Reflections on natural capital

It is extraordinary how quickly the theme of natural capital, defined perhaps as making sense of the economic value of the world’s resources – and the financial impact of preserving or depleting them – has emerged. We do not see it as a new “hot topic”, though; we see it as intrinsically linked to everything in the ongoing climate agenda.

We would argue that the question for investors is not so much, how can we set up a new programme that targets the preservation of nature and biodiversity, but more: how do we extend our current understanding around climate to take account of some of its specifics? In particular, how do we find ways to quantify biodiversity risks and, as a consequence, learn how to best price them?

From an investment perspective, we think about biodiversity and natural capital in three ways.

First, it is a massive risk. The University of Cambridge Institute for Sustainability Leadership (CISL) estimate that at least US$10 trillion of global GDP will be lost due to the decline of ecosystem services by 2050.¹ The World Economic Forum’s estimates are even more damning, putting the figure at US$44 trillion – stating that over half the world’s GDP is “moderately or highly dependent on nature and its services”.² And according to the landmark ‘Economics of Biodiversity’ study led by Partha Dasgupta, natural capital has already declined by an astonishing 40 per cent per head since 1992.³

Second, we see it as interconnected with everything related to the decarbonisation journey. Deforestation simultaneously reduce the planet’s natural carbon sink capacity while also placing stress on natural habitats, thereby impacting biodiversity. The global increase in heatwaves and wildfires due to climate change has negative consequences for crop yields and wildlife.⁴ Soil erosion and mangrove depletion have similar dual effects of carbon capture and biodiversity loss. The list goes on.

But thirdly, we also think we need to be aware of where natural capital’s elements are different. A tonne of emitted carbon is the same everywhere, from Miami to Mozambique. With nature and biodiversity, location matters. Deforesting an acre of pine trees in Finland is not the same as cutting down an acre of palm trees in an Amazon rainforest. Nature – water, wildlife, woodlands – can be highly specific to its location.

History can be a powerful ally to us here. Looking back, over even a relatively short timeframe, can help us develop a sense of how the natural world has been changing – lost animal species, shifting bird migration patterns, how green, or not, the land is. But the history and experience of the investment movement around climate can also give us some useful reminders.

One of the most interesting areas is data. As some of the contributors said, there is actually plenty of data around natural capital. It is neither perfect nor complete, but some of it is contained in the existing work so many of us are already doing around climate change.

There is data around land use, deforestation, water consumption and water stress, for example. There is evidence that we can build on the erosion of natural capital by tracking pollution levels or the routes through which companies source their raw materials. There is satellite technology that can help track forest loss. This is a very good start.

From a portfolio point of view, the challenge then is on internal capacity building. Building up the capabilities of portfolio managers and analysts to understand the data, assess the risk signals, and crucially, pricing them in will be critical. There are some interesting initiatives that can guide on how to assess governance, risk and performance. The Taskforce on Nature-related Financial Disclosures (TNFD), for example, puts nature into four “realms” – land, ocean, fresh water and atmosphere. The TNFD, which will be aligning itself with international accounting standards, will begin consulting in March around the kinds of disclosure it will be seeking from companies in each area.

This gives us a solid framework to work with and we would encourage everyone with an interest to contribute. We have already seen the climate impact some of these initiatives can have: the Task Force on Climate-related Financial Disclosures was rapidly endorsed by the UK government after its release and is being increasingly widely adopted by the corporate world. And while emissions and climate risk disclosure currently remains voluntary, the direction of travel toward stronger regulatory guidelines and mandatory reporting is clear. It makes sense that nature-related disclosures will follow a similar path.

But as investors, while we know how enormous the theme of natural capital is, we also have to try to make it tangible, so we can incorporate it into our portfolios and their models. There are several ways to approach this. One is through avoidance: an investor trying to reduce their biodiversity footprint might choose not to invest in sectors that are really exposed; oil and gas or chemicals companies, for example.

Another way is to “lean in” to the problem, by being prepared to invest in those sectors that are exposed, but targeting those that have best practices and standards in place. There is also engagement, of course, where we can work with companies to try to mitigate their impact. Here, we spend time in those areas where there are already developed methodologies – around water, land use and deforestation – that are well understood by companies. We also concentrate on those situations where we can help to effect change. Some investors embed key performance indicators around biodiversity and the circular economy into their analysis of the companies they own.

Regardless, it is vital to weave the concerns around biodiversity and natural capital into discussions we have with our investee companies around climate. In particular, investors have to ask those questions at a time when big decisions are being made around capital expenditure in order to avoid unintended consequences. A number of oil and gas companies are scaling up their use of biofuels, for example, based on the view that they are a viable alternative to fossil fuels. However, research has shown that when poorly designed and managed, biofuels derived from food crops, predominantly soy and corn, can potentially emit 1.8 times the CO2 of traditional fuel sources. While they might believe that they are solving the problem, the danger is they might be making it worse.

Standing back from all this, and central to the arguments about material risks and the fiduciary duties of investor-owners, as far as I am concerned, the case is clear. As investors, we rely on a system that functions in order to deliver the returns for our customers that enable them to retire or cover a liability. If that system is not working – and that includes society, nature and all the things we rely on economically – then we cannot deliver returns. If something is jeopardising that system then it needs to be confronted. So, it is not just about what is material to your portfolio, it is also about how allocation decision can have an impact on that system. Fail to look after it, and we won’t be able to secure those future financial returns. It really is that simple.

¹‘Integrating Nature: The case for action on nature-related financial risks’, The University of Cambridge Institute for Sustainability Leadership (CISL), April 7, 2022.
²‘Half of World’s GDP Moderately or Highly Dependent on Nature’, World Economic Forum, January 2020.
³‘The economics of biodiversity: The Dasgupta Review’, Partha Dasgupta, HM Treasury, February 2021.
⁴Climate change made deadly heatwave in Argentina 60 times more likely, Imperial College London, December 21, 2022.
5Biofuels are meant to clean up flying’s carbon crisis. They won’t, Wired Inc, January 12, 2020.