Chris Iggo

Focusing on investing in firms more conscious of their biodiversity impact should provide rewards for the planet and for investors, writes Chris Iggo, Chair of the AXA IM Investment Institute and CIO of AXA IM Core at AXA Investment Management,

The damage caused by climate change to the planet, society and economic activity is becoming increasingly obvious every year. Floods and droughts, extreme temperatures and destructive storms all bring with them tangible impacts on people’s lives and livelihoods.

Amongst many others, the financial community has long recognised the existential threat and the truth that man-made activity is responsible for the generation of greenhouse gases that lead to rising atmospheric temperatures and imbalances in the climatic system.

There is increased focus on setting policy, changing consumer habits and redirecting capital to combating climate change before it gets too late. Investors are seeking to invest more in businesses and technologies that both help mitigate the effects of climate change and adapt to them in a way that strives to achieve a sustainable future.

Asset owners and asset managers have pledged to reduce carbon emissions from their investment portfolios and ensure their investee companies deliver the reporting and strategic targets which will allow this to be achieved.

Human activity, along with the impact of climate change, has also led to increased loss of biodiversity. Growing awareness of the risks to sustainable living from degradation of land-use, deforestation as well as soil erosion, and pollution in our rivers and seas, is also starting to impact on investment strategies and corporate behaviour.

Measuring risk

While it is more difficult to put a market price on the externalities of biodiversity loss, in the same way as it is possible to price carbon emissions, companies face regulatory, customer and financing risks if they do not take care of their environmental footprint. Increasingly, investors are adapting metrics designed to assess biodiversity footprints to complement those designed to measure climate impact. These will provide greater richness to environmental, social and governance (ESG) analysis and help portfolios target better biodiversity outcomes.

The reality is that biodiversity loss is proceeding at an alarming rate and economic activity must change to stop this reaching cataclysmic levels. Economic behaviour affects the ecosystem at all stages of the value chain. Fundamentally, land and resource use can have a negative impact on biodiversity, by disturbing ecosystems, displacing species or putting them at risk of extinction.

Natural resource depletion is an obvious cause of biodiversity loss, especially when natural habitats are disturbed to make way for mining and extraction activities. The waste produced and the transportation of mined resources to different markets also impacts biodiversity negatively. More broadly, production creates waste – pollution – and uses energy, while the distribution of goods and services is also resource dependent and generates materials – such as packaging – that is harmful to the environment. Consumption and waste disposal are also activities that can impact negatively.

How investors can play a role

Understanding the interaction between economic activity and its impact on the environment, through enhanced monitoring and reporting and via scientific developments that highlight the risks of biodiversity loss, can help investors deploy capital to those businesses that employ best practices.

There are thousands of examples, such as agricultural activities that do not use pesticides which lead to nutrient leak in soil, or companies that use biodegradable or reusable packaging in the distribution of goods. Parallel to the development of technology in the renewable energy space, as techniques are introduced that have a lower financial and environmental cost, the economics of scale will work in favour of the businesses using them.

Biodiversity is lost every time trees are cut down to provide space for cattle grazing, every time a green field site is built on, and every time waste is discharged into rivers. That loss creates threats to life. Loss of forests worsens the carbon balance in the atmosphere. Soil degradation reduces crop yields. Nitrates flowing from farmland into rivers disturb the ecological balance that helps sustain healthy plant and animal life and pollutes the water supply. Changes to natural habitats that introduce alien species risks crop damage and yields.

As investors, we can do better

We can reduce the impact of economic activity through better practices and preserving habitats whilst thinking about what we really need to consume. Better food production processes from farm to fork can not only help protect biodiversity, but they can deliver health benefits which are a financial positive for society. Public education directed at diversifying diets away from eating meat could reduce the land needed for cattle grazing and the necessary feed crops, as well as reducing the generation of methane, an important greenhouse gas.

How data and disclosure can help

In the coming years, led by the Taskforce on Nature-related Financial Disclosures (TNFD) framework and metrics such as the Corporate Biodiversity Footprint, investors will have more granular data on how businesses they invest in operate, and what ‘costs’ they are imposing on our natural world. As is the case with climate change, the focus on investing in companies which are more conscious of their impact on biodiversity should provide rewards for the planet and for investors.

From an economic point of view, achieving sustainability means incorporating climate and biodiversity loss into our consideration of the cost of production. Unfettered capitalism has led us to where we are today. Climate change is threatening the ability of humans to live in certain parts of the world and to increasingly raise the cost of economic activity. Being at risk from extreme weather or needing to adapt to the worst of climate change brings potential and actual costs to businesses, therefore reducing their returns. Biodiversity loss threatens food and water supplies and the degradation of the natural environment, with consequences for health and welfare.

Regulation needs to play an increasing role. Land and ocean resources need to be protected. Costs should be imposed on companies whose activities contribute to recognised biodiversity loss. We are moving towards greater disclosure from companies which will allow capital to be allocated not only to where economic returns are the highest but where climate and biodiversity costs are the lowest.

It is clear from what is happening in the race to net zero that technological innovations can play a role in shifting the natural cost curve. Sustainable agricultural practices, more regulated land-use, the use of renewable energy, biodegradable packaging, protection of oceans and coastlines – these are all developments that can help slow down biodiversity loss. They, and other developments, provide investors with plenty of opportunities that will not only be positive for the planet but will provide potential returns as technologies that help reduce biodiversity loss take more market share.

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Chris Iggo

Higher carry in bond markets means fixed income returns should beat inflation this year.

And they are on track. Inflation continues to fall and central banks, having increased rates again in May, should be on hold for a while. This suits bond returns, as would any cuts in rates, or evidence that a recession is coming.

Equity market returns are ahead of inflation but, unlike bonds, they are more at risk from any signs of recession leading to a more pronounced decline in earnings than seen so far. A US recession and rate cuts would be nailed on if there is no agreement to raise the debt ceiling.

It probably will not come to that, but it is worth considering how investors would react if it did.

Hedging inflation

Equities have been the best inflation hedge so far this year – or rather, large-cap equities. Large companies have benefitted from the inflation impact on sales revenues while also being in a much better position to control costs than small and mid-cap firms – although US banks have underperformed for obvious reasons. This is all reflected in the performance of stock indices relative to expected inflation rates for 2023.

The NASDAQ and other growth indices have outpaced consumer price increases, as have European and Japanese equities. Small and mid-cap, as well as broad emerging market indices, have failed to keep up.

Higher bond carry

In the bond market, higher carry should allow full-year total returns to be above average inflation rates for the year. Short duration and high yield strategies have benefitted from the rise in short-term rates over the last year while longer duration strategies have seen yields fall, as markets anticipate lower inflation and interest rates going forward. Unless there is a significant weakening in credit markets in the second half of the year, fixed income returns are likely to be positive in real terms across the board.

Are we at the peak?

Investors need to see asset returns beating inflation after the dreadful real returns of 2022. The ‘preferred scenario’ for the remainder of the year is for inflation to continue to decline, which helps real returns, and for the interest rate cycle to peak soon. We had news on both fronts from the US over the past week with the Federal Reserve (Fed) moving its policy rate to 5.25% in what may be the final hike of the cycle.

In addition, there was a further decline in inflation with the headline Consumer Price Index dropping to 4.9% in the 12 months to April. However, the core inflation rate remains sticky with the monthly increase in the core index at 0.4% – a pace it has maintained for the last five months.

The risk is the Fed could still hike again, or is unlikely to rush into cutting rates, an action which is very dependent on the real growth data. As such, we are likely at the peak of the central bank tightening cycle, and that is a good reason for celebration.

Preferred outcomes

The preferred scenario could continue to see markets delivering modest real returns. Bonds do offer a potential buffer to any possible equity volatility while declines in corporate earnings could be limited by the ongoing lift to nominal revenues from residual inflationary pressures. Interest rates on hold and only modest declines in core inflation mean the macroeconomic narrative will not change that much.

For investors, there could be a reluctance to commit cash to the market in case we do eventually get a recession. A recession-induced correction in equities and credit would generate opportunities for better real returns going forward as inflation would decelerate much more quickly. At present, all of this is conjecture, as signs of a recession are still relatively limited. However, caution on equity markets is warranted.

At an aggregate level, earnings growth has turned negative. With most companies in the S&P 500 index having reported, the weighted earnings growth for the latest quarter was -4% relative to the same period last year.

Default?

There is another scenario, however. That is a US debt default. Treasury Secretary Janet Yellen has warned the Treasury might not be able to meet all its spending obligations as early as the beginning of June.

A default on US debt would be a massive shock to the global financial system – most likely leading to rising volatility, a weaker dollar, evaporating money market liquidity and a stock market crash. Faith in the US government has been a key building block of trust in global financial markets. If there is a default – and any form or size of default would be hugely symbolic – that faith could be tarnished for a long time. The repercussions would be global as well, through both global bond yields and the dollar.

Debt ceiling issues

There are already some signs of markets pricing in the non-zero (but probably very low) risk of a default.

The dollar has been weakening in the foreign exchange markets with the dollar index trading near its lowest levels of the last year over recent weeks. More dramatically, the one-year credit default swap on US Treasuries is currently trading at 180 basis points (bp) compared to an average of 10 to 15bp historically.

Growth slowdown and rate cuts

Under the worst-case scenario we need to consider slower real growth given the disruptions to aggregate demand from reduced government spending, private sector investment and consumption. There could also be negative wealth effects if the stock market corrected lower amid the chaos generated by a default. We should also consider the Fed’s response. Undoubtedly more liquidity would be required. The Fed might also have to cut rates in response to heightened market volatility and the deterioration in the growth outlook. The risk aversion would lead to lower long-term bond yields given a recession would be more likely and happen sooner than under other scenarios.

Market reset

There is a general theme that investors have acted cautiously this year and there is frustration at missing positive returns, particularly in equities, but now is not the time to use all the dry powder. Either markets keep grinding higher in the preferred scenario or there is a reset caused by a shock. The latter would suit many, given that valuations of risky assets would be much more attractive. A US debt crisis leading to rapid rate cuts and a sharp slowdown in growth would be the buying opportunity many have been waiting for.

By Chris Iggo, Chief Investment Officer at AXA Investment Managers

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This commitment forms part of AXA Group’s €1.5 billion commitment to protect and sustainably manage forest ecosystems, and this latest investment will further contribute to its target to remove or avoid up to 25 million tonnes of carbon dioxide each year^[2].

Building off AXA IM Alts’ existing expertise within the sector, the Natural Capital Strategy will focus on financing activity that ensures that vulnerable or high value natural habitats are protected from deforestation, including both financing to address the drivers of deforestation and to improve forest conservation efforts, quantified through the issuance of voluntary carbon credits. The portfolio will combine strategic equity investments, with stakes in companies supporting the natural capital ecosystem in local markets, the provision of carbon solutions, and direct project financing.

Jean-Baptiste Tricot, Group Chief Investment Officer, AXA Group, commented, “Forests represent 80% of the Earth’s biodiversity and play an essential role in the fight against climate change. At AXA Group, we are committed to using our capital to help preserve our planet’s natural ecosystems and address climate risk. We have committed to investing €1.5 billion to support sustainable forest management, including this latest €500 million in reforestation projects in emerging countries, enabling a total of 25 megatons of carbon dioxide to be captured or avoided each year, as part of our net zero commitments”

The Strategy will leverage AXA IM Alts’ existing portfolio of strategic equity stakes in key players in the natural capital ecosystem, including project developers with local market access, as well as executing a direct pipeline of carbon projects. It will also seek to build capacity to provide unique carbon solutions to serve the growing demand for carbon offsets.

Alexandre Martin Min, CIO, Structured Finance and Impact Private Equity at AXA IM Alts, commented, “Beyond the need of decarbonizing the human activity over the next 30 years, there is an urgent need to grow scalable investment solutions to protect and manage sustainably natural capital, which are relatively nascent in today’s market. People and local market relationships are key to identifying and accessing investment solutions, particularly in such a complex environment. Over the last 10 years, we at AXA IM Alts have built a wide network of relationships, deepened our expertise and delivered many successful nature-based projects, making us well positioned to lead the acceleration of carbon solutions that seek to preserve natural capital.

A long track record

AXA IM Alts has a long track record investing to protect biodiversity and address climate change. Launched in 2019, the AXA Impact Climate and Biodiversity Strategy^[3] : , which now has c. €350m ($350m) in committed capital, invests in projects and companies globally that are helping to restore degraded ecosystems and support carbon avoidance or sequestration. The Strategy has invested over €100m ($100m) as of end of June 2022 and has a strong track record of successful investments with broad investment exposure including equities, carbon-backed bonds and a project debt facility. Specific investments include^[4] :

• FUNDAECO: A company focused on conservation activities in protected forest areas in Central America. AXA IM Alts’ green bond investment enabled FUNDAECO to finance and expand the largest forest conservation project conducted under the auspices of the REDD+ program

• Forest Carbon: A company that specialises in conserving and restoring degraded peatland, tropical forests, and wetland ecosystems across Indonesia. AXA IM Alts’ $11 million commitment supported Forest Carbon in securing a portfolio of new restoration projects and launching a new series of bonds for each project, allowing large-scale wetland forest restoration to be financed by a growing community of investors

• The Shared Wood Company: AXA IM Alts acquired a minority stake in French nature-based project development company committed to preserving and restoring natural ecosystems and biodiversity whilst supporting local communities. Beyond contributing to The Shared Wood Company’s growth, AXA IM Alts directly supported its development through financing forestry and sustainable land-use projects and by off-taking the high-quality carbon emission avoidances or carbon removals generated by these projects.

In July 2021, AXA IM Alts also announced the acquisition of ‘ClimateSeed’, the voluntary carbon off-setting platform, through its Impact Strategy. ClimateSeed acts as an innovative marketplace, connecting businesses seeking to offset their carbon emissions with project developers offering carbon reduction projects with high environmental and social benefits, complementing the Strategy‘s diversified portfolio of nature-based projects facilitating carbon avoidance and sequestration.

Strengthening the team

In addition to the launch of the new Strategy, AXA IM Alts has also identified a team of natural capital market experts to join the platform as it further expands its efforts to provide natural capital solutions, with Adam Gibbon, Edoardo Cavallo and Camila Alva Estabridis joining the team to support and lead deployment. Adam Gibbon joins AXA IM Alts with over 17 years of experience investing in nature-based climate solutions. He has spent his career designing and implementing investment solutions to address climate change and biodiversity loss. Edoardo Cavallo is a specialist in emerging markets and has extensive expertise working with investors and entrepreneurs to provide nature-based solutions to climate change. Finally, development and environmental economist, Camila Alva Estabridis, joins having spent more than 10 years in public policy, working with governments and development institutions including the World Bank and the International Food Policy Research Institute.

The expanded team combines extensive personal networks and established experience across natural capital markets, with existing relationships and technical knowledge to allow AXA IM Alts to efficiently assess the pipeline of investment opportunities.

The strategy can be exposed to the following risks, among others: performance and market risk, sourcing risk, operational risk, capital risk, regulatory risk, valuation model risk, liquidity risk.

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Chris Iggo

AXA Investment Managers (AXA IM) has announced the launch of the AXA IM Investment Institute, a new platform that aims to help clients make better informed investment decisions by bringing together expertise across the firm’s research and investment teams.

Chris Iggo, current CIO of AXA IM Core, has been appointed Chair of the AXA IM Institute alongside his existing responsibilities.

The AXA IM Investment Institute aims to provide clients with access to timely insights on macro events and views on asset classes and long-term future trends including sustainability, demographics, technology and regulations.

The Institute will invite well-known external experts to provide their views on a range of business, responsible investing and macroeconomic topics which will encourage an open forum incorporating a diversity of opinion for clients.

Chris Iggo will lead The AXA IM Investment Institute Advisory Committee, which will meet quarterly to discuss the key macro and research themes to be covered by the Institute, and to complement the research AXA IM’s experts already provide. The committee consists of representatives from AXA IM Core, AXA IM Alts and senior members of the macroeconomic research, ESG research and Quant Lab teams. In addition, up to three external committee members who are yet to be determined will be appointed.

The Investment Institute will also host regular “AXA IM Institute talks”, a series of video discussions and interviews hosted by Chair, who will be joined by members of the committee, and external guests.

Chris Iggo, commenting on his new role, said: “At AXA IM, we are always looking at ways to improve our service, so we decided to make content produced across our investment and macro research teams more tailored to client needs and answer some of the most burning investment questions. Research is central to all our investment decisions. The move will bring our experts closer together, allowing for greater collaboration on a range of topics from Sustainability to Future Trends. I look forward to chairing our first committee meeting.”

Marco Morelli, Executive Chairman at AXA Investment Managers, added: “Bringing our expert views together under the AXA IM Investment Institute allows not only clients but anyone to access the broadest possible perspectives from across AXA IM’s research and investment teams, to help guide decisions they make for their portfolios.”

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