How to navigate the changing landscape of biodiversity investing

“Biodiversity” has become something of a buzzword among institutional investors, thanks to growing awareness of the nature crisis, the recent adoption of the Kunming-Montreal Global Biodiversity Framework and the advent of the Taskforce on Nature-related Financial Disclosures (TNFD).

The latest World Economic Forum global risks report serves as a stark reminder of these ecologically fragile times, naming extreme weather events, critical changes to Earth systems, biodiversity loss and ecosystem collapse, and natural resource shortages as the top four risks in the next ten years.

Despite these urgent warnings, money continues to flow in the wrong direction. A recent United Nations report showed that the $200 billion dollars invested annually in nature-positive activities is dwarfed by the whopping $7 trillion dollars allocated to nature-negative activities.

While a recent study showed that UK pension funds tend to lag behind their peers at the global level, change is happening fast, both in terms of the interest in biodiversity and natural capital as an emerging asset class, and how markets and specialist fund managers are evolving to respond to that interest.

In this article, Net Zero Investor maps out the key features of this changing investment landscape.

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Timberland is still the top investment choice for pension funds

Timberland and sustainable forestry are widely seen as the most accessible natural capital investments for pension funds.

“Timberland is a large, stable asset class with a long and verifiable track record and a degree of inflation protection,” said Kristen Weldon, head of natural capital at Cibus Capital, formerly the global head of sustainable investing at BlackRock Alternative Investors. “That makes it attractive to pension funds looking to enter the natural capital space.”

"Moving into positive impact sustainable forestry is a logical next step for timberland investors, as they add biodiversity considerations to their natural capital mandates,” she continued.

Timberland has the added advantage of being able to generate carbon credits.

Some consultants like Karen Shackleton, who advises Local Government Pension Schemes, expects the “timberland number one” dynamic to change dramatically in the next two to three years.

“There're a lot of new ideas coming through, and we’re likely to see an increasing focus on land and water, as these relatively nascent markets start to catch up.”

Sustainable and regenerative agriculture are also on the agenda

If timberland tops the league tables, sustainable and regenerative agriculture come second.

Like timberland, agriculture is a real asset that offers inflation protection and a long investment track record.

“Forestry and sustainable and regenerative agriculture currently make up the core components of a pension fund’s natural capital portfolio,” said Rebecca Craddock-Taylor, sustainable investment director at Gresham House. “They are both established markets, with a secure demand basis and known dynamics.”

The global food system is also the single biggest driver of biodiversity loss.

Cibus Capital advises investments in two kinds of companies: those that are developing technologies to support the food system’s sustainable transition, including addressing biodiversity loss and those with real, productive assets that look to implement sustainable, biodiversity-friendly practices.

“We leverage the impacts and dependencies of food and farming on nature, with the wider goal of supporting the emergence of a secure, equitable, and sustainable food system,” said Georgina Thomas, senior ESG associate at Cibus Capital.

The strategy behind capital allocations involves finding a “financially successful means of striking a balance between food production and nature enhancement”.

The emergence of biodiversity and carbon markets as well as other initiatives, such as payment for ecosystem services, and an increase in ambitious nature-positive policymaking, should stimulate more reforestation efforts and the scaling up of sustainable and regenerative agricultural projects, she added.

Carbon and biodiversity credit markets

Carbon and biodiversity credit markets are another possible investment route.

Pension funds with net zero goals may look to use carbon credits to offset their emissions, or if they’re on target, sell them on to third parties.

Carbon markets, such as sustainable forestry projects, can also carry biodiversity benefits.

Voluntary biodiversity credit markets, on the other hand, are still in a very nascent phase, and lack universal standards, especially those that measure the benefits to biodiversity.

Compliance biodiversity credit markets, such as those established in the UK following the UK’s Environment Act and Biodiversity Net Gain rules, are slightly further ahead, and benefit from the protection of prescriptive regulatory frameworks.

The UK’s Environment Bank, which sells biodiversity credits to real estate developers caught by the net gain rules, received most of its private equity funding though pension fund money via Gresham House.

Diversification benefits

Shackleton said consultants have started to recommend natural capital investments to pension funds as a diversifying asset class.

“If you look back over the past decade or so, there have been many instances where listed assets have all moved together and fallen together,” she said. “Having alternative assets that are more resilient to the economy and the listed market can be incredibly attractive at the total fund level.”

Weldon said institutional investors looking at natural capital and biodiversity tend not to create a new category. Rather, they “look to add diversification to their pre-existing portfolio strategies, whether in real assets or private equity.”

This can create a “joint-venture-type structure across portfolio segments” that facilitate investment in “private equity and real assets”, she added.

Biodiversity as part of a wider climate strategy

Most pension funds are still thinking about biodiversity from a climate change perspective. This is perhaps unsurprising, given how much more awareness there is around climate risk, and how much older the Paris Agreement is compared to the Global Kunming-Montreal Biodiversity Framework.

Pension funds often want to use their forestry investments to meet net zero targets. An investment decision may begin with the question, “how much carbon is sequestered with these assets?”

“Climate change targets can be a really good driver for pension funds to start thinking more broadly about nature,” said Craddock-Taylor. “After all, the two crises are inextricably linked.”

Moving from negative screening to positive impact

Sources also noted a shift from negative screening – attempting to weed out harmful investments from portfolios – to achieving positive biodiversity impact.

“Most of our institutional investors are looking at not just managing risks but also creating positive impact going forward,” said Weldon.

This is the case for the UK-based Smart Pension, which has invested in AXA IM’s listed equity biodiversity fund.

Fiona Smith, investment proposition manager at Smart Pension, told Net Zero Investor that the decision to partner with AXA was made after carefully considering around “40 different investment managers” offering listed-equity and listed-bond impact funds.

Public or private markets?

Thanks to the liquidity assurances, listed equity tends to be easier for pension funds than private equity.

However, there is also a growing interest in inflation-protected real assets and private equity funds.

“Tackling the nature crisis means investments must feed into all parts of a portfolio,” said Craddock-Taylor. “We are seeing substantial interest in physical assets such as forestry, agriculture, and infrastructure.”

Ultimately, a pension fund’s approach depends on “what type of investor they are” and their risk appetite.

For example, defined benefit funds tend to have tighter timescale considerations that make long-term forestry investments unfeasible.

“Local Government Pension Schemes have a longer time horizon than most pension funds,” she added. “That gives them more flexibility to invest in assets such as forestry and agriculture.”

London CIV recently set up a natural capital fund. In the UK context, sources noted that Local Government Pension Schemes are further ahead in biodiversity thinking than their peers.

A mixed bag of funds

MSCI has identified 149 funds globally that were thematically linked to biodiversity based on the fund name and investment strategy. These funds collectively held approximately $60 billion, or around 2%, of the estimated $3 trillion invested in sustainable funds as of September 2023.

Among these, there were 15 pure-play biodiversity-labelled funds with just over $1 billion in AUM, the majority of which were mutual funds launched in 2022.

The remaining funds were biodiversity-related with a broader environmental or associated thematic mandate, such as strategies focusing on the circular economy that aim to provide exposure to firms that minimize waste, circulate resources, address water scarcity and regenerate nature

“Investors may be confronted with a broad mix of different strategies and investment approaches that can vary significantly in terms of their level of complexity and their clear link to global biodiversity goals,” the MSCI researchers wrote.

That means understanding the finer details of biodiversity funds are key for investors to navigate this space.