The highest impact biodiversity strategy involves investing in solutions to the five key causes of biodiversity loss, believes Velislava Dimitrova, Fidelity International’s portfolio manager of the FF Sustainable Biodiversity Fund. These are: changes in land and sea use, direct exploitation – mainly related to overfishing in oceans and freshwater exploitation – climate change, pollution and invasive species, which generate adverse impacts on local ecosystems (see chart).

Solutions to the causes of biodiversity loss may range from precision agriculture, fish farming and waste-water treatment to recycling and renewables, which can be embraced in a fund that is “very well diversified in terms of not only technology but also sectors and geographies”, says Ms Dimitrova.

With new business models required in most economic sectors, “these solutions need to be adopted globally, in a relatively short period of time, which means biodiversity will possibly be the largest investment megatrend in our lifetime, because the problem is so widespread,” states Ms Dimitrova.

Investors must also consider accessing developing technologies, possibly through private markets to bridge the funding gap and solve some key issues. These may include lab-grown meat or fish, carbon capture, utilisation and storage.

Another approach is to invest in so-called ‘best-in-class’ firms, which have the smallest 'biodiversity footprint' in their sector, such as companies leading their industries in transforming their business models to mitigate negative impacts.

Data challenge

A key challenge is that companies still have limited information about their impact on nature and ecosystems, which complicates investors’ attempts to assess opportunities and risks.

Major risks include disintermediation, as many value chains will be disrupted in transition to a more sustainable economy, and regulation related to growing legislation around biodiversity in Europe and beyond. The number of climate change litigation cases around the world has more than doubled since 2017, according to the UN, and is expected to rise. Reputational risk for companies failing to adapt is also significant, as lack of consideration for biodiversity can result in lower brand value and loss of customers.

Moreover, companies may face higher costs of capital when engaging in nature-degrading practices, while better biodiversity practices tend to attract higher scores, says Dimple Gosai, head of US ESG strategy at Bank of America. Credit rating agencies have started to include nature-related factors in their methodologies, as institutional investors demand more accountability for businesses’ environmental risks.

Having the right tools, frameworks and insights to help distinguish between winners and losers within the space, and the ability to effectively direct capital is becoming more and more important for portfolio managers.

Over the long-term, “businesses that are addressing their nature dependencies and impacts will be in an advantageous position, as both regulation and real-world changes mean the true value of ecosystem services become visible and embedded in valuations,” says UBP’s head of impact, Victoria Leggett.

But unlike carbon emissions for climate change, there is no single metric to measure biodiversity. There are also important geospatial nuances, requiring in-depth analysis of local impact.

The use of a specialist metric – such as mean species abundance (MSA), which attempts to measure the level of biodiversity in an area – can prove controversial. It may even drive fund managers away from investments in sectors most responsible for biodiversity loss, such as agriculture, forestry and fisheries, fashion, food and beverage and electric utilities, leading them to invest in sectors with little impact on MSA, like tech stocks.

Despite these reservations, data related to nature and biodiversity is becoming increasingly accessible through development of advanced technologies and scientific knowledge, explains Morten Rossé, head of nature and climate at Lombard Odier Investment Managers. “The establishment of dedicated data providers, platforms and facilitators is proof of a wider recognition of the urgency companies face when it comes to identifying and quantifying their impact on nature,” he says.

New techniques

Data innovation is key to attracting private capital to biodiversity. “Investors typically rely on voluntary company disclosure for ESG data, but location-based data such as water pollutants discharged in a certain river basin is still very rarely disclosed by companies,” says Joanne Lee, responsible investment specialist at First Sentier investors.

“New techniques for capturing nature-related data, using satellite images, GPS and artificial intelligence, mean investors may gain access to a company’s nature-related data, independent from the company’s disclosure,” she says. Such data is also be used by NGOs and watchdog groups to monitor the company’s claims and progress, to further improve transparency.

Other technological advancements are being tested as field measurement techniques. For instance, environmental DNA analyses genetic material from the environment to track species and biodiversity, while bioacoustics monitors species populations and behaviours using wildlife sounds.

“Given the need for more rigorous impact assessment methods, technology is crucial to provide investors with sophisticated tools to process information and create actionable insights around which they can allocate capital,” says Lorenzo Saa, chief sustainability officer at sustainability tech platform Clarity AI.

The development and enhancement of such tools will also allow investors to develop more targeted engagement with companies.

“Engagement is crucial as companies have only recently started considering biodiversity,” says Federated Hermes’s Ms Kukuljan, explaining it is a core aspect of the firm’s biodiversity strategy. To halt and reverse biodiversity loss, companies need to reduce their contribution to each of the five drivers of biodiversity loss. Investors should focus on asking companies to assess and disclose their biodiversity impacts and dependencies throughout their operations and supply chains, while also encouraging them to report in line with TNFD recommendations.

Bending the curve

But investors do not need perfect data. They can pick specific areas, where the data set is richer, such as deforestation or plastic, and still have a meaningful impact.

Preservation of forests and freshwater are critical to biodiversity preservation, says Ms Lee from First Sentier Investors. Forests play an important role in climate change mitigation, absorbing one-third of the carbon dioxide released from burning fossil fuels every year, while freshwater is critically linked to the effects of climate change. The firm’s recently published toolkit guide focuses specifically on these twin topics “to help investors prioritise companies in portfolios more dependent on nature or more likely to negatively impacting nature”.

While the situation is improving, there remains much progress to be made, as corporate disclosures on biodiversity impacts are currently scarce and not standardised, believes Rachel Whittaker, head of sustainable investing research at Robeco. The main problem is that “issuer-level biodiversity footprints available from data providers are largely estimated based on sectoral environmentally extended input-output models”. This is not sufficient to differentiate true performance of issuers within sectors, she says.

This led Robeco to develop a biodiversity framework, where sector-level footprint data is enhanced by company-level KPIs based on fundamental industry analysis. The resulting “semi-quantitative assessment” measures the extent to which companies contribute to enlarging or halting/reversing the drivers of biodiversity loss, says Ms Whittaker.

The focus of companies and investors, she adds, must be “on bending the curve of biodiversity loss” in line with the Global Biodiversity Agreement signed by nearly 190 countries in Montreal at the end of 2022. The agreement aims to reach a point of no further nature loss in 2030 and, from there onward, to transition to a pattern of economic growth that goes hand in hand with growth of nature.

Asset allocation

While biodiversity as an investment theme is attractive, its allocation in a diversified portfolio is not straightforward, believes Bank J. Safra Sarasin’s chief sustainability officer Daniel Wild. This is due to the “very limited” number of solution providers and technologies able to address biodiversity loss.

Liquid biodiversity funds mostly invest in ‘best-in-class’ firms or engage corporates to reduce negative impact. As a result, they encompass many sectors, lacking clear focus, and their financial behaviour is difficult to predict. Ultimately, they differ little from existing green or ecology funds, explains Mr Wild.

From an analysis of top 10 holdings in biodiversity funds available on the market, an actual ‘biodiversity signal’ is in many cases not obvious, he says. Performance drivers can also vary. “Since there are not many actual biodiversity products or solutions, ‘biodiversity’ as a signal is rarely a relevant driver,” says Mr Wild.

Another challenge is that biodiversity funds have mostly short track records, unlikely to make it onto recommended lists of private banks.

However, managers that have been investing in natural capital for several decades can pass this test. Their strategies address food and fibre security, climate change and biodiversity loss, generating resilient, uncorrelated returns, with very low volatility, claims Martin Davies, global head of Nuveen Natural Capital.

Private investors are becoming increasingly interested in protecting the world’s biodiversity, says Markus Müller, Deutsche Bank Private Bank CIO for ESG, recommending they consider specific KPIs linked to ‘double materiality’ of companies. This refers to the extent which companies are dependent on biodiversity and have an impact on it, be through offsetting activities, or ‘insetting’ activities, such as implementing nature-based solutions in their own value chain.

To generate direct impact, investors should consider project-level investments using private equity, venture capital or philanthropy. “This approach allows them to steer activities towards biodiversity and/or actively provide funding for biodiversity-focussed new companies or projects,” adds Mr Müller.

Private markets offer greater investment opportunities than listed equity, agrees Lombard Odier’s Mr Rossé. “The opportunity – and the challenge – is to invest in the underlying land asset and restore it to make it more resilient for future production,” he says. Nature-based real assets can convert degraded, vulnerable or under-utilised land, and its related ecosystem services, into productive and resilient forms of financial capital.

Currently, only 14 per cent of capital for nature-based solutions is provided by the private sector, according to the World Resources Institute, presenting a huge challenge to plug the financing gap of $8.1tn in nature-based solutions by 2050, according to the UN.

But this also translates into significant investment opportunities, facilitated by new tools, data innovation and integration of nature-related risks and opportunities into financial decision-making, concludes Lombard Odier’s Mr Rossé.

“The growing international focus on preserving and restoring nature and biodiversity is creating new asset classes,” he says. “This is pushing companies and investors to identify new investment opportunities in this space and attracting private capital.”