When it comes to the environment, climate change and carbon emissions have been the main focus for investors, regulators, governments and the general public in the UK. However, last year the UK government, in its response to the Dasgupta review on the Economics of Biodiversity, said it will bring in a target on species abundance for 2030 to halt the decline of nature.[i] It plans to "leverage private sector finance to enhance our natural environment, encouraging private sector-led, market-based solutions". The areas of interests are "natural capital markets for carbon, water quality, biodiversity, natural flood alleviation and other ecosystem services". UK Pension funds must be among the sources of capital the government is looking to in order to achieve this objective. The pensions minister Guy Opperman said in March he would reach out to pension funds about deforestation issues, stating that the UK is "putting forests front and center of our global response to climate change".[ii] But are trustees ready to discuss natural capital? Some schemes are breaking new ground on this topic but for the majority, it seems the discussion has not even started.
Natural Capital - the next big focus?
MFS believes natural capital could be the next ESG related point of focus for pension schemes. Schemes who thoughtfully engage on it now potentially stand to benefit by understanding the risks and opportunities before the wider market can do so. But what is it and how can trustees assess its impact?
Natural capital is the world's stock of natural assets, including soil, air, water, grasslands, forests, wetlands, rocks, minerals and all living things. Collectively, these provide vital ecosystem services such as water for agriculture, natural filtration for clean drinking water, crop pollination, carbon sequestration and flood or storm protection. In monetary terms, these services are valued at USD 44 trillion a year and form the basis of half the world's GDP.[iii]
Why focus on natural capital now?
While natural capital is worth considering in its own right, its link to climate change makes it all the more important right now. Meeting the goals of the Paris Agreement will require halting and indeed reversing nature loss. Land use and forestry changes amount to just under a quarter of human-caused greenhouse gas emissions.[iv] Forests and oceans absorb vast amounts of carbon dioxide, but this capability is diminishing due to acidification, biodiversity loss and plastic pollution. As we approach various tipping points, the impact of this impairment of natural capital becomes more important.
The growing appreciation of natural capital could significantly impact the economics of many companies and, as investors, it is our job to price future risks and opportunities then turn those into an investment thesis today. The following framework shows how MFS is beginning to integrate natural capital into their fundamental analysis.
How to assess the impact of natural capital?
MFS investment team use a three-step framework to analyse the risks and opportunities for companies arising from natural capital.
The team's initial focus is applying it to the food industry, given its high dependency on natural capital compared to other industries. The food industry also has the largest impact on natural resources, driven primarily by intensive and industrialised processes. Moves towards more sustainable food production are also likely to impact profit margins. If no such transition is made, the food sector's reliance on natural capital and ecosystem services makes it particularly vulnerable to deteriorating value derived from nature. This has implications for food sector companies and investors alike.
This post was funded by MFS
The views expressed in this presentation are those of the speakers and are subject to change at any time. These views should not be relied upon as investment advice, as securities, recommendations or as an indication of trading intent on behalf of the advisor. No forecasts can be guaranteed. Please keep in mind that a sustainable investing approach does not guarantee positive returns and all investments, including those that integrate ESG considerations into the investment process, carry a certain amount of risk including the possible loss of the principal amount invested
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