TBLI Weekly - February 21st

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Regenerative agriculture: Key to solving the climate crisis

?by? Hunter Lovins ?| Feb 15, 2023

Meet?Gabe Brown. If you haven’t read his groundbreaking book?Dirt To Soil,?visited his?North Dakota farm, seen his Netflix documentary?Kiss The Ground,?or his?Congressional testimony, you can find Gabe?speaking?around?the?country?about regenerative farming.

Brown describes how regenerative agriculture not only fixes farming, but also the farming?business model. It delivers more nutritious food, healthier rural culture, and enables?smallholder?farmers worldwide to feed themselves and the rest of us. It’s also essential if we want to solve the climate crisis.?

“Regen ag,” as it’s called, enables farmers and ranchers to?sequester enormous amounts of carbon in the soil?— and?at a profit. If farmers around the world adopt the practice, it will start to roll climate change backward. Couple that with renewable energy, and it solves the climate crisis.

“It’s unbelievable, the change,” Gabe told?Farmers Weekly. “Finally, there is the realization that while agriculture is part of the problem, it can be a bigger part of the solution… Regenerative practices can not only help farmers, but society as a whole, no matter where your interests lie.”

He’s right:?Regenerative agriculture?enhances native biodiversity?— and cuts costs. Water use is optimized, because the carbon-rich soil better holds moisture. Improved farm worker safety and investment in local businesses better sustain stressed farming communities. Because more people may be needed to do work that chemicals previously did,?regenerative farming creates jobs. Because region ag melds the best of modern science with ancient culture, farm life becomes more rewarding and sustainable. For insight on different approaches, see?A Finer Future, Creating an Economy in Service to Life.

In contrast, industrial agriculture is energy-intensive, polluting, destructive of rural communities, and?hazardous?to our?health. It both worsens and is?threatened by climate change. In 1940 Americans produced 2.3 calories of food energy for every calorie of fossil fuel energy we used. Now it?takes 10 calories of fossil-fuel energy to produce a single calorie?of modern supermarket food. Think about that.

Gabe’s journey

Ironically, it was his early failure with industrial farming that?drove Gabe into regenerative agriculture, and led to his now enduring success. Storms, droughts, and the deaths of crops and cattle at the 2,000-acre farm he took over from his in-laws in 1991, led him to step back from the industrial farming practices they had used. To survive, he became one of the pioneers of no-till planting, year-round diverse cover crops, “animal?impact” and soil improvement.

Gabe’s operation is now very profitable. But “we’re not in this to make a profit?this?year. We’re in it to regenerate our soil — and long-term profitability,” Gabe told the?Center for Regenerative Agriculture and Resilient Systems. “And because we’ve gone to this (regenerative) production model, we’re able to produce our cash commodities at a fraction of the cost.”

When Gabe took over the farm, which grew corn and soybeans,?soil quality was poor after generations of commodity farming. The shallow topsoil required annual inputs of fertilizer, pesticides, and herbicides to grow anything. In 1995, Gabe switched to no-till production. This cut his costs. He then?diversified into a variety of cash crops and began rotating his fields. In 1997, he?started using deep-rooted?multi-species cover crops.

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Private equity firms seek piece of the impact investment action

The sector is attracting big inflows — but with them come fiercer competition and closer regulatory scrutiny

Impact investors seek to do good while doing well — to deploy their wealth in a way that benefits society and also generates a profit. And, though some observers question whether “social returns” can be rigorously quantified, money has still flooded in. Industry body the Global Impact Investing Network calculates that the market is now worth $1.2tn. This growth has — in effect — turned impact investing into its own asset class, capable of attracting interest from some of the world’s largest private equity investors. In 2021, TPG, the Texas-based private equity firm, said it had raised $7.3bn for a climate-focused impact fund from backers including the Ontario Teachers’ Pension Plan and insurance company Axa.

It is one of several impact offerings that TPG has launched since 2016, making it one of the biggest private equity firms to offer an alternative to pure profit-seeking. TPG’s six impact funds have raised $15bn and invested in businesses ranging from medical education to dairy farming in India. TPG stresses that its impact investing funds are different from environmental, social and governance (ESG) strategies. Impact investing actively seeks businesses that deliver measurable social or environmental benefits — rather than simply screening out companies for failing to match up to certain ESG criteria. As its impact funds have grown, TPG’s position in this sector is getting crowded. Rival private equity firm KKR has raised almost $2bn for its second impact fund, according to a regulatory filing this month, improving on the $1.1bn the firm achieved for its inaugural impact fund, which launched in 2018.

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Understanding the Important Difference Between ESG Risk and ESG Impact

It is important to know the difference between these terms — and the potential for there to be some divergence between how a company performs on either measure. A company with a high impact rating and low ESG risk doesn’t necessarily mean it’s a great investment opportunity.

Tesla?is frequently in the headlines of the mainstream media — and often not for the reasons investors would like. The company is founded on principles that were meant to revolutionize the automotive market and clean technology space. But the eccentric, sometimes confounding behavior of founder and CEO?Elon Musk?means that the firm does not rate highly on governance and social metrics.

For example, Musk’s dramatic acquisition of?Twitter?last year caused?stock price volatility and reputational risk.?Morningstar Sustainalytics?— which rates listed companies on ESG factors — rates Tesla as medium risk and in the bottom half of both the automobile sector and all companies, despite its lofty climate ambitions.

According to research from Morningstar’s?Investable World?— a data-driven digital experience designed to make sustainable investing more understandable, engaging and actionable for investors — Tesla has an estimated 86 percent of revenue tied to the Climate Action impact theme but a Medium ESG Risk Rating, owing to weak product governance and social and management concerns.

Other companies boast similarly high impact, yet face high ESG risk.

CVS, for example, rebranded itself in 2014 to?CVS Health?to reflect its broader healthcare commitment and a desire to improve the future of health in the?US. That same year, the company famously?banned the sale of all tobacco products?in all its stores, in spite of the expectation that it would cost an estimated $2 billion in sales.

But Sustainalytics rates CVS as medium risk and similar to subindustry average. Despite its industry-leading commitment to health and wellness, in the past year CVS has suffered backlash over several controversies — relating to abortion-drug policies and a $5 billion settlement in an opioid lawsuit — the latter of which is the most financially material for the company and constrains our fair value estimate by about 3 percent.

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Is Impact Investing Undermining Resilience in the Global South?

Impact investing advisor Clint Bartlett ’17 and Professor Todd Cort say that overpriced expected returns demanded by investors can destabilize the ventures that could help build resilience in the most precarious parts of the world. With a group of colleagues from leading universities and global funders, they are working on innovative approaches in which businesses that create positive social outcomes get cheaper capital.

Why is it important to invest in resilience in the Global South?

Todd Cort:?When we talk about resilience, what we’re talking about is whether a community of people can recover quickly when a shock to a social or environmental system occurs. With climate change, there are going to be more and more of these shocks. There are going to be more severe droughts and massive flooding events, severe weather that knocks out the grid for days or weeks at time. More migration between countries.

Resilience is inherently tied to physical and social and cultural infrastructure—the way that people can adapt and renew after these systems are knocked out. When we talk about the Global South, that infrastructure often does not exist, or there isn’t the money to rebuild it. If we have flooding in New York—which we’ll have more of—New York’s got billions of dollars to get things back up and running. But if the same thing happens in Jakarta, there’s just not that much money to bring it back up. If it happens in rural areas in Africa, there’s no way to recover.

Resilience is already part of the way that we invest. We move money to investments that have higher return-to-risk ratios. If markets identify that a system is not resilient, then the money stops flowing to that investment. If I know that this city is prone to climate impacts and if it’s flooded it’s not going to get up on its feet and running quickly, I’m less inclined to invest in a bond that that city might issue. And what that does is it chokes off investment into those regions where the investment is needed the most.

Clint Bartlett:?If you simply look at it from an investment perspective, then you have to realize that if you are going to have increasingly fragile societies across the Global South, it will impact you in the Global North. You don’t want South Africa with its massive coal fired power stations polluting because it will impact you in the north. To the extent that we have conflict-created food shortages, that impacts not only the cost of food landing in Baltimore, but it also impacts across your entire outsourced supply chain, from supply through to labor costs. Sometimes the framing of the question itself already sets up an error of thought: that the Global South is separate from the Global North. And it’s not true. It’s all part of a series of concentric systems.

And then a final point is the question whether you reverting back to the status quo after one of these shocks? Of course, if the status quo is a negative status quo, then you’re not going to advance anything. We are trying to embed what some would call a transformative nature, where how we define resiliency has an incremental, positive aspect to it. Not just revert it back to what was, but revert to something that is better than before.

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Micro-lending market takes rising interest rates in its stride

Fund managers are optimistic that the booming market for impact lending to small businesses in developing countries can survive sharp increases in global interest rates, after coming through the coronavirus pandemic relatively unscathed.

The global impact lending market has grown from $715bn at the end of 2019 to $1.164tn today, according to data from industry body the Global Impact Investing Network. This has been driven by surging investor demand for more ethically-minded investments and products that can make a positive difference to society or the environment.

Much of this growth has largely taken place in an environment of low global interest rates, supported by trillions of dollars of quantitative easing by western central banks, which made for easier conditions for borrowers, globally.

But, with US interest rates shooting up from near-zero to between 4.5 per cent and 4.75 per cent — their highest level since 2007 — in less than a year in a move to tame inflation, the market for lending to micro businesses faces a serious challenge.

However, some analysts and fund managers believe that the structure of the market and the financial health and flexibility of the underlying borrowers mean that any rise in defaults will be limited. “There’s not a lot of panic yet,” says Antonio Fatás, professor of economics at business school Insead.

“There’s no doubt there are some investment projects that don’t make sense at a higher interest rate. But I don’t think everyone in these markets is on the edge.”

The impact lending market has grown as part of an effort to plug the estimated $5.2tn funding gap faced by about 65mn micro, small and medium-sized enterprises in developing countries each year, according to the International Finance Corporation. This gap is particularly acute in Latin America, the Caribbean, the Middle East and north Africa. Micro and SME borrowers are key providers of jobs and growth in developing countries — and they can range from a smallholder in Mali borrowing money to buy a cow and sell the milk, or a woman in Tajikistan running a small catering business for schools and weddings. But, with very likely no access to bank lending, their funding options are typically limited to friends and family, local loan sharks who can charge more than 1,000 per cent interest per year — or impact lenders.

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Climate Change Is Altering the Way Pension Funds Invest

The capital markets saw just how much climate change could impact the investing world, especially with the explosive growth of environmental, social, and governance (ESG) investing. It’s changing the way institutional money is invested, including that of pension funds.

One way to accommodate the impact of climate change is for pension funds to be more flexible. Changing policies and regulatory measures make the climate change industry a dynamic one, requiring the ability to shift and pivot quickly.

“Few areas of our industry have evolved as rapidly as climate change in recent years, so the onus is on asset owners and managers to be nimble in response,”?said?Faith Ward, chief responsible investment officer at Brunel.

In a?Pensions & Investments article, Ward noted that?new climate change policy?“will not only affect how we design and evolve our portfolios. It will also impact how we recruit and monitor the managers we appoint to run mandates on those portfolios. Finally, it will impact how we engage more broadly beyond our partnership, whether coordinating with other asset owners on RI issues, or pressuring companies to improve their practices.”

2 Climate Change ETF Options to Ponder

Given the evolving nature of climate change’s impact on the investing world, it presents opportunities in exchange traded funds (ETFs) that can capitalize on this growth. One such opportunity, especially for a Euro-centric focus, is the?KraneShares European Carbon Allowance ETF (KEUA), which offers targeted exposure to the EU carbon allowances market and is actively managed.

The fund’s benchmark is the IHS Markit Carbon EUA Index, an index that tracks the most traded EUA futures contracts, a market that is the oldest and most liquid for carbon allowances. The market currently offers coverage for roughly 40% of all emissions from the EU, including 27 member states and Norway, Iceland, and Liechtenstein. KEUA has an expense ratio of 0.78%.

For a more global reach in the carbon credit market, investors may want to consider the?KraneShares Global Carbon ETF (KRBN). KRBN tracks the IHS Markit Global Carbon Index, which follows the most liquid carbon credit futures contracts in the world.

As mentioned on its?product website, KRBN “introduces a new measure for hedging risk and going long the price of carbon while supporting responsible investing.” In terms of its global reach, the fund includes contracts from the European Union Allowances (EUA), California Carbon Allowances (CCA), Regional Greenhouse Gas Initiative (RGGI) markets, and the United Kingdom Allowances (UKA).

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