investment viewpoints

    How does LOIM address the forest management challenge?

    How does LOIM tackle the deforestation challenge?
    Alina Donets - Portfolio Manager

    Alina Donets

    Portfolio Manager
    Laura Garcia Velez - Quantitative Analyst

    Laura Garcia Velez

    Quantitative Analyst
    Thomas Höhne-Sparborth, PhD - Head of Sustainability Research

    Thomas Höhne-Sparborth, PhD

    Head of Sustainability Research

     

    Need to know

    • Forests can provide 30% of the emission reductions needed by 20301, yet receive only 3% of climate finance2. Simultaneously, we continue losing an important part of natural capital, with 420 million hectares of forest lost globally from 1990 to 20203 – roughly equivalent to the size of all combined forests of the United States and Indonesia
    • LOIM’s Natural Capital strategy addresses the forest management challenge by following a multi-pronged approach of assessing the relevance, credibility and quality of its forest management approach. The strategy aims to invest in solutions, leveraging assessment tools across several disciplines
    • The assessment tools apply, among other capabilities, LOIM’s expertise in satellite imagery and machine learning to verify forest management practices at a company level

    The scale of the problem

    It is nearly impossible to talk about nature-positive development ambitions without talking about the need to improve forest management practices. Whichever way you look at it, the statistics on global loss of tree cover are a scathing reminder that our deeply extractive economic model is threatening the planet, humanity and economic output worldwide.

    Consider this, for instance. In the three decades since 1990, the world has lost about 420 million hectares of forest that roughly amounts to the size of all combined forests of the United States and Indonesia.

    Forests cover almost one-third of global land area and are home to 80% of the Earth’s terrestrial species, including plants and animals, whose diversity is essential for planetary health. In addition, forests provide invaluable ecosystem services including balancing precipitation and water cycles, cleaning the air, filtering water supplies and controlling floods and land erosion.

    Forests also absorb vast amounts of carbon dioxide – a major contributor to global warming – so cutting down trees can have a seismic impact on climate change, and undermine the ecosystem services vital to human health and economic prosperity.

    Following efforts to protect forests, more than 100 world leaders pledged to end and reverse deforestation by 2030 at the COP26 climate summit.  More than 30 leading financial institutions, collectively with over USD 8.7 trillion in assets under management have also committed to tackle agricultural commodity-driven deforestation as part of broader efforts to drive the global shift towards sustainable production and nature-based solutions. Yet progress remains tardy and urgent action is needed. The investment community can play a crucial role, providing access to much needed capital for innovation and scaling up of solutions.

     

    The LOIM approach

    Lombard Odier Investment Managers (LOIM), a proud member of the Forest Investors Club, believes forest management approach and performance is a key factor in the systemic, sectoral or company level analysis to ascertain how well companies are positioned for the transition to a sustainable, nature-positive economy. In addition to assessing the risks, investing in solution providers is a lever accelerating the achievement of nature-positive targets. 

    LOIM’s Natural Capital strategy aims to preserve and harness the regenerative power of nature, which involves a diligent approach to assessing forest management practices and solutions of investees. Forest degradation is also one of the nine planetary boundaries, which we draw on for our sustainable-investment strategies, including the Natural Capital strategy.

    Among the range of sustainability and financial metrics the strategy employs, the investment process incorporates an assessment of portfolio companies’ performance in relation to forest management. This captures historical and targeted performance levels  in both practices and solutions.

    The strategy’s multi-pronged approach to assessing this performance in portfolio companies can be broken down into the following steps.

     

    Forest management in the Natural Capital strategy
     

     

    Through our in-house expertise, we assess relevance to and performance against forest management approaches across portfolio companies. To do this, companies’ revenues are. assessed to consider their relevance to forest management considerations. For instance, an appropriate approach to forest management would generally be deemed to be essential for any company involved in the production of forest-related commodities, or where mining or agricultural supply chains may have an indirect impact on land use.

    We estimate that forest management considerations are material to approximately 26% of the revenues of the investments in our Natural Capital strategy.This takes into account the relative weight of the holdings of the strategy, the revenue exposure of each investee company, and the proximity of relevant assets to forest areas.   

    For those companies where forest management considerations are deemed to be relevant, through the analysis above, we then evaluate if the related companies have an appropriate approach in place (forest management score in Figure 1).

     

    Figure 1. Forest management assesment for some of the companies within the Natural Capital strategy

    Source: LO SIRSS. Data as 28th February 2022 The graph shows the two components of the forest management metric.

    Materiality (Relevance)(0-100%): the relevance of forest management factors in company revenues.

    Forest Management Score (A+to F): incorporates an assessment of existing company management policies, their progress, and signs of land-use controversies.

    For the management score, we first assess the scope and comprehensiveness of the companies’ policies in this regard. Secondly, we verify whether despite such policies, the company has been involved in deforestation-linked controversies. Thirdly, we verify whether any of its operations are known to be located in sensitive, biodiverse areas, using a variety of databases of protected areas and forest landscapes. These three assessments are combined into the forest management score.

     

    Figure 2.  Geospatial approach to forest-related monitoring

    Source: LOIM as at 03/2022. For illustrative purposes only. 

     

    In our Natural Capital strategy, we aim to use this information to verify that investee companies, based on known information, meet essential forest preservation standards, where these issues are material to the activity or industry involved.

    Today, these assessments necessarily depend on a combination of company-reported disclosures and external sources that may have limited granularity. To address gaps in coverage and eliminate the risk of inaccurate or incomplete disclosures, we are advancing work to independently assess forest management practices, using satellite imagery as one of a number of applications of geospatial in the field of finance, as covered in a recent report sponsored by Lombard Odier.

    Using a machine-learning model developed in collaboration with the University of Oxford, we are seeking to directly measure forest loss linked to specific assets. In future, this methodology can be used to better understand and verify whether companies are avoiding forest loss, or delivering on reforestation commitments.


    Figure 3.  Satellite-imagery to improve our understanding of companies’ forest-management approach

    Source: LOIM as at 03/2022. For illustrative purposes only. 

     

    Forest management improvement: a potential catalyst for investor returns

    LOIM’s in-house expertise and proprietary tools, which reflect our long-standing commitment to improve forest management in our investment activities, help provide a clearer picture of risk exposures, and assess the areas of positive progress and contributions.

    Despite forests providing an indispensable solution to tackle biodiversity loss and mitigate climate change, deforestation and forest degradation continue at alarming rates. Bold action is needed to leave a breathing planet for current and future generations.

    Identifying companies that champion the transformation of supply chains, operational management and product designs by fully integrating forest preservation is an essential step in addressing this challenge. The winners of this transition could encounter further economic benefits, through multiple avenues of risk mitigation, return enhancements and market share gains, supporting the financial performance outlook of investing in them.

    LOIM Natural Capital strategy, which targets profitable companies whose products and services harness the regenerative power of nature, seeks ever-greater incorporation of well designed and implemented forest management approaches.

    To read more about the sustainability impact of our Natural Capital strategy, download the link above.

     

    Discover more about our Natural Capital strategy here.

     

    Sources

    [1] https://racetozero.unfccc.int/heres-why-we-must-urgently-scale-up-natural-climate-solutions/
    [2] https://www.conservation.org/priorities/stabilizing-our-climate-by-protecting-and-restoring-nature
    [3] State of the World’s Forests 2020 (fao.org)
    [4] This indicator does not translate into actual deforestation, but simply means that companies derive revenues from the areas that either use commodities that are linked to deforestation, or are placed in areas where deforestation can happen.
    [5] Standards on Science Based Targets for Deforestation and Emissions (Global Accountability Framework, GHG accounting conventions) recommend that impacts on deforestation remain on the balance sheets for 20 years.

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