Our current system of evaluating investments is broken. It is based on outdated understandings of the impacts of public and private investments, who bears risk, and how investment returns should be allocated. This system has perpetuated itself in earnest over the past few decades, and a path to aligning the health of our planet and economic growth remains unclear. What is clear at this juncture is that we cannot afford business-as-usual valuation methods: nature and the economies it supports cannot bear it.
There is a clear disconnect between current, business-as-usual valuation techniques and our collective futures. While there are different valuation techniques for investments and/or assets, they all fundamentally rely on estimating future cash flows and the future replacement values of assets. These estimates are based on past information.
What is clear at this juncture is that we cannot afford business-as-usual valuation methods: nature and the economies it supports cannot bear it.
These estimates will often consider the risk that the final result may not match up to these expectations. Yet, there remains no accepted methodology to evaluate climate risk when discussing these investments. Reporting on the climate-related risks facing businesses also remains in the early stages. Moreover, investments that would be positive forces against the march of climate change are often ignored by these valuation techniques.
To respond to this need, our team developed the Sustainable Asset Valuation (SAVi) methodology to show the value that infrastructure projects can deliver to society when environmental, social, and economic risks and externalities are considered. In 2018, our team expanded the SAVi methodology to cover nature-based infrastructure (NBI). We made this change to better understand how specific investments can protect and enhance ecosystems while supplying critical public goods and services. The evidence so far from completed valuations point to NBI outperforming traditional infrastructure investments when environmental and social benefits are considered.
While we have continually proven the multiple benefits associated with investing in NBI projects, we remain confronted with views that NBI investing is niche and has limited potential to scale. There remains a common perception that NBI investing is the purview of public financiers and philanthropies, not institutional investors and other large, private investors.
One major constraint on scaling investment into NBI is that it is not considered a distinct “asset class” in its own right. This misunderstanding can be alleviated by better communication and understanding of the opportunities provided by NBI investments and by policies that are conducive to these investments.
Communicating the benefits of investing in nature
One of the key challenges we are tackling at IISD is how we communicate the benefits of NBI investments. To date, these communication efforts remain in early stages, and part of the challenge in telling this story comes from how the terms “asset” and “asset class” are applied to NBI relative to other assets.
Our work has found that investments in NBI protect and enhance ecosystems and deliver economic returns. Assets are considered holdings that provide current, future, or potential economic benefits; therefore, NBI, by definition, is an asset.
Assets are considered holdings that provide current, future, or potential economic benefits; therefore, NBI, by definition, is an asset.
To make NBI an asset class is to simply consider that these assets are similar, given that asset classes are defined as groupings of investments that exhibit similar characteristics and are subject to the same regulations. However, discussions of NBI as an asset class are usually shaded by an acknowledgement that economic benefits are disparate, inconsistent, and do not accrue solely to the investor.
While in certain instances this situation may be true, in other instances, enough but not all economic benefits accrue to the investor to make the investment financially viable. The current practice of treating NBI assets as requiring one owner to reap all the benefits to justify the investment is not something we ask of other asset classes. For example, equity investors share in the profits of a company after salaries, debtors, and other expenses are paid, but equity investments are still viewed as an asset class.
Moreover, there are substantial equity and debt investments made by venture capital firms in companies, projects, and/or new products that do not have discernable revenue streams at the outset or where the revenue streams may not be consistent. However, we do not label these opportunities as unworthy of investment. Our work will continue to meet this challenge of communicating that NBI, in many cases, performs similarly to other assets while also enhancing our ecosystems, supporting our economies, and providing for the well-being of affected populations. With a larger evidence base, greater recognition of these points, and the treatment of NBI as an asset class, we expect that NBI will increasingly become a go-to choice for investors.
Improving the investment climate
A conducive investment environment can also make it easier to scale up NBI investments. While national and subnational governments have created incentives for private citizens and businesses to lower the cost of “going green” or to make their dwellings and businesses more energy efficient, these governments remain behind in creating incentives for large investment flows to go to NBI projects.
Governments remain behind in creating incentives for large investment flows to go to NBI projects.
For example, if governments made capital gains and distributions from NBI holdings more tax advantageous than gains or distributions from other asset classes, investors would have an incentive to move more money toward these beneficial projects. While we acknowledge that issues over how to define NBI and nature-based solutions could undermine government efforts to make the necessary policy changes, we also acknowledge the painstaking work being done by the International Union for Conservation of Nature (IUCN) in this area.
Clearer parameters around what can be considered an NBI investment could catalyze government action and scale investment, so long as stakeholders understand the benefits of NBI.
Our continued work through the NBI Global Resource Centre and our SAVi assessments aims to provide the evidence base to communicate the benefits of NBI, shaping the understanding of NBI as both an asset and an asset class and inducing policy-makers to create a conducive environment for scaling up investment in this type of infrastructure.
We recognize that we need a stronger evidence base for NBI than what we have now, and we look forward to working with all stakeholders to build that evidence base together. What we cannot do is continue to ignore the value of nature and the infrastructure it provides when making investment decisions. If we do so, we miss a crucial opportunity to improve the lives and livelihoods of many. Understanding NBI as an asset class is one step in that direction, as it puts NBI on a level playing field with other investment options in the hopes of driving much-needed investment flows toward NBI as a solution to our future infrastructure questions.
This article was written by Matthew Gouett, Senior Policy Advisor at the International Institute for Sustainable Development. This article first appeared on the IISD website on November 18, 2021.