Investing in nature 

When a stranger comes to the south he cries twice, when he arrives and when he leaves

Those immortal lines are from the Italian film ‘Benvenuti al Sud’. You might share the sentiment if you've ever visited Puglia, a beautiful region in the heel of the boot of Italy, that I cannot describe even if I had Balzac's pen. The region is responsible for roughly half of Italy’s olive oil production¹ and yet a bacterium, Xylella fastidiosa, that researchers believe arrived from Costa Rica on a coffee plant², has killed millions of olive trees and left ‘spectral panoramas’³. A stark illustration of a real life example of biodiversity⁴ loss and economic impact.

Nature is likely to become one of the prominent ESG themes for investors and financial markets in the next few years. The natural world is the basis of our existence on this planet: nature underpins all life on Earth and we cannot exist without well-functioning natural ecosystems. However, since more than half of global GDP depends on nature⁵ and human activity has already threatened one million species with extinction,⁶ biodiversity loss poses significant systemic threats.

The frameworks for incorporating nature and biodiversity considerations into investment portfolios are still emerging. Nevertheless, there are actions that investors can take today that can enhance risk management and ensure portfolios are positioned to support nature-positive opportunities.

Two types of investors

In considering how to proceed, we differentiate between two different types of investors — those pursuing ESG Good Practice and those striving to be an ESG Leader.

The ESG Good Practice recommendations that we put forward we feel all investors can aim to incorporate, where possible, on the basis that they will improve risk management and regulatory compliance. The second level of recommendations are aimed at more advanced investors, ESG Leaders, who are looking to set best practice in this area and pursue nature-positive outcomes.

Below we list four steps investors can take today to help integrate nature as an investment theme.

We believe wealth managers in particular should review these steps, especially when they are acting as an asset owner of behalf of their clients.

Recommended step #1 – Revisit your ESG beliefs and policies

We recommend investors following ESG Good Practice seek to understand nature and climate linkages and incorporate nature considerations in their climate objectives. Those looking to be an ESG Leader should conduct a belief workshop to define policies around nature and how nature positivity could be incorporated into investment objectives.

Nature and biodiversity are intrinsically linked to climate change. There can be no solution to global warming unless natural systems are restored around the world. Incorporating nature and biodiversity considerations into climate policies is an imperative for investors, and by doing so some of the unintended consequences of climate transition can be avoided. For example, investments into hydroelectric schemes, can have deeply negative impacts on the natural environment if nature is not taken into account in the investment decision.

Moreover, policies that are nature-positive are likely to help move the climate transition forward. For example, natural capital⁷ investments can deliver a powerful climate solution. investors should therefore consider setting targets to allocate to this theme as part of their overall allocation to climate solutions. Where investors have set net-zero targets, it is important to include nature positive targets through the net zero journey. This is vital as the reversal of biodiversity loss and the restoration of biodiverse ecosystems is a fundamental part of achieving net-zero.

Recommended step #2 - Engage in nature-related investment stewardship

An ESG Good Practice approach should ensure that the stewardship activities of asset managers are monitored and ESG themes such as nature or climate are identified. An ESG Leader could include nature as a stewardship priority.

Investment stewardship is a vital tool that investors can use to promote nature positivity in their investment portfolios. A number of industry initiatives can support this, notably the Taskforce on Nature-related Financial Disclosures (TNFD), which is to publish a framework on nature disclosure by September 2023. We believe that this framework will help investors pursue nature positivity in stewardship activity. The TNFD’s priority sectors⁸ provide a good starting point for a nature-focused stewardship programme. The TNFD encourages investors to engage with companies in these priority sectors to ensure they are minimizing their impacts on the environment and also managing biodiversity risks.

When investors invest client assets through third-party investment managers, it is important to understand how these underlying managers are engaging on nature-related topics to ensure they are being responsible stewards of investor capital. We recommend that all investors seek to collect information on how their investment managers are voting and engaging on their behalf. During this process, it is important to separate the different ESG themes as much as possible. This will help to identify engagements that are relevant to nature.

Recommended step #3 - Assess your portfolio's exposure to nature-related risks

We recommend that as ESG Good Practice, investors should conduct a nature-focused audit of their asset managers. ESG Leaders are going one step further and are starting to evaluate their exposure to nature-related risks through identifying portfolio exposures to the TFND priority sectors.

Investors should consider conducting an audit of their investment managers to understand what policies they have in place to manage nature-related risks. The audit should also ascertain whether asset managers have dedicated sufficient resources to oversee these risks. We suggest using the following checklist:

• Does the manager have a nature/biodiversity policy in place or does their climate policy make reference to nature/biodiversity?
• Can the manager provide evidence that they engage with portfolio companies on nature/biodiversity to deliver nature-positive outcomes?
• Does the manager consider nature/biodiversity risks when making investment allocation decisions?
• Does the manager produce any nature/biodiversity risk metrics for its portfolios?
• Does the manager participate in key ESG initiatives focused on climate (e.g., Net-Zero Asset Managers initiative) or nature (e.g., the TNFD Forum)?

Recommended step #4 - Consider an allocation to natural capital opportunities

There is a growing opportunity set in natural capital and some investors are allocating to ideas that aim to produce positive impact through protecting or restoring natural ecosystems.

The opportunity set for investment strategies focused on natural capital and biodiversity (i.e., products and solutions that specifically address natural capital challenges) is relatively new but growing rapidly. Due to the complexities of some of the investment structures, as well as the relatively short track record of many of the funds, we advise investors to conduct thorough due diligence on any prospective investments. The majority of investment ideas we see in the market are within the public equities and private markets/real assets spaces. We have mapped some of the key investment themes across public and private markets that we have come across in our due diligence 

Asset managers are differentiating themselves into those investing in solutions to mitigate biodiversity loss, and those investing in companies that are working through their supply chains to ensure a net-positive impact on biodiversity.

Investment ideas around biodiversity tend to focus primarily on addressing the key drivers of biodiversity loss: climate change, pollution, changes in land and sea use, invasive alien species and the exploitation of organisms (e.g., overfishing). Many of these strategies focus on investing in companies that are aiming not only to mitigate, but also to reverse, biodiversity loss.

The most common themes across biodiversity strategies tend to include the following issues: waste management, the circular economy, sustainable forestry and agriculture, natural capital, renewable energy, energy infrastructure and efficiency, sustainable packaging solutions, and ocean and water.

Key nature related investment themes

Sustainable agriculture. These are funds that include projects, facilities and businesses that are involved in the purchase of and/or management of agricultural land, and in the production of agricultural products.

Sustainable timberland/forestry. These are funds that are involved in the purchase of and/or management of timberland and forests, with the aim of harvesting trees in a certified sustainable manner and/or purchasing tracts of timberland to create and sell the carbon credits from sequestration. To ensure best practice in terms of ESG issues, it is important to make sure any funds adhere to the highest standards of carbon credit certification.

Biodiversity and natural capital. These are funds that are investing in the protection and restoration of biodiversity and ecosystems. These could include investments in nature-based solutions to protect, restore and regenerate ecosystems (e.g.,landscape regeneration, rewilding, coastal restoration and sustainable aquaculture) or projects that derive revenues from payments for ecosystem services. Where possible, such projects should promote the well-being of people as well as the conservation of biodiversity.

Sustainable oceans. These are funds that focus on the protection and restoration of oceans and which also drive the regeneration of ocean biodiversity. Examples include the restoration of mangroves and coral reefs. These habitats support sea life and help prevent flood damage. There are also opportunities involving sustainable fishing, although controversies remain as to how sustainable fisheries can be. There are also animal cruelty issues to consider in relation to fishing and aquaculture, which can make such projects less attractive from a broad ESG perspective. 

Key Takeaways

• In our view, nature is rapidly rising to prominence as an investment theme and nature and biodiversity considerations are likely to become increasingly financially material to asset valuations.
• We advise that investors be proactive in integrating nature and biodiversity into their portfolios. Preparing ahead of time could put investors in a position to take advantage of the upcoming market developments as they occur.

If you would like to read more on this topic, please check out the white paper ‘Nature Alert’ available on MercerInsight Community here. 

¹ https://www.oliveoiltimes.com/business/a-new-project-to-promote-olive-oil-roads-in-puglia/111257

² https://www.oliveoiltimes.com/business/europe/xylella-arrived-in-italy-from-costa-rican-coffee-plant/105988

³ https://www.oliveoiltimes.com/business/italy-post-xylella-puglia/107761

⁴ Biodiversity: The variety of living organisms found on the planet, such as animals, plants, fungi and bacteria.

⁵ Business for Nature Coalition, 2021, available at https://www.businessfornature.org

⁶ IPBES. The Global Assessment Report on Biodiversity and Ecosystem Services, 2019, available at https://ipbes.net/sites/default/files/2020-02/ipbes_global_assessment_report_summary_for_policymakers_en.pdf

⁷ Natural capital: The collection of renewable and non-renewable natural assets providing resources and services to people and economic systems.

⁸ Food and beverage, Infrastructure, Healthcare, Consumer goods, Renewable resources and alternatives, Extractives and mineral processing, Resource transformation and Transportation