Seeing the wood for the trees
The assessment carried out in September by F&C Asset Management (formerly ISIS Asset Management) of the exposure of FTSE sectors to biodiversity is a further indication of the increasing importance of SRI in the investment equation of many funds and their managers.
In scientific terms biodiversity is the number of species and genetic variety within species. F&C highlights that the value of biodiversity to companies lies in the economic value of “the complex simultaneous interaction between many species that has long been integral to economic success, and is now at risk from growing biodiversity loss”.
F&C identified nine sectors it considers exposed to significant biodiversity risk: construction and building materials, electricity, food and drug retailers, food producers and processors, forestry and paper, leisure and hotels, mining, oil and gas, and utilities.
F&C’s report highlighted seven key risks, and gave examples for each:
q Access to land – access to new sites is affected by a company’s track record on protecting/restoring biodiversity and water resources;
q Reputation – a biodiversity campaign over an issue such as genetically modified organisms reduces consumer confidence in a brand or company, resulting in lower sales;
q Access to capital – environment credit risk may be assessed as high due to a company’s poor biodiversity track record or management plans, and cost of capital increases;
q Access to markets – inability to meet specifications from buyers such as government departments and agencies for sustainably sourced materials like timber restricts access to a major market;
q Security of supply – reduction in the quality and availability of essential materials such as fish;
q Relations with regulators – concerns about a company’s track record on biodiversity management lead to permit delays or fines;
q Liabilities – unforeseen impacts of activities on biodiversity lead to financial liability even though a company’s regulatory licences have not been exceeded.
The report concluded that “biodiversity does present material risks” but that the “majority of companies in the high risk sectors are not taking substantive action to manage their biodiversity risks effectively.”
So what role can be played by those that invest in these companies, not least institutional investors? Karina Litvack, director and head of governance and SRI at F&C, is concerned. “I am not sure that pension funds hold their fund managers to account on these issues; that is really where more attention needs to be focused. This would then legitimise fund managers’ engagement with companies.”
Realising the importance of biodiversity is one thing but understanding what it is is another and perhaps we have a problem communicating this to pension funds. Litvack agrees: “That is why fund managers have an obligation to understand what the relevance is to them and their investments.”
Litvack cites the value of shock therapy: “You feel that you’re banging your head against a brick wall and then suddenly a scandal erupts. For example, an insurance company might misjudge the significance of a conflict of interest and then, boom, the share price collapses, and suddenly people realise there is a connection between ethics and value. Bit by bit people will see this is integral to the company.”
She adds: “But when we have tried to come up with a model to see what the connection might be we found it impossible because it varies so much from one case to another.”
It is interesting to note that the motivation to understand and incorporate biodiversity is not always financial; sometimes it comes down to image. “There is no doubt that does play a big part,” says Litvack. “Within a group of trustees some will be entirely motivated by hard figures. But others
will have concerns that go beyond
the numbers. But all in all, if performance is at least average, then they want it.”
The marketing effort made by multinationals to tell us about the good they are doing for the environment, and,
on the other hand, pressure on
these companies by groups such as Greenpeace, makes it hard for funds to decide what constitutes an ethical investment.
Litvack agrees that small pension funds lack the resources to figure out what is a good investment in this area. “We struggle with it and put a lot of effort into making head or tail of the different claims,” she says.
If specialist asset managers are struggling to make sense of the different claims, institutional investors have their work cut out.