ESG Investing: How to Assess and Navigate Biodiversity Risk

December 19, 2022 Adrienne Lawler

Biodiversity loss among the top 3 global risks over the next 10 years

Biodiversity loss can cause significant and financially material risks to portfolios. Julie Moret, head of sustainable investing and stewardship, explains why investors need to address these risks and how, as part of their environmental, social and governance (ESG) investing efforts.

What is biodiversity and why is it relevant to investors?

The diversity of all organisms and their ecosystems represents biodiversity, which nature needs to produce the renewable resources that support the global economy. The World Economic Forum estimated that more than half the global economy depends on nature and identified biodiversity loss as one of the top three risks on a global scale over the next decade. Investors no longer can ignore how biodiversity impacts their portfolios.

How is the investment industry addressing this challenge?

In December 2022, Montreal will host the second half of the Convention on Biological Diversity with a goal to “bend the curve” of biodiversity loss by 2030. As the Paris Agreement in 2015 brought the world to consensus on climate change, expectations are that this meeting will do the same for biodiversity.

This event may spur momentum for investment efforts to protect biodiversity through three key investor initiatives. The first initiative is the Finance for Biodiversity pledge, which includes 103 investment firms and banks with more than $14 trillion in assets committed to protect and restore biodiversity through their activities and investments. The second is Nature Action 100+, a collaborative initiative where investors collectively engage with companies and governments to mitigate biodiversity loss, aligned with the goals set out by the Finance for Biodiversity pledge. The third is the Taskforce on Nature-related Financial Disclosures, which aims to offer tools to help investors integrate nature-related risks into their decisions.

How can investors assess companies on biodiversity risk?

As investors gain more access to biodiversity data with increasing nature-related disclosures by companies, investors can use this data to construct their portfolios and engage with companies with biodiversity impact in mind. They can evaluate biodiversity risks from a sector-specific perspective, including palm oil, mining and animal agriculture industries that have a high impact on ecosystems. Investors can also develop a holistic approach to evaluating a company’s impact on biodiversity through its water use, land use, and raw material sourcing along with its management of packaging material, waste and electronic waste.

To understand which products and business models are unsustainable from an environmental perspective, investors can rely on sector-specific financial materiality frameworks such as the SASB codified standards, which are also part of our proprietary ESG Vector Score. Materiality frameworks may help investors apply screens to remove the worst-performing companies in terms of their impact on biodiversity and the environment. For example, investors could screen out companies with water-intensive production processes in areas of water stress or identify these as targets for engagement.

What are the practical ways to integrate biodiversity into the investment process?

Biodiversity loss and climate change are the “twin crises” of the environment, with biodiversity loss reducing nature’s ability to mitigate climate change and global warming exacerbating biodiversity loss. Investors increasingly need to understand the interconnected environment to encourage progress on the transition to sustainable economies and businesses.

To navigate the “twin crises” of the environment in one of our investment strategies, we rely on a combination of responsible investment screens, alignment to the Paris Agreement goal of limiting global warming to 1.5 degrees Celsius, and nature-aware tilts and screens. The strategy screens out companies linked to ecosystem loss and water pollution. It also increases exposure to companies that minimize natural capital loss and contribute to environmental improvement, including:

• Climate change mitigation and adaptation.

• Sustainable use and protection of water and marine resources.

• Protection and restoration of biodiversity and ecosystems.

How else can investors support biodiversity?

We believe engaging with companies is essential. At NTAM, preserving biodiversity is one of our key stewardship priorities. We focus on limiting environmental damage and deforestation and promoting sound practices in water management.

One example is animal agriculture. This sector contributes to climate change, land degradation and biodiversity loss, according to Farm Animal Investment Risk and Return (FAIRR). In 2021, we continued to participate in FAIRR’s collaborative engagement on sustainable proteins, which is the world’s first and largest investor engagement effort focused on encouraging global food companies to transition to more sustainable food products. As a result, all the companies targeted by the campaign are investing in the development of plant-based protein products and nearly 30% of them plan to increase sales of alternatives to meat and dairy.

Explore our sustainable investing expertise.

About Sustainable Investing

At Northern Trust Asset Management (“NTAM”), we define Sustainable Investing as encompassing all of NTAM’s investment strategies and accounts that utilize values based and norms based screens, best-in-class and ESG integration, or thematic investing that may focus on a specific ESG issue such as climate risk. NTAM’s Sustainable Investing includes portfolios designed by NTAM as well as those portfolios managed to client-defined methodologies or screens. As the data, analytical models and aforementioned portfolio construction tools available in the marketplace have evolved over time, so too has NTAM. NTAM’s Sustainable Investing encompasses strategies and client assets managed in accordance with client specified responsible investing terms (historically referred to as Socially Responsible), as well as portfolios that leverage contemporary approaches and datasets, including ESG analytics and ESG thematic investing.

IMPORTANT INFORMATION. For Asia-Pacific markets, this information is directed to institutional, professional and wholesale clients or investors only and should not be relied upon by retail clients or investors. The information is not intended for distribution or use by any person in any jurisdiction where such distribution would be contrary to local law or regulation. Northern Trust and its affiliates may have positions in and may effect transactions in the markets, contracts and related investments different than described in this information. This information is obtained from sources believed to be reliable, and its accuracy and completeness are not guaranteed. Information does not constitute a recommendation of any investment strategy, is not intended as investment advice and does not take into account all the circumstances of each investor. Opinions and forecasts discussed are those of the author, do not necessarily reflect the views of Northern Trust and are subject to change without notice.

This report is provided for informational purposes only and is not intended to be, and should not be construed as, an offer, solicitation or recommendation with respect to any transaction and should not be treated as legal advice, investment advice or tax advice. Recipients should not rely upon this information as a substitute for obtaining specific legal or tax advice from their own professional legal or tax advisors. Information is subject to change based on market or other conditions.

All securities investing and trading activities risk the loss of capital. Each portfolio is subject to substantial risks including market risks, strategy risks, adviser risk and risks with respect to its investment in other structures. There can be no assurance that any portfolio investment objectives will be achieved, or that any investment will achieve profits or avoid incurring substantial losses. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Risk controls and models do not promise any level of performance or guarantee against loss of principal. Any discussion of risk management is intended to describe Northern Trust’s efforts to monitor and manage risk but does not imply low risk.

Northern Trust Asset Management (“NTAM”) may utilize an environmental, social, and governance (“ESG”) framework in certain investment strategies. Considering ESG factors may result in reduced or increased exposure to certain companies or industries, which may cause the applicable strategy’s performance to be lower than that of strategies that do not consider ESG factors. In addition, the added cost of ESG-related diligence in assessing the ESG parameters of an investment may also reduce the profitability of an applicable strategy’s investments. There may also be different views of what it means for an issuer to have positive or negative ESG characteristics. There can be no guarantee that an NTAM’s determinations regarding an issuer’s ESG characteristics will be accurate, including whether any such ESG characteristics are financially material or immaterial; any such inaccuracies could adversely affect a strategy’s performance.

Past performance is no guarantee of future results. Performance returns and the principal value of an investment will fluctuate. Performance returns contained herein are subject to revision by Northern Trust. Comparative indices shown are provided as an indication of the performance of a particular segment of the capital markets and/or alternative strategies in general. Index performance returns do not reflect any management fees, transaction costs or expenses. It is not possible to invest directly in any index. Gross performance returns contained herein include reinvestment of dividends and other earnings, transaction costs, and all fees and expenses other than investment management fees, unless indicated otherwise. For additional information on fees, please refer to Part 2a of the Form ADV or consult a Northern Trust representative.

Forward-looking statements and assumptions are Northern Trust’s current estimates or expectations of future events or future results based upon proprietary research and should not be construed as an estimate or promise of results that a portfolio may achieve. Actual results could differ materially from the results indicated by this information.

Northern Trust Asset Management is composed of Northern Trust Investments, Inc. Northern Trust Global Investments Limited, Northern Trust Fund Managers (Ireland) Limited, Northern Trust Global Investments Japan, K.K, NT Global Advisors Inc., 50 South Capital Advisors, LLC, Belvedere Advisors LLC and investment personnel of The Northern Trust Company of Hong Kong Limited and The Northern Trust Company.