Biodiversity loss integration next frontier for fixed income portfolios

Managing risks, having a positive impact and meeting regulations are three reasons why fixed income investors are considering biodiversity within their portfolios, says Bruno Bamberger, senior solutions strategist at AXA Investment Managers.

Alongside the risks posed by biodiversity losses, Bamberger believes that increasing interest in investing with impact, as well as regulation, is driving the need for the integration of biodiversity factors into institutional fixed income portfolios.

He says, “Large asset owners are starting to measure their impact and consider how to adapt portfolios. At the same time, the risks are becoming ever more evident. We expect companies that do not proactively address these risks and do not adopt more sustainable nature-positive business models could face higher costs or lower revenues, therefore reducing their ability to repay debt in the future.” 

“Alongside this, The Taskforce on Nature-Related Financial Disclosures (TNFD) is set to release its complete recommendations for a biodiversity risk management and disclosure framework in September this year. As with climate-related disclosures, adoption may quickly filter through to mandatory reporting on biodiversity, requiring a greater understanding of the topic among all investors.”

Bamberger breaks biodiversity risk into two key categories for investors to consider: physical risks from ecosystems degradation and depletion of natural resources, which can create significant pressures on issuer supply chains and manufacturing processes; and transition risks linked to global efforts to tackle the problem, including new technologies, evolving regulation, changing consumer spending patterns or even boycotts and litigation.

He believes the interactions between these two categories of nature-related risks could eventually lead to a nature-related systemic risk with consequences for global economies around the world.

With this in mind, Bamberger outlines three key steps to integrating biodiversity into fixed income portfolios.

Harnessing available data

While still in its relative infancy, Bamberger believes that the availability, quality and coverage of data on nature-related risks available to investors and managers is improving. This is allowing them to better identify and properly manage nature-related impacts, dependencies, risks and opportunities.

“We are harnessing data such as the Corporate Biodiversity Footprint (CBF) metric from Iceberg Data Lab to provide a holistic view across fixed income asset classes, such as the global investment grade credit landscape, and compare the primary drivers of biodiversity loss, such as GHG emissions, air pollution, land use, and water pollution.”

“In this way, data is increasingly enabling investors to focus their attention on the most harmful impacts when looking to minimise their overall footprint and develop positive solutions. It can also highlight the skews in impact between different sectors, enabling investors to pinpoint the issuers with the biggest footprint within their portfolio.”

Building biodiversity into your investment process

After identifying such portfolio ‘hot spots’ across sectors and specific issuers, Bamberger believes that investors can then start the process of re-aligning their portfolio to reflect where best practice lies in biodiversity integration.

“A basic starting point is to tilt portfolios away from issuers with a high biodiversity footprint and little ambition to reduce it, towards companies in the same sector that have identified the risks and impacts and who are managing (reducing) and monitoring them. Detailed issuer-level analysis is critical here to assess the ambition and credibility of corporate objectives.

“Fixed income investors can also use the lever of bond maturities to mitigate biodiversity-related risks within their portfolios. For example, issuers with a high dependency on natural resources or a high biodiversity footprint could be invested in only at shorter maturities and only re-invested into upon maturity if they have sufficiently mitigated those risks or reduced their footprint.”

Engaging with key sectors and issuers

According to Bamberger, having a constructive dialogue and actively encouraging issuers to shift their business practices is a key method to foster positive change. Moreover, he believes that helping them to become more aware of (and resilient to) the implications of supply chain and consumer risks from biodiversity loss can also help them to avoid any surprises that might impair their ability to repay debt.

“As with climate change, engagement on biodiversity loss can be extended from individual dialogue with companies to participation in industry consultations or collaborative initiatives such as Nature Action 100. Ultimately, global collective action is important to achieve both issuer-level and system-wide positive impacts.

“If an issuer is resistant to change their business practices, perhaps for fear of reducing profitability in the short term, a clear and established engagement framework and escalation process – which, in extreme cases, may even result in divestment – is critical to monitoring and implementing actions based on engagement activities.

“It should be noted, however, that divestment can prove counter-effective by reducing the investible universe and eliminating the point of contact with (and potential leverage over) any given issuer. While financial institutions are still building knowledge on the topic of biodiversity protection, an active engagement strategy may be better adapted than divestment for effectively tackling nature-related risks and identifying opportunities.”