How does LOIM address the forest management challenge?

 

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.⁴ 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

Sources

FOR PROFESSIONAL INVESTORS ONLY
This document is issued by Lombard Odier Asset Management (Europe) Limited, authorised and regulated by the Financial Conduct Authority (the “FCA”), and entered on the FCA register with registration number 515393.
Lombard Odier Investment Managers (“LOIM”) is a trade name.
This document is provided for information purposes only and does not constitute an offer or a recommendation to purchase or sell any security or service. It is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful. This material does not contain personalized recommendations or advice and is not intended to substitute any professional advice on investment in financial products. Before entering into any transaction, an investor should consider carefully the suitability of a transaction to his/her particular circumstances and, where necessary, obtain independent professional advice in respect of risks, as well as any legal, regulatory, credit, tax, and accounting consequences. This document is the property of LOIM and is addressed to its recipient exclusively for their personal use. It may not be reproduced (in whole or in part), transmitted, modified, or used for any other purpose without the prior written permission of LOIM. This material contains the opinions of LOIM, as at the date of issue.
Neither this document nor any copy thereof may be sent, taken into, or distributed in the United States of America, any of its territories or possessions or areas subject to its jurisdiction, or to or for the benefit of a United States Person. For this purpose, the term "United States Person" shall mean any citizen, national or resident of the United States of America, partnership organized or existing in any state, territory or possession of the United States of America, a corporation organized under the laws of the United States or of any state, territory or possession thereof, or any estate or trust that is subject to United States Federal income tax regardless of the source of its income.
Source of the figures: Unless otherwise stated, figures are prepared by LOIM.
Although certain information has been obtained from public sources believed to be reliable, without independent verification, we cannot guarantee its accuracy or the completeness of all information available from public sources.
Important information on case studies
The case studies provided in this document are for illustrative purposes only and do not purport to be recommendation of an investment in, or a comprehensive statement of all of the factors or considerations which may be relevant to an investment in, the referenced securities. The case studies have been selected to illustrate the investment process undertaken by the Manager in respect of a certain type of investment, but may not be representative of the Fund's past or future portfolio of investments as a whole and it should be understood that the case studies of themselves will not be sufficient to give a clear and balanced view of the investment process undertaken by the Manager or of the composition of the investment portfolio of the Fund now or in the future.
Views and opinions expressed are for informational purposes only and do not constitute a recommendation by LOIM to buy, sell or hold any security. Views and opinions are current as of the date of this presentation and may be subject to change. They should not be construed as investment advice.
No part of this material may be (i) copied, photocopied or duplicated in any form, by any means, or (ii) distributed to any person that is not an employee, officer, director, or authorised agent of the recipient, without Lombard Odier Asset Management (Europe) Limited prior consent. In the United Kingdom, this material is a marketing material and has been approved by Lombard Odier Asset Management (Europe) Limited  which is authorized and regulated by the FCA. ©2022 Lombard Odier IM. All rights reserved.