Why it pays to take a deeper look at sustainable investments

Understanding the downstream impact of a business’s actions is key to sustainable investing. Regnan’s MOHSIN AHMAD explains why

• Watch out for second-order effects of sustainable solutions
• A system-wide view required
• Find out about Regnan Global Equity Impact Solutions fund

YOU may have heard sustainable investors refer to the second or third-order effects associated with a business.

Understanding a business’s downstream impacts — sometimes referred to as “externalities” — is a key concept in sustainable investing. (Pendal CEO Richard Brandweiner explains the idea here).

Sustainability proponents can often fail to account for these effects when promoting a new solution.

That means responsible investors need to take a wide, system-level view when considering challenges like climate change and food security, says Regnan’s Mohsin Ahmad (pictured below).

“It’s not just farm-to-fork,” says Ahmad, who co-manage’s Regnan Global Equity Impact Solutions fund.

“It’s what happens before the farm — with a farm’s suppliers — and what happens after the fork — how a consumer manages recycling and food waste.”

This week London-based Ahmad was in Sydney to address Regnan’s Director Roundtable on Sustainable Agriculture, a meeting of top executives and directors seeking to improve agricultural and food production practices.

Second-order impact

Ahmad uses the example of biodiesel — a renewable and biodegradeable fuel — to illustrate how second-order effects can play out.

“Biodiesel reduces greenhouse gas emissions by 72 per cent versus conventional diesel,” he says.

“On the face of it, that sounds great.

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“But when you look at the system-wide effect of everyone moving to biodiesel, there’s a lot more that’s going on when you scratch the surface.”

Land needs to be diverted from food production to produce biodiesel. Often, this requires deforestation and reduces biodiversity.

Forests are often replaced with monoculture which reduces the soil’s ability to sequester carbon. There are also knock-on effects in terms of chemical usage which generates run-off that pollutes waterways.

The net, system-wide result is that climate change is exacerbated, biodiversity reduced and food security risks rise as a result of wide biodiesel adoption, says Ahmad.

Positive impact

Second-order effects are not always negative, however.

Regenerative farming is often criticised as a high-cost approach with lower yields than industrial farming methods.

“That may well be true near-term. But what it doesn’t take into consideration is the system-wide positive effects of regenerative farming practices,” says Ahmad.

“The fact that you’re not using chemicals or you’re using less chemicals means there’s less pollution going into the waterways and less fossil fuel for fuel usage because many of these chemicals are produced based on hydrocarbons.

“There are benefits from a climate mitigation perspective and a biodiversity perspective… but also from the perspective of the soil health as well.

“Those practices, the evidence shows, improve the organic content of the soil which means there’s greater potential for carbon sequestration.

“It also means that there’s more water retention, your crops are healthier and as a result yields over time over the long run will actually improve based on regenerative farming practices.

“So, you can have this positive feedback loop as well.”

Ahmad says this means investors need to take a wide approach and pick solutions that are genuinely going to have a positive effect on whole system.

Read more about sustainable agriculture investing in Regnan’s Catalysing Sustainable Agriculture and Food Production report.

About Mohsin Ahmad

Mohsin is a fund manager with Regnan’s impact investment team. He focuses on Regnan Global Equity Impact Solutions Fund. Before joining Regnan, Mohsin was a senior analyst working on the Hermes Impact Opportunities Equity Fund. He has worked on thematic equity funds such as water, clean energy and agriculture.