It was a sunny afternoon when I dropped off the beautiful bird in a wooded park in the middle of a city’s concrete jungle. The pitta bird is a rare sight in rainforests, even to the trained eyes of bird watchers. Yet there she was hours before, perched on my apartment window, in a bustling metropolis teeming with traffic and millions of pedestrians, miles from my home.
Rather unoriginal, I named it Pitta. I hope she will survive.
Biodiversity loss ranks among the top five global risks. It depends “The Global Risks Report 2020from the World Economic Forum. Of these top five risks, three were environmental in nature. The figures are striking: the total populations of wild species have fell 68% between 1970 and 2016And one million animal and plant species threatened with extinction. This deterioration of biodiversity and the ecosystem service is the combined result of changes in land and sea use, direct exploitation, climate change and pollution.
Let’s explore why institutional investors should protect ecosystems and biodiversity and how sustainable investment strategies that provide opportunities for risk mitigation and value creation can help achieve this.
The case for sustainable investing
1. Institutional investors have a fiduciary responsibility manage assets in the best interest of the client.
Failure to consider long-term investment drivers, including financially material environmental, social and governance (ESG) criteria, constitutes a breach of fiduciary duty, according to the 2019 PRI Report.
2. The annual monetary value of ecosystem services is US$125-140 trillion. That’s more than one and a half times the world’s GDP.
A wide range of investment sectors depend on natural resources and ecosystem services and can have a potentially negative effect on biodiversity. These include agriculture, fishing, mining, fast moving consumer goods (FMCG) companies, forestry and utilities.
3. Can sustainable investing reduce risk and improve returns? Research says yes.
Several studies and meta-studies indicate that ESG issues can be financially material to companies’ operational performance, reduce the cost of capital and potentially improve alpha. Engaging with companies on ESG issues can create value for both investors and companies.
What investment approaches, asset classes and strategies are available?
Responsible investing strategies range from social investing with sub-market returns to impact investing with market-driven return targets to full ESG integration for long-term value creation. Sustainable investing now extends to the full range of asset classes that make up diversified investment portfolios. These include stocks, bonds, real estate, private equity and venture capital. A growing number of ESG-focused exchange-traded funds (ETFs) are also available. Sustainable investing assets in Europe, the US, Japan, Canada and Australasia stood at $35.3 trillion at the end of 2020 “Global Alliance for Sustainable Investment Investment Review: 2020.”
Alignment, integration and engagement: a necessary paradigm shift
“A sustainable investment strategy consists of basic elements familiar to institutional investors: a balance between risk and return and a thesis on the factors that strongly influence the financial performance of the company.—Sara Bernow, Bryce Klempner and Clarisse Magnin, Mckinsey
Thus, for a client seeking risk-adjusted returns focused on biodiversity, the investment strategy must align with their objectives and timelines and integrate these longer-term risks and factors into their investment processes.
Full integration extends investors’ objectives beyond risk mitigation to value capture and must occur across the entire financial system value chain.
Time limit : Pension funds and sovereign wealth funds, among other institutional investors, have long-term investment horizons. Fund managers and recipient companies, however, measure profitability on much shorter timeframes – quarterly, for example. This misalignment of interests requires a change of perspective.
Explicit costs of natural capital and externalities: Understanding the value of impacts and dependencies on natural capital helps business and financial decision makers assess whether these issues affect their institutions and make more informed decisions. The Dasgupta Review of 2021 recommends valuing biodiversity as an economic asset rather than as a free resource to halt its depletion.
The cost of externalities: On the other side of the coin, the environmental impacts of products or services that are not explicitly priced – repercussions — can affect the broader economy and potentially the long-term total return to investors. The solution? Internalize externalities through market-based instruments such as taxes, regulatory instruments such as emission and vehicle safety standards, or voluntary instruments such as emission reduction agreements.
The value of commitment: By opening a dialogue, investors and institutions can encourage companies to become more sustainable, more efficient in their use of natural resources and to ensure that their current income does not borrow from their future income.
Political dialogue: Whether institutional investors generate sustainable returns and create value depends on both market efficiency and the effectiveness of public policies. The EU taxonomy for sustainable activities is a critical example. Investors can work with regulators, standard setters, exchanges and other stakeholders to design a stronger and more stable financial system that better integrates ESG into financial decision-making.
Back to Pitta. What can be done? Various financing initiatives that leverage public sector and development finance for sustainable agriculture, biodiversity conservation and blue economy are emerging. Many of them focus on vulnerable developing economies. The Asian Development Bank and the World Bank, among other such institutions, are creating innovative financing products that support these efforts. THE World Bank Five-Year $150 Million Wildlife Conservation Bondfor example, is a form of thematic biodiversity investment that aims to protect South Africa’s black rhinos while providing investors with a competitive return based on achieving indicators of conservation success.
Efforts are therefore underway. Let’s just hope they are enough.
Stay safe, Pitta. We will do our best.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, and the opinions expressed do not necessarily reflect the views of the CFA Institute or the author’s employer.
Image courtesy of Tahmeen Ahmad, CFA
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