Factoring in nature in equities: why biodiversity matters for AP3
Powered by new tools, investor awareness of biodiversity risk is on the rise as AP3's approach towards mapping biodiversity risks in its equity portfolio shows
“Nature is not the elephant in the room, it’s the huge green scorpion running towards us”, warns Dr. Nicola Ranger, an academic at the University of Oxford. Ranger’s analogy carries a critical message. The scorpion’s sting - biodiversity loss - would make climate change a lot more severe and a lot less predictable.
For asset owners, this amplifies the urgency to map and address biodiversity risk.
One such asset owner is AP3 – the Third Swedish National Pension Fund. Biodiversity entered AP3’s responsible investment policy in 2022 and its latest stewardship report shows that the fund is pushing for improved biodiversity risk management at companies such as PepsiCo, Home Depot and Tyson Foods. At last count, a total of 179 of AP3’s engagements included biodiversity as a theme.
“We want and expect the companies in our portfolio to assess, manage and report on risks in a structured way, preferably aligned with the Taskforce on Nature related Financial Disclosures recommendations” says Fredric Nyström, AP3’s head of sustainability and governance.
Biodiversity risk and AP3’s equity portfolio
For asset owners, identifying and mapping biodiversity risks across their portfolios is an on-going project. New tools and methodologies are expediting progress.
In its latest biodiversity action plan, AP3 makes an attempt at mapping potential biodiversity impact and dependence in its equity portfolio. The analysis found that 40 to 50 percent of the portfolio has a high or very high materiality when it comes to biodiversity risks.
The report attributes these potential risks to water use, water pollutants, soil pollutants and greenhouse gas emissions from investments in industrials, health care, real estate and consumer staples.
“The analysis of our equity portfolio is our initial attempt of mapping our risk exposure, a 1.0 version if you’d like, and we plan to continuously develop our methodology and strategy around biodiversity”, Nyström told Net Zero Investor.
AP3’s risk mapping exercise is set against the backdrop of strong results in listed equities. AP3’s interim report for 2024, shows a 14.1% return for listed equity investments- the highest amongst all asset classes.
Mapping impact and dependence – the ENCORE project
AP3’s methodology draws on the Exploring Natural Capital Opportunities, Risks and Exposure (ENCORE) tool.
A partnership of three organisations maintains and updates ENCORE: Global Canopy, the UN Environment Programme – Finance Initiative and the UNEP Conservation Monitoring Centre (WCMC). The trio was formerly known as the Natural Capital Finance Alliance.
Explaining the logic behind the tool, Sebastian Bekker, Senior Programme Officer in the Nature Economy team at the UNEP-WCMC told Net Zero Investor:
“ENCORE helps people understand what types of nature-related issues might be important for different types of economic activities. This is often referred to as ‘exposure to nature-related risk’, which can be built upon to derive an assessment of biodiversity-related risk”
The tool utilizes a broad scope to map materiality. “ENCORE’s focus is on nature as a whole, and it includes many elements relating to biodiversity given the important relationship between biodiversity and the provision of ecosystem services”, says Bekker.
Rising awareness
As tools and methodologies to map biodiversity risks improve, so too does an investor’s awareness of biodiversity’s materiality. That perhaps, is ENCORE’s greatest raison d'etre.
“The increasing awareness among investors about the risk of biodiversity loss to their portfolios is a significant development. This systemic risk, which will impact all asset classes and sectors, is a clear indication of the urgency of the issue”, commented Romie Goedicke, co-lead of UNEP FI’s nature team.
For AP3, the analysis of its equity portfolio sets the stage to explore potential biodiversity impact in other asset classes. “We will conduct screening and analysis of parts of the portfolio annually, either focused on different asset classes or deep dives in specific sectors or specific ecosystems”, says Nyström.
Awareness is spreading across other asset classes too. According to Goedicke, fixed income investors are increasingly factoring in biodiversity in credit assessments while in private equity, investors are starting to explore the potential impact of project activities.
“Across all asset classes, the trend is clear: biodiversity is becoming a critical consideration in investment decisions”, adds Goedicke.
Addressing the risks
If mapping materiality is the first step, addressing potential risks is the next. When it comes to the latter - its identity as a global active asset owner and its stewardship capacities are AP3’s tools of choice.
Commenting on how the pension fund incorporates biodiversity in stewardship, Nyström said, “We vote on the annual general meetings of all companies in our equity portfolio and have supported most of the shareholder resolutions related to assessing and minimizing risks related to nature and biodiversity”.
AP3 also takes biodiversity and deforestation risk into account before making investment decisions. “If the company is operating within sectors that are considered high risk of deforestation, we check whether the company has a policy on biodiversity and on deforestation, whether it has done assessments of impacts and dependencies and whether it is reporting according to TNFD or similar frameworks”, adds Nyström.
Tools such as ENCORE add to an investor’s biodiversity risk management toolkit. While awareness over materiality is rising, there is some way to go before investors can assess the actual impact of a portfolio on biodiversity. For now, investors await measuring tools that make this possible but patience, in the minds of asset owners such as AP3, does not imply nor justify inaction.
