Shaping Impact Series
07/2023
Investments in climate solutions have been consistently rising in recent years, and there is a clear rationale behind this trend. Impact investments, which aim to generate positive social and environmental outcomes alongside financial returns, have gained recognition for their ability to deliver value to investors, the environment, and society.
While all investments in this field hold importance, it is crucial to address two fundamental questions for maximizing the impact of investments: (1) Are these funds being directed to the appropriate destinations, and (2) Is the allocation being made in the correct proportions?
Make Impact Effective: The Nature Tech Case
Many of us commonly assume that road transportation has a more significant impact on greenhouse gas emissions than natural resource utilization. However, analyzing the sectors according to their GHG contribution is crucial to ensure that funds are distributed in sectors with significant reduction potential, even if they have less public recognition.
According to the World Resources Institute (2020, see Figure 1), the road transport sector is responsible for about 12% of total emissions, while agriculture, forestry, and land use account for almost 18.5%. This means that investing in climate solutions that address natural resource use, such as reforestation efforts or sustainable farming practices, is equally crucial as investments in transportation solutions.
Figure 1 – Global GHG Emissions by Sector
- https://ourworldindata.org/ghg-emissions-by-sector
The World Economic Forum[1] estimates that NbS (nature-based solutions) could deliver more than one-third of the emissions reductions needed by 2030 to reach the Paris Agreement’s temperature targets. According to the Nature Tech Market report issued on November 2022, without forming decarbonization pathways based on nature-based sources and nature-based sinks, achieving net zero in 2050 will be impossible (see Figure 2).
Figure 2 – Decarbonization Pathways - https://static1.squarespace.com/static/5e5e0b0c7589e422f9d8b83c/t/6436c33d4bfa7c3cb8a656ee/1681310532569/N4C-C4C-nature-tech-market-report-final.pdf
The Momentum for nature-based solutions is indeed strong, specifically after the perceived success of COP 15 on Biological Diversity in Montreal earlier this year, which resulted in concrete decisions to halt and reverse nature loss, including putting 30% of the planet (land and ocean) and 30% of degraded ecosystems under protection by 2030.
However, while more than half of the world’s GDP depends on nature and its services, and despite the global momentum, investments in nature are massively underfunded. UNEP’s State of the Finance for Nature Report highlights this financing gap. Finance flows to NbS are currently US$154 billion per year, less than half of the US$384 billion per year investment in NbS needed by 2025 and only a third of the investment needed by 2030 (US$484 billion per year) (see figure 3).
Within the NbS segment, NatureTech is a term for any technology that can be applied to enable, accelerate, and scale-up Nature-based Solutions (NbS), and its primary focus is on impacts on the natural world.
The financing gap for NbS and Nature-tech specifically highlights the potential of maximizing the effectiveness of impact-tech investments.
Figure 3 –NbS’ Financing gap https://wedocs.unep.org/bitstream/handle/20.500.11822/41333/state_finance_nature.pdf?sequence=3
Make Impact Impactful: Allocation Matters
Imagine walking into a supermarket with $10 in your pocket and deciding what to buy for dinner for two starving friends. Will you choose a sushi roll with six tiny, beautiful units or pasta and sauce lasting six courses?
Likewise, we expect a correlation between the relative rate of dollars invested in climate solutions and the relative rate of direct emissions cuts. In practice, there is often no strong correlation between the two.
According to Project Drawdown (see figure 4), in 2021-2022, nearly 40% of all investments made by venture capital funds were made in transportation solutions, even though their potential to reduce carbon footprint is ‘only’ 13%. In contrast, 20% of the capital invested in food, agriculture, and land use solutions has the potential to result in a 21% reduction in emissions, not accounting for the additional potential of ecosystem restoration as carbon sinks and their biodiversity co-benefits.
Also, The Inflation Reduction Act of 2022 heavily prioritizes energy, allocating approximately 60% of its capital toward it. Investment allocation, it seems, can be enhanced by directing towards highly capital-efficient solutions.
Figure 4 – Emissions Cuts Needed Compared to Investments -
https://drawdown.org/sites/defaulr/files/DrawdownRoadmap_KeyGraphics06_2x.png
Making the Difference: The Investors’ Additionality
By recognizing the dual responsibility of determining where and how capital is invested, impact investment managers can unlock the potential for investments to generate significant results, underscoring their pivotal role in driving transformative change.
Robust impact evaluation methodologies can help investors measure and assess the effectiveness of their investments. With an emphasis on maximizing additionality, focusing not only on underfunded sectors but also on underfunded sub-sectors within heavily invested sectors, and investing in solutions that deliver tangible results, impact investors can make a difference where it matters most.