A farming lesson for risk-conscious investors

The degradation of the Mamalana wetland in Mpumalanga saw Bushbuckridge farmers lose their purpose and income to soil erosion.

A cost-benefit analysis performed after the rehabilitation of the wetland showed a 294% increase in the economic value derived by the surrounding community.

Improved crop production, livestock grazing and access to crafting materials supported a rise in household incomes and food security, strengthening the area’s socioeconomic fabric.

That’s biodiversity at work on a small scale. Its butterfly effects have large implications for investors.

Diversification isn’t just a portfolio thing

South Africa is part of an elite club – we excel despite ourselves – made up of 17 countries classified as ‘megadiverse’. Together, our borders hold two thirds of the world’s biodiversity, defined as:

The variability of plants, animals and other organisms, both terrestrial and aquatic, that comprise functioning ecosystems.

To support our population explosion and materialistic thirst, homo sapiens has – ignorantly but increasingly maliciously – degraded the natural environment needed to sustain healthy biodiversity.

In SA, that looks like habitat loss, the sullying of freshwater flow, nutrient-devoid soil and the proliferation of alien plant and animal species.

Much like an investment portfolio, a lack of (bio)diversification reduces the ability of our ecosystems to function properly, especially during times of stress (read climate change).

A thinning of indigenous species might sound like a problem for the conservationists. But just as the Bushbuckridge farmers came to realise, good business is often dependent on services that only nature can provide.

Nature-to-business (N2B)

The essential ‘ecosystem services’ on which businesses depend include, but are not limited to, the following:

• Access to clean water (for energy production and industrial activity)
• Access to clean air (for healthy and productive employees)
• Stable topsoil (for arable farmland and nourishing pastures)
• Pollination (for food production)
• Flora & fauna (for tourism)

Without these services, whole industries would struggle to operate. One study found that 7% of SA GDP is reliant on biodiversity, accounting for nearly half a million jobs; another valued our fynbos at R10 billion per annum; yet another has linked 25% of the African continent’s GDP to nature.

It also pays to remember that businesses are nothing without their consumers, the latter of which are also influenced by biodiversity.

On the one hand, their buying decisions are increasingly informed by whether a business conducts itself in a sustainable manner. On the other, biodiversity plays an important role in creating a healthy cohort of consumers – financially, physically and mentally – that rouse the economic activity businesses need.

At this point, it should be clear that corporate fortunes, some more than others, are tied to natural ecosystems that are under threat.

Investment considerations

Here are two questions that investors can ask to mitigate the risk of biodiversity loss having a negative impact on investment returns:

1. How is a business/fund contributing to biodiversity loss?
2. How dependent is the underlying business/fund on ecosystem services?

To the first point, a business or fund that contributes to the degradation of natural spaces is more susceptible to profit-sapping regulation and runs the risk of incurring reputational damage.

To the second point, a business or fund that is heavily dependent on water, for example, could experience operational issues during dry spells and suffer expensive transition costs as they try to reduce their future dependency on natural ecosystems.

In short, biodiversity dynamics can hurt business bottom lines.

As is often the case when investing, just being aware of the risks and how they might manifest is half the battle won. Giving the above questions more weight will help strengthen portfolio risk management and promote better risk-adjusted returns.

Starting points

Where does an asset allocator or institutional investor begin incorporating biodiversity into their client portfolios? Here are three starting points:

First, four fifths of natural habitat loss globally can be laid at the doorstep of three culprits: agriculture, infrastructure development and energy production. The incumbents who comprise these industries should, therefore, attract additional scrutiny inside a given investment process.

Second, climate change is both a cause of, and caused by, biodiversity loss. It follows that allocating capital with an eye to slowing or reversing the former will simultaneously address the latter. Double-down on these efforts.

Third, initiative and maintain an open dialogue with fund managers and/or portfolio companies around biodiversity issues, using engagement and coordinated voting power to promote and instil business practices that protect and support natural ecosystems.

The sharp end

But the careful custody of client capital will ultimately require:

1. quantifying biodiversity risk at a company or fund level; and
2. integrating that understanding into portfolio construction.

We believe the most efficient way to achieve that outcome is to partner with global investment managers, like Robeco, on the cutting edge of sustainable investing. They have the expertise, systems and insight necessary to identify, measure and integrate biodiversity factors – that are material to investment returns – into our client portfolios.

What can you do, as a responsible citizen, to help reverse biodiversity loss? You know the drill: eat sustainability produced food; don’t buy single-use items like plastic bags; recycle; reduce energy and water consumption.

If you’re looking to make a higher-octane contribution, head down to your local woodland and hack away at some silver wattle. Or wade into a wetland and wrestle some water hyacinth. A farmer nearby might thank you.