Over the past few years, defined contribution (DC) pension schemes have made efforts to place sustainability at the heart of their investment strategies, particularly in regards to climate change.
As schemes continue to align their investment strategies with environmental and climate change goals, the lens has now started to shift towards the topic of biodiversity.
This has become a more pressing issue as schemes gain a deeper understanding of biodiversity’s role in reducing the impact of climate change.
Climate change and biodiversity are flip sides of the same coin: climate change threatens species and, therefore, biodiversity. Yet, healthy ecosystems are more resilient to the effects of climate change, such as floods and storms, and can absorb greenhouse gas emissions to limit further environmental degradation.
The importance of the topic has been further amplified since the Taskforce on Nature-related Financial Disclosure (TNFD) developed a risk management and disclosure framework for organisations to report and act on nature-related dependencies, impacts, risks and opportunities.
With over 400 organisations now complying with the TNFD’s recommendations, DC pension schemes are among the organisations are starting to look at how their investments can protect nature and biodiversity.
Net zero targets
More schemes are recognising that biodiversity and climate change go hand in hand. As a result, they are investing in biodiversity as a means to work towards meeting their net-zero targets.
Anne Sander, head of ESG at Zedra Governance, says the link is clear as many of the solutions needed to solve climate change issues rely on improvements in the world’s biodiversity.
For example, initiatives to rebuild diverse forests and restore marsh lands also create environments where carbon is naturally stored, she notes.
“That’s why these projects are attractive to pension schemes, either in providing carbon offset credits that have an independent value which is expected to grow as the cost of offsetting carbon emissions increases or useable in reaching the pension scheme’s own net zero targets,” Sander says.
Joe Condy, investment consultant at Quantum Advisory, agrees that from a net zero perspective, there is a link between climate change and biodiversity loss.
“If we’re defining biodiversity strategies as investing in companies whose activities aim to preserve life on land and in water and protect ecosystems,” he says, “then naturally we could assume that these types of companies could have an impact on real-world decarbonisation.”
Schemes also have a better understanding of the dangers of not protecting biodiversity and are more eager to embrace biodiversity in their investment strategies to prevent the dangers.
Sam Tripuraneni, head of sustainable investments at Aviva Investors, cites data from WWF that revealed the world has seen an average 68 per cent drop in mammal, bird, fish, reptile and amphibian populations since 1970.
“If we continue on the current course which will be well in advance of the 2°C stated in the Paris Agreement, there will be a catastrophic scale of biodiversity loss by [the year] 2100 – which will have far reaching consequences for ecosystem stability on land and in oceans,” he says.
While the foremost reason for combatting biodiversity loss may be the positive impacts on the natural world, there are potential financial gains from investing in this sphere, too, adds Jane Wadia, head of sustainability, core products and clients at Axa Investment Managers.
She says the increasing appreciation of biodiversity’s role in economies is driving more schemes to mitigate the risks to financial returns. “Investors are increasingly aware of the future financial risk associated with biodiversity loss as well as the return potential given the transition to a nature positive economy offers a multi-decade growth opportunity,” she says.
It’s not only schemes that have recognised the link between biodiversity and climate and risk of ineffective protection, but also the members, who are demanding greater consideration of these factors in their investments.
Biodiversity has connected more strongly with members compared to climate change, as it is a topic that resonates more personally with them, whereas climate change can be seen as more technical, says Tripuraneni.
“Biodiversity is a simpler premise – how many species exist. That simplicity makes it more tangible and therefore a topic closer to the heart of the UK DC membership, since we are a nation of animal and nature lovers,” he says.
Data holds schemes back
Even though schemes are recognising the need to integrate biodiversity into their investment strategies, many remained hindered by challenges. Paul Francis, principal investment consultant at Quantum Advisory, says data is the biggest issue that schemes face.
“One of the challenges is that there isn’t much historical data available on such strategies making it challenging to analyse their impacts,” he says.
While there is extensive data on the state of biodiversity, there is limited information on how biodiversity specifically relates to pension schemes in a way that can be easily and meaningfully incorporated into their decision-making processes.
Tripuraneni adds the availability and quality of biodiversity data lacks in part because the demand for it has only recently emerged, as investing in biodiversity itself remains relatively nascent.
“Embracing biodiversity within investment strategies is hugely challenging, even more so than with climate change, as the issues and data quality are different sector by sector,” he says.
As a result, the progress we are seeing is being made through engagement and industry efforts aimed at improving data quality and understanding, he notes.
Impact on returns
For schemes interested in biodiversity strategies, a question which is common with any new investment arises: how will it impact returns?
According to Sander, when schemes are investing in biodiversity strategies, they should be prepared for a longer wait before seeing returns, as immediate gains are unlikely.
“While there may be a short-term cost to creating these biodiversity solutions the expectation is that in the longer term the carbon offsets they generate will be positive for pension scheme returns,” she says.
Wadia agrees the return on investment will be more long-term as growth opportunities span over multiple decades but adds this shouldn’t deter schemes from pursuing it.
“Investors don’t have to choose between positive biodiversity impact or the potential for strong financial returns – financial sustainability underpins both of these goals,” she adds.
However, Condy argues investing in biodiversity could potentially negatively impact returns. “Naturally, impact funds – and ESG funds to a lesser extent – limit their investable universe and are usually more concentrated, so investors do need to accept periods of underperformance and increased volatility, relative to global benchmarks,” he says.
Therefore, schemes need to strike a balance between investing sufficiently to manage risks and avoiding over investment to the point where it negatively impacts returns, adds Jo Sharples, senior partner and chief investment officer at Aon’s DC Solutions.
For example, investing in biodiversity can make supply chains more resilient so schemes should see less risk and better returns, she says.
“On the other hand, if you go off on an extreme and, say, put money in a forest and don’t get any return for it, that’s more on the philanthropic end of it, and actually that would damage your returns,” she says.
Risks of not embracing biodiversity
Since biodiversity and climate change are inextricably linked, their impacts are also similar. This includes extreme weather events like flooding and extreme heat, which can reduce company productivity, Sharples says. “Biodiversity is not going to make that happen directly, but the risk is that climate effects get exaggerated if you don’t look after biodiversity,” she notes.
Wadia adds that just like with climate change, failing to incorporate biodiversity into investment strategies can introduce both physical and transition risks, leading to potential financial risks.
“In fixed income, laggards could face increased risk of downgrades and defaults from emerging and material biodiversity risks whereas biodiversity-positive business models could lead to stronger long-term viability and a greater ability to repay debt,” she says.
Axa increasingly sees biodiversity as an investment opportunity in equities, she adds.
“Identifying the winners of the biodiversity transition – which we believe to be quality companies with proven execution, and that provide scalable and commercial solutions to the worlds’ environmental challenges – should assist investors to seek out companies that could deliver profitable growth and strong financial returns over the long-term,” Wadia says.
