Key Takeaways
Biodiversity–a critical ESG issue for investors–is deeply intertwined with economic prosperity and strongly impacts humanity’s ability to survive.
In recent years, biodiversity has been declining at an alarming rate. As a result, the natural systems we rely on to provide food and remove toxins from the air and oceans are under threat.
While biodiversity affects virtually every segment of the global economy, American Century Investments has identified key industries and countries/regions upon which to focus.
Biodiversity Means Economic Health and Life Itself
Over half (55%) of the world’s gross domestic product (GDP), equal to US$41.7 trillion, depends on healthy biodiversity and thriving ecosystem services.1 According to the World Economic Forum (WEF), China, the EU and U.S. have the highest absolute economic exposures to nature-dependent industries, while construction, agriculture, and food and beverage production are the largest highly nature-dependent industries.
At American Century Investments, we believe the long-term health of the global economy is ultimately rooted in biodiversity.
The 15th meeting of the Conference of the Parties (COP 15) of the Convention on Biological Diversity is slated for October 2022. With its theme of “Ecological Civilization: Building a Shared Future for All Life on Earth,” this meeting should bring attention to biodiversity risks and opportunities for governments and companies, likely resulting in subsequent regulations and corporate pledges to uphold biodiversity.
We will closely monitor the conference proceedings as American Century portfolios invest in industries and countries that depend on and impact biodiversity.
In this article, we first explain why biodiversity has such far-reaching and profound implications for all investors. Then, we describe our framework for systematically analyzing how our investing affects and is affected by the loss of biodiversity the world is now facing.
What Is Biodiversity?
Simply put, biodiversity encompasses the diversity of life on earth. It includes humans, all other animals and plants, and the ecosystems in which we all survive and thrive—unless these ecosystems are under threat.
Biodiversity helps to meet our basic needs for food, fuel and shelter and provides many types of medicine. It is also important for its potential to lead to new developments in the health care and pharmaceutical industries, and inspire new products and services. Biodiversity also has cultural value, ranging from the spiritual or religious significance to leisure activities we enjoy.
To understand its all-encompassing effects, we think it helps to separate the overall concept into biodiversity and the ecosystem services and natural capital it entails.
Biodiversity
Biodiversity encapsulates the wide range of all living things, from single-celled amoeba to tree moss, to whales and elephants. This concept of diversity applies to entire ecosystems—from diversity within oceans, lakes, forests and deserts, to species variation (number of species and size of a species’ population) to the genetic diversity critical for an individual species’ resilience and survival.
Ecosystem Services
These are the benefits that flow from nature to humans. These include food, energy and medicinal resources that we consume directly, as well as services that nature provides, such as water filtration, crop pollination, carbon sequestration and flood protection.
Natural Capital
This refers to the natural assets that underpin these services, including the mangroves that purify water, bees that pollinate crops and forests whose trees naturally capture carbon dioxide (CO2). Biodiversity loss and degradation can reduce the quantity, quality and resilience of ecosystem services.
Preserving biodiversity is critical to protecting the natural capital underlying the ecosystem services we rely on.
Trees – A Biodiversity Perspective
Biodiversity | 73,300 species worldwide2 |
Ecosystem Services | Regulate temperature, provide shade, filter air pollutants, sequester CO2, manage and filter rainwater, stabilize soils, maintain soil health, provide food and shelter for numerous living organisms, and help improve our mental and physical well-being |
Natural Capital | Rainforests, old-growth forests, city trees |
Source: American Century Investments.
Biodiversity Crisis
We are living amid a human-caused mass extinction—often referred to as the Holocene extinction or 6th great extinction—that is nearly irreparable.3 Ecologically, the human race is an unprecedented global super-predator that continuously preys on apex predators and other animals and plants, with worldwide effects on food webs and ecosystems.4
Over the last 50 years, vertebrate species populations have declined by close to 70%.5 Some 30% of coral reefs have been killed, and 75% of those that remain are at risk of bleaching. Wetlands and natural forests are disappearing at an unprecedented pace. While some extinctions have always occurred naturally throughout history, the current rate of extinction is 100 to 1,000 times greater than the average rate over the past 10 million years.6
Moreover, because every ecosystem is composed of symbiotic components, collapsing biospheres and animal extinctions lead to even more collapses and extinctions at an increasing rate. If we continue down this path, we will lose flora, animal species, and entire ecosystems and biospheres that the world will never recover.
Therefore, we must make changes to reduce biodiversity loss, to help ensure the health and continuity of human society and the global economy.
This deterioration of biodiversity is driven primarily by human activity, including agricultural processes that deplete nutrients in the soil, overharvesting (fishing and logging), urban development, fossil fuel production, pollution and climate change.7
Saving the ecosystems that support economies everywhere will require systematic changes in our production processes and consumption habits, ambitious goals and collaboration across governments, industries, and nonprofit organizations, and investors who can supply the capital needed to bring about significant change.
Absolutely, because nothing exists in isolation. For example, if a plant-eating insect goes extinct, the plant the insect used to eat could grow unchecked and choke off other plants.
Deprived of a key food source, birds that used to feed on this insect could start eating other things, upsetting the natural balance of “supply and demand” for each species in the ecosystem that existed before the extinction. This result could impact numerous other species by having a domino effect on the entire system.
Why Investors Care About Biodiversity
From an investing perspective, we believe biodiversity demands our attention because entire industries depend on it. Our food supply, health and economic well-being rely on stable and thriving ecosystems. Economies around the world use natural capital to meet basic needs and make products that sustain and improve the quality of life. It is no exaggeration to say that diminished biodiversity poses a direct threat to human societies.
In its Global Risks Report 2021, the WEF ranked biodiversity loss among the top five global risks in terms of likelihood and impact. As just one example of the effect of biodiversity loss on health, the World Health Organization noted that wildlife-borne viruses like COVID-19 will arise more often if biodiversity loss continues, as the buffer zone that protects us from wildlife-borne viruses breaks down.8
As investors, we understand that many sectors depend on maintaining healthy biodiversity. According to the WEF, half of the world’s GDP is moderately or highly dependent on nature and its services,9 while 20% of nations worldwide are at risk of their ecosystems collapsing due to declining biodiversity and the related loss of ecosystem services.10
Example: Biodiversity and the Apparel Industry
Impact on Biodiversity | Apparel industry supply chains can degrade soil, convert natural ecosystems and pollute waterways. Dyeing textiles may contaminate freshwater sources through chemical run-off and non-biodegradable waste. |
Impact on Industry Economics | Roughly 25% of textile fibers and more than 50% of apparel are cotton-based.11 Degraded ecosystem services will increase the cost of growing cotton, pushing up prices. This will affect industry profits and hurt consumers. |
What Can the Industry Do? | While organic cotton farming is feasible, it is unlikely to be scalable and affordable in the near term. As alternatives, innovators have created fibers from cellulose, wood pulp and agricultural waste. Biodegradable polyesters and bio-polyesters have also been developed. More investment is needed to make these approaches scalable. |
Source: Anna Granskog, Franck Laizet, Miriam Lobis, et al., “Biodiversity: The next frontier in sustainable fashion,” McKinsey & Co., July 23, 2020.
In the next section, we describe our framework for identifying and analyzing how investing affects and is affected by biodiversity in six critical areas.
Our Areas of Focus and Research Framework
Given the widespread implications of biodiversity for all investors, we have identified key focus areas and developed a framework to systematically analyze how our investments affect biodiversity and how biodiversity affects our investments.
While biodiversity affects investment risk and outcomes in almost every industry and region of the world, we are focusing on two aspects of the investable universe:
Six sectors most affected by and contribute the most to biodiversity loss.
Six key biodiversity themes in six countries/regions widely deemed as biodiversity hotspots.
Examining these vital segments of the investable world allows us to target and engage in areas where biodiversity issues present the most pressing risks and opportunities.
6 Sectors Most Connected to Biodiversity
Food
Food-related supply chains put immense pressure on ecosystem services globally. Approximately one-third of the earth’s land surface and 75% of freshwater resources are now devoted to crop or livestock production and issues such as deforestation, overfishing and generating plastic waste are extreme threats to preserving biodiversity.12
Infrastructure
Urban areas have more than doubled since 1992, and building urban infrastructures requires land conversion. Sourcing materials for infrastructure development involves significant additional land use, resource stripping and pollution. Housing, public buildings, technical infrastructure, transportation infrastructure and vehicles are responsible for about 25% of the pressure humans place on biodiversity.13
Energy
While sourcing energy directly affects biodiversity in locations where oil and gas are extracted, most of this sector’s impact comes from the effects of burning these fossil fuels, including air and water pollution, and the effects of climate change on virtually every ecosystem.
Metals and Mining
Like energy, most of mining’s effects on biodiversity are indirect. For example, while mining represents less than 1% of total land use, mining activities result in habitat destruction, pollution and toxic emissions that harm the surrounding flora and fauna and may threaten various species and the overall ecosystem.
Apparel
A significant percentage of clothing is made from materials that grow in nature. Roughly 25% of textile fibers and more than 50% of all clothes are cotton-based.14 The primary effects of apparel on ecosystems are through land use and conversion, raw material extraction and waste.
Tourism
Tourism can harm biodiversity through habitat destruction, pollution, over-exploitation of natural resources and the impacts of visitor traffic on sensitive ecosystems. Tourists and suppliers often unwittingly introduce invasive plant and animal species, as well as diseases, which are not native to the local environment. This can cause enormous disruption and even destroy ecosystems.
On a positive note, supporting vital biodiversity could generate new revenue for the tourism industry—the global ecotourism market generated $92.2 billion in 2019 and is estimated to grow to $103.8 billion by 2027.15
6 Key Themes in 6 Biodiversity Hotspots
Biodiversity is not uniform across the globe, and different countries have varying exposures to biodiversity loss and conservation. We focus on six biodiversity-rich countries and regions where we typically hold investments and industries in those areas that we deem critical in terms of biodiversity challenges and opportunities.
Our analysis framework incorporates how government regulations and corporate pledges will help these countries to better preserve biodiversity, thereby strengthening their economies and populations and supporting business opportunities.
Cattle Farming in Brazil
Brazil is home to the second-largest number of cattle globally—22.2% of the world's total, according to the U.S. Department of Agriculture’s Economic Research Service—behind only India, which does not raise cows for consumption. Cattle farming is a massive source of methane and contributes to deforestation in the Amazon.
Infrastructure in India
With almost 18% of the global population crammed into just 2.4% of the earth’s landmass, India’s challenge is to sustainably allocate land and resources to support its nearly 1.4 billion people. The Indian government intends to spend US$1.4 trillion on infrastructure by 2025. However, WWF-India has noted that 45% of the country’s road projects have been abandoned or delayed due to inadequate consideration of environmental and social issues.16
Fast Fashion in China
China is the planet’s largest producer of fast fashion. Chinese apparel manufacturers and consumers worldwide discard 26 million metric tons of clothing each year.17 As the biggest consumer of fast fashion, the U.S. also contributes to this problem—Americans throw away an estimated 81 pounds (37 kgs) of clothing per person, every year.18
Agriculture in the U.S.
California is the largest producer of agricultural products (crops and livestock) in the U.S., accounting for almost 11% of the nation’s total. The state has some of the richest biodiversity in the country thanks to its long, diverse coastline.19 But it is also one of the most water-stressed states, with wildfires and droughts now routine. Maintaining the U.S. food supply will require significant changes to conserve water and protect biodiversity.
Climate Change Resilience and Ecotourism in Australia
Climate change is already producing rising sea levels, marine heatwaves, longer fire seasons and extreme heat patterns in Australia. The Great Barrier Reef has experienced eight mass bleaching events since 1979, with over 50% of its coral bleached. This loss of biodiversity could have a substantial economic impact, as the reef’s tourism, commercial fishing and recreational fishing contribute US$6.9 billion to Australia’s national economy annually.20
Palm Oil Production in Southeast Asia
Southeast Asia is home to an estimated 15% of the earth’s tropical forests. The region also supplies most of the palm oil used in many food products. Producing palm oil is a major cause of deforestation in Southeast Asia’s biodiverse forests, destroying the habitat of endangered species such as the orangutan, pygmy elephant and Sumatran rhino. Converting carbon-rich peatlands into oil palm plantations releases millions of tons of greenhouse gases into the atmosphere.21
Our Framework for Evaluating Biodiversity Risk
American Century’s environmental, social and governance (ESG) research and engagement protocols identify biodiversity risks as part of our investment process. Our four-stage evaluation combines bottom-up ESG research with active ownership activities.
To analyze the extent to which a company is exposed to biodiversity risk and whether it is prepared to mitigate this risk, we leverage two important resources.
ENCORE
ENCORE (Exploring Natural Capital Opportunities, Risks and Exposure) is a U.N. tool that links environmental changes to economic consequences. To evaluate the risk associated with the deterioration of natural capital, we use this tool to identify natural capital dependencies within our six key sectors and geographies.
Nature-Related Risk & Opportunity Management and Disclosure Framework
In March 2022, the Taskforce on Nature-Related Financial Disclosures (TNFD) released a draft of its disclosure recommendations with respect to governance, corporate strategy, risk management and metrics and targets. We leverage the TNFD’s developing framework to assess company-specific biodiversity risk and mitigation efforts.
We then independently evaluate exposures on a company-by-company basis. The following shows how we leverage these two resources within our four-stage evaluation process.
Snapshot of Our Process
Stage 1: Uncover
Uncover natural capital dependencies in six sectors and six geographies using ENCORE
Stage 2: Evaluate
Evaluate company biodiversity mitigation using the TNFD framework and disclosures
Stage 3: Identify and engage
Identify and engage with companies that show high-risk biodiversity exposures
Stage 4: Reevaluate and reengage
Reevaluate and reengage with these companies to track changes and progress
The following example illustrates how we apply our framework to evaluate an individual real estate company’s exposure to biodiversity risks and identify metrics and targets to discuss when we engage with company management:
Example: Real Estate Company
Uncover industry risks and remediation efforts | Evaluate company using TNFD framework | Engage with company on key issue | Reengage with company for updates |
|---|---|---|---|
Real estate activities affect: • Groundwater Bioremediation efforts include: • Filtration | Company has strong disclosures regarding its water and nature-related risks but has not provided sufficient information as defined under “Metrics and Targets”. | Discuss best practices with respect to missing metrics and targets with company management. | Company has set biodiversity targets and has reduced its water intensity per its targets. |
Sources: ENCORE and American Century Investments.
We developed a supply chain-oriented perspective to analyze the six biodiversity hotspots. Using this approach, we engage with companies to encourage their use of more biodiversity-friendly supply chains.
Here, we show the categories we may use when engaging with company management on biodiversity and the types of questions we might ask in each category.
Example: Engagement With a Hypothetical Food Supplier
Sources of Palm Oil from Indonesia
Sustainable Opportunities | Remediation Efforts | Government Policies | Theme-Specific Best Practices | Risk Mitigation |
|---|---|---|---|---|
R&D for products without palm oil or that use sustainable palm oil? | Reforestation efforts? | Effects of Indonesia ending its three-year palm oil moratorium? | Roundtable on Sustainable Palm Oil (RSPO) certification? | Regular supplier audits? |
Source: American Century Investments.
We also engage with third parties and nonprofits to supplement our perspectives, drive conservation progress and support proxy measures about biodiversity where possible.
At American Century Investments, we champion helping our clients to Prosper With Purpose®. To that end, we believe that to be the best possible stewards of capital for our clients, we must understand how our capital is exposed to risks resulting from biodiversity loss.
Using a framework that includes research and engagement, we deepen our understanding of biodiversity risks, as well as the opportunities that companies have to change how they operate to help preserve life on earth in all its forms while also continuing to drive shareholder value.
To contribute to this essential transition, we will help companies and investors to understand how preserving biodiversity across the regions in which we invest can support continued economic development and improved quality of life for everyone. Led by our ESG team in collaboration with our investment and client support teams, these initiatives will allow American Century to contribute to the healthy biodiversity at the root of our economy.
Author
Sharvari Johari
World Economic Forum, “Half of World’s GDP Moderately or Highly Dependent on Nature, Says New Report,” News Release, January 19, 2020.
Will Dunham, “Scientists count the world’s tree species (spoiler: It’s a bunch),” World Economic Forum and Reuters, February 8, 2022.
William J. Ripple, Christopher Wolf, Thomas M. Newsome, et al., “World Scientists’ Warning to Humanity: A Second Notice,” BioScience 67, no. 12 (2017): 1026-1028.
Chris T. Darmont, Caroline H. Fox, Heather M. Bryan, et al., “The unique ecology of human predators,” Science 349, no. 6250 (2015): 858-860.
World Wildlife Fund, “68% Average Decline in Species Population Sizes Since 1970, Says New WWF Report,” Press Release, September 9, 2020.
Hannah Ritchie and Max Roser, “Extinctions,” Our World in Data.org, accessed April 15, 2022.
Intergovernmental Panel on Climate Change, “Special Report on Climate Change and Land: Chapter 4, Land Degradation,” August 2019.
World Health Organization, “WHO-convened global study of origins of SARS-CoV-2: China Part,” April 6, 2021.
World Economic Forum, “Half of World’s GDP Moderately or Highly Dependent on Nature.”
Swiss Re Group, “A fifth of countries worldwide at risk from ecosystem collapse as biodiversity declines, reveals pioneering Swiss Re Index,” Press Release, September 23, 2020.
Torsten Kurth, Gerd Wübbels, Adrien Portafaix, et al., “The Biodiversity Crisis Is a Business Crisis,” Boston Consulting Group, March 2, 2021.
Kurth, Wübbels, Portafaix, et al., “The Biodiversity Crisis Is a Business Crisis.”
Kurth, Wübbels, Portafaix, et al., “The Biodiversity Crisis Is a Business Crisis.”
Ibid.
Allied Market Research, “Global Ecotourism Market to Generate $103.8 Billion by 2027,” Press Release, January 18, 2021.
Shashank Singh, “Integration of Environmental Risks in Infrastructure Investments in India: A Business Case for Financial Institutions,” WWF-India, 2021.
Collective Responsibility, “Unspoken Crisis: Mounting Textile Waste in China,” July 5, 2018.
“Fast Fashion in China: A Humanitarian Issue,” Borgen Magazine, October 14, 2020; “The Fashion Industry Waste Is Drastically Contributing To Climate Change,” Calpirg, accessed April 28, 2022.
U.S. Department of Agriculture Economic Research Service, “Agricultural Production and Prices,” accessed April 15, 2022.
Australian Department of Agriculture, Water and the Environment, “Australia’s Biodiversity and Climate Change: The Great Barrier Reef and Climate Change,” 2009.
WWF-UK, “8 Things to Know About Palm Oil,” accessed April 15, 2022.
Many of American Century's investment strategies incorporate the consideration of environmental, social, and/or governance (ESG) factors into their investment processes in addition to traditional financial analysis. However, when doing so, the portfolio managers may not consider ESG factors with respect to every investment decision and, even when such factors are considered, they may conclude that other attributes of an investment outweigh ESG considerations when making decisions for the portfolio. The consideration of ESG factors may limit the investment opportunities available to a portfolio, and the portfolio may perform differently than those that do not incorporate ESG considerations. ESG data used by the portfolio managers often lacks standardization, consistency, and transparency, and for certain companies such data may not be available, complete, or accurate.
This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.