A Natural Capital Approach to Sustainable Investing: A Tribute to Pitta

Goodbye, Pitta

It was a sunny afternoon when I left the beautiful bird in a wooded park in the middle of a concrete jungle of a city. The pitta bird is a rare sight in rainforests, even to the trained eye of bird watchers. Yet there she was a few hours earlier, perched on my apartment window, in a busy metropolis filled with traffic and millions of pedestrians, miles from home.

Rather unoriginally, I named her Pitta. I hope he survives.

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Biodiversity loss is among the top five global risks. This is according to “The Global Risks Report 2020” of the World Economic Forum. Of these five main risks, three were environmental in nature. The numbers are stark: total populations of wildlife species have plummeted by 68% between 1970 and 2016, and a million animal and plant species are now facing extinction. This deterioration of biodiversity and related ecosystem services is the combined result of land and sea use changes, direct exploitation, climate change and pollution.

We explore why institutional investors should protect ecosystems and biodiversity and how sustainable investment strategies that offer opportunities for risk mitigation and value creation can help achieve this.

The case of sustainable investment

1. Institutional investors have a fiduciary responsibility to manage assets in the best interest of the client.

According to the 2019 PRI Report, failure to consider long-term investment factors, including important environmental, social and governance (ESG) criteria, is a breach of fiduciary duty.

2. The annual monetary value of ecosystem services is between US$125 trillion and US$140 trillion. That’s more than one and a half times the world’s GDP.

A wide range of investable sectors depend on natural resources and ecosystem services and can have a potentially negative effect on biodiversity. These include agriculture, fisheries, extractive companies, fast moving consumer goods (FMCG) companies, forestry and utilities, among others.

3. Can sustainable investment reduce risk and improve profitability? Research says yes.

Several studies and meta-studies indicate that ESG issues can be financially important to firms’ operating performance, reduce the cost of capital, and potentially enhance alpha. Collaborating with companies on ESG issues can create value for both investors and companies.

What investment approaches, asset classes and strategies are available?

Responsible investment strategies range from social investing with sub-market returns to impact investing with market-driven return objectives to full ESG integration for long-term value creation. Sustainable investments now span 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-leaning exchange-traded funds (ETFs) are also available. Sustainable investment assets in Europe, the United States, Japan, Canada and Australasia stood at US$35.3 trillion at the end of 2020, according to the “Global Sustainable Investment Alliance Investment Review: 2020”.

Alignment, integration and involvement: 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 about which factors strongly influence the financial performance of companies.” — Sara Bernow, Bryce Klempner and Clarisse Magnin, Mckinsey

Thus, for a client seeking risk-adjusted returns with a focus on biodiversity, the investment strategy must align with their goals and timelines and integrate these long-term risks and factors into their processes of investment

Total integration it expands investors’ goals beyond risk mitigation to value capture and must occur throughout the value chain of the financial system.

Time Frames: Pension funds and sovereign wealth funds, among other institutional investors, have a long investment time horizon. Fund managers and investee companies, however, measure returns on much shorter timescales, such as quarterly. This mismatch of interests requires a change of perspective.

File for the future of sustainability in investment management

Explicit costs of natural capital and externalities: Understanding the value of both natural capital and dependency impacts helps business and financial leaders assess whether these issues affect their institutions and make more informed decisions. The 2021 Dasgupta Review recommends valuing biodiversity as an economic asset rather than a free resource as a means of halting its depletion.

The cost of externalities: On the other side of the coin, the environmental impacts of products or services that do not have an explicit price—externalities—can influence the broader economy and potentially the long-term total return of investors. The solution? Internalize externalities through market-based instruments such as taxes, regulatory instruments such as vehicle safety and emission standards, or voluntary instruments such as emission reduction agreements.

The value of the commitment: By opening a dialogue, investors and institutions can encourage companies to be more sustainable, more efficient in their use of natural resources and ensure that their current income does not borrow from their future income.

Political dialogue: Whether institutional investors generate sustainable returns and create value is influenced by both market efficiency and public policy effectiveness. The EU taxonomy for sustainable activities is a critical example. Investors can work with regulators, standard setters, stock exchanges and other stakeholders to design a stronger and more stable financial system that better integrates ESG into financial decision-making.

Fact Sheet for ESG and Responsible Institutional Investment Worldwide: A Critical Review

Final thoughts

Back to Pitta. What can be done? Various financing initiatives are emerging that favor public sector and development financing for sustainable agriculture, biodiversity conservation and the blue economy. Many of these 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’s five-year, $150 million Wildlife Conservation Bond, for example, is a form of biodiversity-themed investment that aims to protect South Africa’s black rhinos while offering investors competitive performance based on achievement of conservation success indicators.

So efforts are being made. We hope they are enough.

Be safe, Pitta. We will do our best.

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All posts are the opinion of the author. Therefore, they should not be construed as investment advice, nor do the views expressed necessarily reflect the views of the CFA Institute or the author’s employer.

Image courtesy of Tahmeen Ahmad, CFA

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Tahmeen Ahmad, CFA

Tahmeen Ahmad, CFA, is a financial management specialist at the Asian Development Bank, working with brilliant teams to develop sustainable and profitable investment solutions for the Asia-Pacific region, particularly in the green protection space and clean energy Earning CFA Institute’s ESG certification has added a neat set of tools and incentives. He began his career as a Chartered Accountant at PriceWaterhouseCoopers, providing audit and business advisory services to the financial, energy and social sectors. Always a supporter of the underdog, his best memory is an overall win in an MBA team case competition in Singapore, for a little-known semiconductor manufacturing company.

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