Biodiversity Indices are getting more popular!

Last month, on Feb 5th, 2024, the S&P Dow Jones Indices (S&P DJI) released new indices relating to biodiversity. We explore here what they are and why they are getting popular.

As described in a recent article of ESG Today, and detailed by S&P Dow Jones Indices, the two indices are rooted in two of the most famous indices of the index provider, and are called the S&P 500 SDG Index and the S&P Global LargeMidCap SDG Index. The mention of SDG in their name refers to the UN's Sustainable Development Goals, emphasizing their alignment with the SDG targets.

As claimed by S&P DJI, the biodiversity indices intend to "measure the performance of a subset of eligible equity securities, selected and weighted to collectively reduce the ecosystem impact intensity, limit the proportion of ecosystem impact to significant land, enhance the alignment to specific UN Sustainable Development Goals, and reduce the carbon footprint relative to the benchmark." [Ref. here]

The publication of these new indices is thus a great occasion to dig a little into the business of "green" indices, and to give a tentative description of the different types of investment tools relating to biodiversity.

Use of indices in sustainable finance

Sustainable finance has developed a variety of investment solutions to assess the impact of companies on the environment. Among these, one can mention the following:

1. Thematic Indices: These are indices focused on specific themes or sectors that have a direct or indirect impact on biodiversity. For example, indices that track companies in sustainable agriculture, forestry, fisheries, or water management can have a strong biodiversity component. While not exclusively biodiversity indices, their focus areas are closely linked to the health of ecosystems and biodiversity conservation.

2. Impact Investment Funds and Indices: Impact investments are made with the intention to generate positive, measurable social and environmental impact alongside a financial return. These can include investments in natural capital, conservation projects, sustainable land use, or ecological restoration. The funds and indices specifically target investments which have positive biodiversity outcomes.

3. Green Bonds and Sustainability Bonds: While individual bonds are not indices, the market for green and sustainability bonds is often tracked through indices. These bonds raise funds for projects with environmental benefits, including biodiversity conservation. Indices that track the performance of green bonds or sustainability bonds provide insight into the market's growth and the interest in environmentally focused investments.

4. Nature-based Solution Investments: Nature-based solutions (NbS) involve actions to protect, sustainably manage, and restore natural or modified ecosystems, addressing societal challenges effectively and adaptively, while simultaneously providing human well-being and biodiversity benefits. Indices and funds focusing on NbS can offer opportunities for investment in biodiversity conservation and ecosystem restoration.

As one can infer from the above already, the main purposes of market indices are:

1. Benchmarking: Indices are often used as benchmarks to measure the performance of investment portfolios or individual securities against a representative segment of the market. For example, the S&P 500 is a commonly used benchmark for U.S. equity performance.

2. Market Analysis: Indices can provide insights into the health and trends of specific markets or sectors. For instance, housing price indices can indicate trends in real estate markets, while consumer price indices (CPI) are crucial for understanding inflation trends.

3. Investment Vehicles: Many indices are directly linked to tradable financial products, such as exchange-traded funds (ETFs) or index funds. These products allow investors to invest in a broad market segment or a specific sector with a single transaction, benefiting from diversified investments at low cost.

4. Economic Indicators: Indices like the GDP, unemployment rate, or CPI are used by policymakers, economists, and analysts to assess the overall health of an economy, make policy decisions, and forecast future economic activity.

5. Environmental and Social Assessment: In the context of sustainability, indices such as the Environmental Performance Index or Human Development Index help measure countries' progress on environmental protection, social development, and public health. These indices can inform policy-making, aid allocation, and international comparisons.

6. Risk Management: Certain indices are designed to measure and monitor risks, including credit risk, market risk, or environmental risks. These tools help companies, investors, and policymakers in decision-making processes by providing a quantifiable measure of risk.

7. Performance Tracking: For businesses and organizations, indices can track performance in areas such as customer satisfaction, employee engagement, or corporate social responsibility. These indices help in setting targets, monitoring progress, and implementing improvements.

8. Scientific Research: In environmental science and biodiversity, indices such as the Biodiversity Intactness Index or the Living Planet Index provide critical data on the state of ecosystems and species populations, guiding conservation efforts and research.

As we can understand from the above, the development of biodiversity indices is a natural consequence of a general concern about the loss of biodiversity, and the intention by market participants to measure their impact on the environment (such as carbon emissions) and now on biodiversity. In addition to pure understanding, investors also want to benefit from their investments which are deemed sustainable, and indices can be used to build investment vehicles (such as ETFs). Finally, using indices for measuring exposure to risk factors is of importance for institutional investors with a fiduciary duty (such as pension funds).

Examples of biodiversity indices already in existence

Now that we know the context and main motivations behind the biodiversity-related indices, let us present a list of some of the most popular indices already available on the market.

1. WWF’s Living Planet Index (LPI): The LPI, managed by the World Wildlife Fund, measures the state of the world's biological diversity based on population trends of vertebrate species from around the world. It is an indicator of health of the planet's ecosystems.

2. S&P Global ESG Indices: These indices are designed to measure the performance of companies with strong ESG characteristics. They include criteria related to environmental impacts that can affect biodiversity, such as natural resource use and ecological sensitivity. Some of these indices are tradable in the form of exchange-traded funds (ETFs) or other financial products.

3. FTSE4Good Index Series: The FTSE4Good Index Series is designed to measure the performance of companies demonstrating strong environmental, social, and governance practices. Environmental criteria consider companies' approaches to biodiversity, among other factors. These indices are used by investors to create and assess responsible investment funds and other products.

4. MSCI ESG Leaders Indexes: These indexes aim to target companies with high ESG performance relative to their sector peers. The environmental criteria include a company’s impact on biodiversity. MSCI ESG Leaders indexes are tradable through ETFs and other financial products.

To this list of indices could be added Green Bonds and ESG Bonds which are issued to fund projects with environmental and climate benefits, including biodiversity conservation projects. Hence, they can take part in the construction of ESG-focused investment portfolios. Other important bonds are the Wildlife Conservation Bonds (or "Rhino Bonds") launched by the World Bank and aiming at conservation efforts such as the protection of endangered species, with investment returns linked to the success of conservation outcomes.

S&P DJI's biodiversity indices

It is time to come back to the new indices released by S&P DJI. Looking at their documentation (available here), we learn that they are modified market cap weighted indices, rebalanced on a semiannual basis, and made of equities only.

Among multiple characteristics, one can notice the following:

• S&P 500 Biodiversity Index: - Its goal is to measure the performance of 400 equity securities, selected and weighted to collectively reduce their ecosystem impact intensity, limit impact on land, increase alignment with UN's SDGs, and reduce carbon footprint relative to the S&P 500 Index. - Its Weighted Average Carbon Intensity (WACI) is 111.33 metric tons CO2e / $1M of revenues. - Its constituents are all in the USA and mostly made of information technology companies (~30%), financial sector companies (~13%) and health care (~13%), plus other sectors among which energy, materials, real estate and utilities take a minor share (all together less than 10%).
  

• S&P Global LargeMidCap Biodiversity Index: - It measures the performance of 1324 equity securities taken from the S&P Global LargeMidCap Index, with the same goals of reducing the ecosystem impact intensity, limit impact on land, increase alignment with UN's SDGs, and reduce carbon footprint relative to the S&P Global LargeMidCap Index. - The WACI of this index is 143.94 metric tons CO2e / $1M of revenues. - Constituents are similarly heavily weighted on information technology, financial services, and health care (with weights of ~24%, ~16% and ~11%), and similar observations in the minority sectors can be made. - The securities cover more than 45 countries but the index has 61.5% of its weight on USA, the next country being Japan with only 6.7%. The reason behind those numbers is that the index represents the top 85% market capitalization of each developed and emerging countries in it.

In conclusion, this release of two new biodiversity indices is the proof that investors demand benchmarks and performance tools to assess their impact on biodiversity. As the concerns for preservation of nature continue to grow, and considering the emergency of the situation, one can expect such kind of indices to gain more market presence and take a more important role in investment decisions in the near future.