Commentary: Carbon’s elemental role in the future of impact investing

"Tell me the one about the virus again, and then I'll go to bed." So begins "The Great Realization," a popular video poem from Tomos Roberts chronicling how in the years after enduring a deadly pandemic, the world emerged a better place. Ironically, despite the suffering caused by the virus, it somehow brings life back into sharper relief.

2020 was supposed to be the "super year for nature;" yet even as the United Nations passed its resolution declaring so, COVID-19 was spreading undetected around the globe. Human encroachment on wildlife habitats as well as tropical deforestation have since been linked to emerging zoonotic diseases like COVID-19. Nature had a very strong voice at the table when disaster struck, and we learned the hard way that public health depends on planetary health.

If there is a silver lining, it is that COVID-19 has shown us in fast forward what will likely happen more gradually but with far worse consequences if we fail to act on climate change. Five years after the Paris Agreement, we're falling woefully short on progress. We know the risk of climate change. We know how to mitigate it. And we have not acted decisively. Yet."

Indeed, a groundswell of corporate climate (and nature) commitments, alliances, disclosures, reporting frameworks and accounting standards has emerged. On top of pre-existing frameworks such as the Task Force on Climate-related Financial Disclosures, the Science Based Targets initiative, and the Net Zero Asset Owner Alliance, we're seeing the launch of numerous new initiatives. In the past year alone, the number of companies setting their sights on net-zero carbon targets has roughly doubled to more than 1,500, according to a 2020 Data-Driven EnviroLab and NewClimate Institute report. With the foundation for private-sector climate action firmly in place, companies are responding in kind — and investors are taking notice.

In particular, we're seeing rapidly growing interest in natural climate solutions and nature-based solutions — 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.

Natural climate solution land management decisions increase carbon storage or prevent greenhouse gas emissions in global forests, wetlands, grasslands and agricultural terrain. These "natural sinks" occupy the low end of the carbon sequestration cost curve and can provide more than one-third of the cost-effective climate mitigation needed between now and 2030 to stabilize warming to below 2 degrees Celsius. How fitting that nature itself would provide the solutions key to mitigating climate change.

According to the United Nations-backed Principles for Responsible Investment, nature-based solutions will generate nearly $7.7 trillion through 2050. The PRI believes that land sector carbon policy will move toward valuing carbon stored in vegetation and soil, creating an entirely new industry driving economic growth and investment. It is an industry that needs to grow more than fifteenfold by 2030 to deliver the 1.5 degrees Celsius reduction pathway, according to estimates from the Taskforce on Scaling Voluntary Carbon Markets.

That's a tall order. So the question is, how do investors get there?

As the impact of climate change becomes clearer and the need for mitigation and adaptation through NCS becomes more emphatic, investment managers must provide opportunities to invest in a stable and resilient natural world. A new class of impact-first investors is growing, who themselves invest with a view to fighting climate change and nature loss. These institutions see value in carbon sequestration and ecosystem services; in fact they may even prioritize these goals over financial returns. Valuing carbon more than society at large and putting their own proprietary price on carbon, they may invest in forests or strategies that seem to offer suboptimal rates of return today — but perhaps a windfall later.

While this view on carbon may be new, the strategy derives from classic mispricing. When investors value carbon the way we believe society at large should, their investment calculus is seen in a different light. Forests may be more valuable to impact-first buyers 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 higher the potential for financial returns.

If governments implement the inevitable policy response levers required to limit global warming to 1.5 degrees Celsius, investors will soon value carbon more highly than we do now. Portfolios that valued carbon more highly to begin with — portfolios that invested in carbon removal before it made financial sense — will then win the day.

There is the risk that this doesn't happen — but this is the nature of investing. Let's bear in mind that if we're not dealing with 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.

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. 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 may be limitless.

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 20/20 focus, the year of the Great Realization? We are going long. Join us, the forest is waiting.

Bill Peressini is Boston-based CEO of Hancock Natural Resource Group, a company of Manulife Investment Management. This content represents the views of the author. It was submitted and edited under Pensions & Investments guidelines but is not a product of P&I's editorial team.