Heeding nature: what’s at stake in a changing world?

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As with any investment, your capital is at risk.

When was the last time you saw a partridge in a pear tree? Or two turtle doves, for that matter? Your chances are slim: partridge populations in the UK have plummeted by 92 per cent since the 1970s, and turtle doves by 95 per cent since the 1950s.

This trend is echoed across the world and species: almost one million animals and plants are threatened with extinction, according to the UN.

Such biodiversity loss would be tragic in itself. But it’s also emblematic of something more fundamental: a structural decline in the health of natural ecosystems – or the ‘depreciation of natural assets’ to those more economically minded. This misfortune threatens the resilience and productivity of companies, societies, and, in turn, investors.

Companies’ footprints

The companies we invest in all depend upon the stocks and flows of the natural world. For some, the connection is tangential or relatively trivial. But for many, nature is a fundamental enabler of success and growth.

TSMC’s computer chip production, for example, requires more water than 170,000 US households. Kweichow Moutai’s baijiu spirits rely upon China’s Chishui River’s crystal clear waters, unique purple soils and clean air to cultivate and ferment the sorghum grass that provides their distinctive taste.

But through a concoction of climate change, pollution and habitat modification, humans are disrupting the natural assets we rely upon. This disruption can lead to higher operational costs, resource scarcity and increased regulatory pressures for businesses that rely on them.

Both the soils and water in the Chishui River Basin have suffered significant heavy metal pollution, as well as industrial waste and sewage. Expanding agriculture is exacerbating rates of soil erosion. And since baijiu fermentation occurs in an open environment, emissions from vehicles and industry can also affect the process.

For TSMC, it’s not water pollution that’s the main concern but securing the required volumes. In 2021 and 2023, Taiwan saw two drought events that were previously assumed to be of 1-in-100-year severity. Typhoons, which induce 70 per cent of the island’s rainfall, are now bypassing the island more frequently. These drought events call into question TSMC’s social licence to operate – ie approval from its stakeholders, employees and the general public – with its production facilities competing against drought-stricken communities and farmers for water.

Can’t we just adapt?

As investors, we are making increasing efforts to understand how the physical world is changing for our holdings. Which of our companies are highly reliant upon water, soils, air, flora or fauna? Are these resources likely to be under threat in the future? Most importantly, how resilient and adaptable are companies and the stakeholders they depend upon to future shocks?

The good news: humans are incredibly adaptable. It’s what sets us apart from other species. You won’t find any other apes living in both Svalbard and Sierra Leone. Companies can adapt by geographically diversifying, investing in alternatives or sustainably managing the ecosystems they rely upon.

Kweichow Moutai, appreciating the uniqueness of the Chishui Valley, has taken to the latter. It has embarked on a wide variety of efforts to protect the soil, water and air it depends upon. These include tree-planting schemes, community education, ecological compensation funds and sewage processing plants.

But you’ve got to pay attention to the changing competitive environment. Could increased water and energy costs from desalination and trucking water across the country put TSMC at a structural disadvantage to international competitors? Our analysis suggests not, but that might not hold true in other industries.

Focused analysis

Nature and climate risks are complex. Over the past two years, we’ve been trialling approaches and building our understanding of the topic. In doing so, we’ve leaned heavily on our academic partnerships and conducted assessments at the stock, portfolio and firm level.

Given the breadth of the topic, we have found it useful to narrow the focus of our analysis. Our three priority areas this year have been:

• deforestation
• water
• climate impacts

We have developed an assessment framework for companies that most contribute to and are impacted by deforestation and are in the process of doing so for water. We are working with external experts to consider how physical risks such as wildfires and hurricanes can affect company operations, which you can read more about in our TCFD report.

Nature is a constant theme in our Climate Scenarios work with investment teams and clients. Our methodology in the Climate Scenarios project – long-term, qualitative explorations of the future – is well-suited to the complexity of climate and environmental shifts.

We’ve explored questions such as whether Canada and Russia emerge as net beneficiaries due to increased arable land in a warming world, and to what extent can India adapt to intense water stress this century, including the implications for migration and potential conflict.

Looking to the positives

Though nature loss and climate change can paint a dreary picture of the future, our Climate Scenarios sessions often point us towards the positives. As growth managers, we know disruption can create unique investment opportunities in companies providing innovations and solutions that support a resilient, adaptable and sustainable society.

As a dual-mandate strategy, our Positive Change Team leads the way in explicitly seeking companies that can make a difference to society and the environment in addition to generating strong long-term returns. However, our other investment managers are increasingly selecting such companies for other portfolios, too.

Farming equipment maker John Deere, for example, aims to alleviate pressures caused by agriculture through its precision technologies that reduce the amount of fertilisers and pesticides used.  

Bioscience specialist Chr. Hansen is improving soil quality through biological, not chemical, means. And Advanced Drainage Systems is minimising the impact of heavy flooding via its water transport, storage and treatment products.

Our advantage

In short, biodiversity loss matters. And the range of plants and species affected and inputs involved – from forest cover to bee pollinator levels – is dizzying.

That makes predicting the investment implications almost infinitely more complex than those of climate change, assuming you rely on data alone.

Our qualitative focus is better suited to the task, drawing on detail-rich narratives, our specialists’ research, external expertise and conversations with the companies we back.

Our long-term outlook underpins all this, ensuring we focus on the developments and efforts that really matter over time rather than short-term interventions and outcomes. We relish this challenge, and as we develop our thinking, we look forward to sharing our conclusions more widely and constantly improving our efforts to deliver long-term value.

Risk factors

The views expressed should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.

This communication was produced and approved in December 2024 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.

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