Go long on the Earth

A super year for nature?

Last year was intended to mark the launch of the United Nations Environment Programme’s (UNEP) Super Year 2020. UNEP’s Executive Director Inger Andersen advocated a plea to governments to reinforce their commitment “to making sure nature has a strong voice at the table… we need to change what drives our economic growth, the way we build our cities, the way we produce our food, the choices we make each and every day.”¹ Yet even as these words were spoken, COVID-19 was spreading undetected around the globe. 

We’re now painfully aware that human encroachment on wildlife habitat as well as tropical deforestation have been linked to emerging zoonotic diseases like COVID-19.² We’re just as aware of the preparations that might have been made, at relatively little expense, to prevent what’s clearly the worst pandemic in a century.³ In fact, we knew the risk, we knew how to mitigate it, and we failed to act. Nature indeed had a very strong voice at the table when disaster struck, and we learned the hard way that public health depends on planetary health.

“We knew the risk, we knew how to mitigate it, and we failed to act.”

If there’s a silver lining, it’s that it fast-forwards us toward the likely scenario—more gradual but with far worse consequences—of failing to act on climate change. Five years after 197 member countries endorsed the Paris Agreement agreed under the United Nations Framework Convention on Climate Change, progress is falling woefully behind. We’re aware of the risks, we know what to do, yet there’s still no decisive action. So, although 2020 could not provide the advances we’d hoped for, it has illuminated the path forward.

Another global phenomenon: climate commitments and standards

As the pandemic spread rapidly around the world last year, something else, something far better, also emerged—a groundswell of corporate climate (and nature) commitments, alliances, disclosures, reporting frameworks, and accounting standards. On top of preexisting frameworks such as the Task Force on Climate-related Financial Disclosures, science-based targets, and the Net-Zero Asset Owner Alliance, we saw the launch of new initiatives—the Taskforce on Nature-related Financial Disclosures,⁴ science-based targets for nature, Transform to Net Zero,⁵ the EU taxonomy for sustainable finance, Partnership for Carbon Accounting Financials,⁶ and the Partnership for Biodiversity Accounting Financials.⁷ Last year, the number of companies setting their sights on net-zero targets roughly doubled to more than 1,500.⁸ With the foundation for private sector climate action firmly in place, companies are responding in kind.

And another: natural climate solutions

We’re also seeing rapidly growing interest in natural climate solutions (NCS) and nature-based solutions (NbS)—initiatives grounded in functioning ecosystems that deliver value not only by addressing challenges faced by society, but also by benefiting nature through enhancing biodiversity and ecosystem services. NCS are NbS land management decisions that increase carbon storage or prevent greenhouse gas emissions across global forests, wetlands, grasslands, and agricultural terrain.

The top two NCS categories are forests and farmland, with research showing that NCS “can provide over one-third of the cost-effective climate mitigation needed between now and 2030 to stabilize warming to below 2°C.”⁹ These 'natural sinks' occupy the low end of the carbon sequestration cost curve¹⁰ and offer, according to the UNEP, “the best way to achieve human well-being, tackle climate change and protect our living planet.”¹¹ How fitting that nature itself would provide the solutions that are key to mitigating climate change.

We believe we urgently need these natural solutions, and the first big tranche is likely to come from forests. According to the UN-supported Principles for Responsible Investment (PRI), “forest-based carbon stocks can generate nearly US$7.7 trillion in net present value for investors through to 2050. That is, land sector carbon policy will move towards valuing carbon stored in vegetation and soil, creating an entirely new industry driving economic growth and investment.”¹² Only underscoring the size of forest carbon projects we're going to need, the recently launched Taskforce on Scaling Voluntary Carbon Markets estimates that “voluntary carbon markets need to grow by more than 15-fold by 2030 in order to support the investment required to deliver the 1.5°C pathway.”¹³

That’s a tall order, so the question is: How do we get there?

Impact-first investing and the NCS revolution: seeing value in underpriced assets

Since our foundation, our company's underlying principle has been "good stewardship is good business." Aiming to make lives better through stewardship of people and the environment, our mission is to create value through the sustainable management of natural resource investments. From the beginning, we’ve focused on food and fiber, meeting basic human needs with products such as fruit, nuts, lumber, paper, and cotton.

As the impact of climate change becomes clearer, however, and the need for mitigation and adaptation through NCS becomes more emphatic, we’re beginning to work on another basic human need: a stable and resilient natural world.

While traditionally our investors trusted us to sustainably manage and harvest land, we now know there are impact-first investors who invest with a view to fighting climate change and nature loss. These investors see value where others may not—in carbon sequestration and ecosystem services—and may in fact prioritize these over financial returns. Valuing carbon more than society at large and perhaps putting their own proprietary price on carbon, they may invest in forests or strategies that seem to offer suboptimal rates of return. 

“Good stewardship is good business.”

It’s natural to think that optimizing forest management for carbon sequestration, when carbon is valued at zero, is unlikely to “pencil out” (i.e., prove profitable)—but only while repeating the mistake that steered us towards this climate emergency in the first place: undervaluing carbon. Some see the fact it’s held in low esteem as proof that the market doesn’t value it, and as a result, it’s not worth investing in. Others see opportunity—the impact-first investor may welcome carbon precisely because they believe the market has mispriced it.

Forests may be more valuable to these investors because they value carbon more than traditional timber revenue. These investors often account for the value of carbon in their underwriting, and when financial returns include the avoided costs of a carbon price, the returns may become more attractive—the higher the carbon price, the greater the potential for financial returns. When investors value carbon the way we believe society at large should, their investment calculus is seen in a different light and there are hopeful signs that land sector carbon policies will shape a whole new industry.

The voluntary carbon market grew by 6% in 2019. 

If governments implement the PRI’s Inevitable Policy Response levers that appear to be required to incentivize limiting global warming to 1.5°C, we’ll all soon value carbon more highly than we do now. When that time comes, whose portfolios will benefit more? Those who decided not to invest in carbon removal because it didn’t make financial sense at the time, or those who valued it more highly to begin with—portfolios that invested in carbon removal before it made financial sense?

At the same time, there’s the risk that this doesn’t happen. But this is the nature of investing and investors are generally compensated for taking risks. Let’s bear in mind that if we’re not dealing with the transition risks on the horizon, it’s because we’re dealing with physical risks related to extreme warming, risks that science warns will lead to far greater value destruction than we can imagine. Our assessment going forward: Go long on the Earth and your downside may be negative a few basis points; short the Earth and your downside could be limitless.

"Short the Earth and your downside could be limitless."

Only time will differentiate bona fide climate and nature commitments from empty promises that fail to deliver. We believe the difference lies in who values carbon higher, first. 

The verdict is still out on 2020. Will it be the super year for nature that never was or the year when everything came into twenty-twenty focus, the year of the great realization? Only 2021 will tell.  As for us: We’re going long on the Earth—join us, the forest is waiting.

Glossary:

natural sinks: natural systems that absorb and store carbon dioxide, e.g. the oceans, plants and soil 

carbon sequestration: the process of capturing and storing carbon dioxide from the atmosphere

carbon stocks: an amount of carbon that has been sequestered from the atmosphere and stored within an ecosystem

voluntary carbon markets: markets that allow for the purchase of greenhouse gas or carbon credits to mitigate or offset the production of harmful emissions

1 “2020 resolutions for nature,” Inger Anderson, United Nations Environment Programme, January 31, 2020. 2 “Emerging threats linking tropical deforestation and the COVID-19 pandemic,” Pedro H.S. Brancalion et al., Perspectives in Ecology and Conservation, September 30, 2020. 3 “Inside America’s 2-decade failure to prepare for coronavirus,”, Dan Diamond, Politico, November 4, 2020. 4 “Bringing together a taskforce on nature-related financial disclosures,” Taskforce on Nature-related Financial Disclosures, December 2020. 5 Transfer to net zero, December 2020. 6 Partnership for Carbon Accounting Financials, December 2020. 7 Partnership for biodiversity accounting financials, December 2020. 8 “Accelerating net zero: exploring cities, regions, and companies’ pledges to decarbonize,” Data-driven EnviroLab and NewClimate Institute, September 2020. 9 “Natural climate solutions,” Natural Academy of Sciences of the United States of America, October 31, 2017. 10 “Carbonomics: the green engine of economic recovery,” Goldman Sachs Equity Research, June 16, 2020. 11 “Spotlight on nature and biodiversity,” UNEP, February 10, 2020. 12 “The inevitable forest finance response: investor opportunities,” PRI, October 2020. 13 “Taskforce on scaling voluntary carbon markets,” consultation document, November 2020. 

Editor’s note: Much of this material originally appeared in Pensions & Investments, February 10, 2021. 

This material was prepared solely for informational purposes, does not constitute a recommendation, professional advice, an offer or an invitation by or on behalf of Manulife Investment Management to any person to buy or sell any security or adopt any investment strategy.