In recent years, investors have increasingly recognised that they have an important role to play in the fight against climate change. They have responded by avoiding firms with high emissions, investing in climate solutions providers and supporting net-zero strategies. Many investors are now considering how they can help preserve the world’s biodiversity.
It might not be immediately obvious why preserving biodiversity is as important as minimising climate change, but the science is clear: biodiversity loss has major implications, including disruption to supply chains, threats to food security and increased vulnerability to natural disasters.
It also has major economic consequences – the European Central Bank (ECB) has said that biodiversity loss is a significant risk to financial stability.
With this in mind, investors are now beginning to consider how they can integrate biodiversity into their investment process.
At BNP Paribas Asset Management, we have been incorporating biodiversity into our investment process for several years as part of the extra-financial analysis and ESG1 scoring that we apply in portfolio construction for most of our investment strategies. We exclude companies with the worst impacts from our investment universes.
We are now going further, with a sharper focus on biodiversity as a separate issue. Given that many clients adopt a passive approach to investing, we describe below how we reduced the biodiversity footprint of a passively managed large-cap global equity portfolio without significantly affecting its tracking error.
Determining the biggest biodiversity offenders
Our starting point is assessing which companies have the largest impact on biodiversity.
This is easier said than done – while the concept behind measuring which companies have the biggest impact on climate change is relatively clear (the more greenhouse gases they are emitting, the greater their impact), measuring a firm’s effect on biodiversity is less straightforward.
We use data from Iceberg Data Lab, a fintech which measures individual companies’ impact on the five direct drivers of biodiversity loss identified by IPBES (the Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem Services). They are
- Land and sea use change
- Direct exploitation of species
- Climate change
- Pollution
- Invasive alien species.
It bundles them into a single metric – the Corporate Biodiversity Footprint.2
The data makes it clear that companies in the materials and consumer staples sectors account for most of the biodiversity loss, whereas companies in the IT and financials sectors have the smallest impact.
Minimising tracking error in a passive equity portfolio
For a portfolio with a limited tracking error relative to its benchmark – here we use the MSCI Europe ex-UK index – we use an optimisation to determine the impact of reducing the portfolio’s overall biodiversity footprint by varying amounts.
As exhibit 2 shows, reducing the footprint by 50% does not have a much bigger impact on the tracking error than reducing it by 20% or 30%. However, cutting the footprint (labelled CBF in the exhibit) by 70% leads to a significantly higher tracking error.
From an investment standpoint, it would be undesirable to have exposure to only a limited number of sectors, not least because it would increase a passive portfolio’s tracking error. Accordingly, we would overweight companies with a low biodiversity footprint and underweight or avoiding entirely those with a larger footprint.
For example, in the consumer staples sector, we would choose to underweight supermarkets, which have a high impact on biodiversity due to their exposure to agricultural supply chains.
The importance of engaging on biodiversity loss
Reducing a portfolio’s biodiversity footprint is an important step for investors to take, but on its own, it may not necessarily lead to much less biodiversity loss in the real world. As such, we believe that engaging with the companies we invest in across our portfolios is vital.
In recent years, we have been engaging with pharmaceutical companies to urge them to stop using the blood of the endangered horseshoe crab in tests for endotoxins which can cause sepsis. These actions have produced results, with several firms pledging to phase out their use of these animals.
Other examples of our active ownership practice include filing shareholder proposals to eliminate deforestation caused by the Cambodian apparel industry and degradation of Canada’s boreal forests.
Other approaches to biodiversity-related investing
In the case of the passive large-cap equity portfolio described here, we focused on minimising the exposure to companies with the worst impact on biodiversity.
Portfolios with different goals and constraints may require other approaches.
For actively managed portfolios with less of a focus on minimising tracking error or which can invest in asset classes such as small caps, private markets and fixed income, a more flexible approach may allow for an increased exposure to solutions providers that are actually reducing biodiversity loss and potentially contributing to the United Nations Sustainable Development Goals.
With biodiversity-related investing still in its early stages, we believe it is important for investors to work together closely with an asset manager on their biodiversity goals and possible solutions.
[1] ESG – Environmental, Social and Governance. ESG assessments are based on BNPP AM’s proprietary methodology which integrates all 3 aspects of E, S & G.
[2] For more on how this data is computed and its limitations, https://docfinder.bnpparibas-am.com/api/files/60B8656F-6A6F-4A35-9244-A997DCCB59FD
