ESG, stable returns moving pension plans to real assets

A push for sustainability and desire for stable returns are piquing interest among some defined benefit plans for real assets such as timber, agriculture and farmland.

Though the total dollar amount allocated toward timber fell 3.2% to $9.4 billion in the year ended Sept. 30 among the largest 200 defined benefit plans reporting allocations in Pensions & Investments' latest survey, pension plans have made recent decisions that suggest a trend toward such real asset allocations.

"One reason definitely is that there is a 2050 zero-carbon emission initiative for many institutional investors including many pension funds, insurance groups," said Christoph Schumacher, Manulife Investment Management's global head of real assets, private markets and CEO of timberland and agriculture.

"So with this initiative, you see more attention to how these institutions can get there, so that means they look especially into timberland as a carbon sink, carbon sequestration as one solution to reach that."

According to the NCREIF Farmland Property index, at the end of the fourth quarter of 2022, U.S. farmland had a total market value of more than $15.3 billion, with a 2022 annual return of 9.64%. NCREIF's Timberland index had a total market value of nearly $24.5 billion in the U.S. and 2022 annual return of 12.9%.

All of the properties in the indexes are held on behalf of institutional investors, many of which are pension funds, according to NCREIF's website.

"Real assets is obviously a fantastic tool that delivers attractive risk-return characteristics, and it also allows you to diversify your portfolio," Mr. Schumacher said. "If you look purely into returns, investors might say, well, in fixed income I get more at the moment, but … it's not only the highest return, it's also having a stable contributor to the portfolio."

Manulife has $47.6 billion in AUM for real assets, including $10.4 billion in timber and $4.2 billion in agriculture, according to a spokesman.

Institutional investors committed to timber are increasing their portfolios. The average dollar amount of the 26 plans in the top 200 that reported a timber allocation rose to roughly $363 million in the 2022 survey, the highest average figure in P&I's data since it began tracking the category in 2006. The 30 plans that reported timber in the 2021 survey had an average allocation of $323 million.

Christoph Butz, senior investment manager of Pictet Asset Management's timber strategy based out of Geneva, Switzerland, said that in the current inflationary environment, his firm has witnessed an increased interest in timberland in the Southern U.S. and Northern Europe. Pictet's timber strategy has seen increased inflows from both private and institutional investors, he said. Pictet declined to disclose the dollar amount of those inflows. The AUM for the timber strategy is $2.7 billion as of the end of February.

In the past year, several retirement plans have made commitments to timber, farmland and agriculture funds:

• The $3.4 billion Sonoma County Employees' Retirement System committed up to $125 million to Fiera Comox Global Agricultural Fund in August.
• In November, the $10.3 billion Rhode Island State Investment Commission put up to $50 million toward Homestead Capital USA Farmland Fund IV. The commission previously committed $35 million to Homestead Capital USA Farmland Fund IV.
• In January, the £25 billion ($30.5 billion) National Employment Savings Trust, London, confirmed it is exploring a potential investment into forestry and is discussing a possible allocation with its managers.
• In February, the $181.6 billion Washington State Investment Board, Olympia, committed
• $200 million to farmland fund Homestead Capital USA Farmland Fund IV. It also disclosed an additional investment of up to $200 million in Olympic Sun, a separate account managed by UBS Farmland Investors that invests in U.S. permanent and vegetable cropland.

A spokeswoman for the Rhode Island plan said in an email that the commission's real asset allocation segment primarily consists of private infrastructure funds. It has only invested in two farmland funds managed by Homestead Capital while to date avoiding timber and minerals.

She added that the commission sees two key benefits it seeks to achieve: diversify the private real assets (excluding real estate) portfolio relative to its predominant exposure to traditional infrastructure asset and protect against long periods of unanticipated inflation, which can have detrimental impacts on the purchasing power of an asset portfolio.

"Farmland investments have historically exhibited a direct linkage to inflation through farm revenues which rise when food and crop prices increase and through land values which tend to appreciate in inflationary environments," she said.

On Jan. 25, the $17.4 billion Ohio Police & Fire Pension Fund approved $250 million to $350 million in new commitments by year-end for its real assets portfolio, which consists of agriculture, timber and infrastructure. Ohio Police & Fire has $968 million in real assets — a 5.6% allocation with a target of 8%, according to a spokesman. That includes $267 million in timber and $30 million in agriculture as of Jan. 31.

"Our real assets portfolio continues to build deliberately toward the (8%) target, while seeking vintage diversification and accounting for market conditions and available investment opportunities," the spokesman said in an email. "The goal is the same as the rest of the portfolio. Preserve investment capital, generate attractive risk-adjusted returns … provide a hedge against inflation (and) provide diversification."

The Fort Lauderdale General Employees launched a search in January to commit $35 million toward farmland managers. The $710 million pension fund had no money in farmland as of June 30. And the $360 million Taunton (Mass.) Contributory Retirement System announced in December it was looking to commit $2 million to a timber fund.

Some of the new real assets interest coincides with steady price increases in wood fiber for pulp manufacturing.

Neale Ellis, Dallas-based co-chief investment officer at Fidelis Capital, a registered investment adviser that gives assessments of alternative investments for institutions, said pension funds are also increasing allocations to non-correlated assets that also serve as an inflation hedge. Most of timber's value comes from the actual growth of trees.

"A lot of these pension plans are revisiting their allocation to these hard assets like timber and farmland, (to) take some of the volatility out of their investments," he said.

In June 2021, J.P. Morgan Asset Management struck a deal to acquire Oregon-based Campbell Global, a sustainable investment manager that focuses on timber.

When Campbell was acquired by JPMAM, Anton Pil, global head of J.P. Morgan Global Alternatives, said that the acquisition would provide an opportunity for the firm to strengthen and diversify its ESG focus by building a carbon sequestration platform as well as enhance its offerings in alternatives.

According to a February news release, institutions advised by Campbell Global had acquired roughly 250,000 acres of commercial timberland in the Southeastern U.S., valued at around $500 million.

Joe Sanderson, CEO and senior managing director of Domain Timber Advisors LLC who is based out of Atlanta, also sees ESG benefits to owning timber.

"(One) thing to think about timber from an ESG standpoint is, unless you burn the wood from the trees, really what it is doing is constantly pulling carbon out of the atmosphere, and then it's storing it permanently in the wood," he said.

"You're starting to see, especially on the pension side, (the interest having) to do with ESG and the idea of folks wanting to invest the things that are good for the environment for a long time," he said. "Timber always had this (misconception) … some folks thought about people cutting down Brazilian rainforests or things like that and had sort of a negative environmental view … but you couldn't be more wrong."

Of the $500 million in timberland acquired Campbell Global's institutional clients, 120 million standing trees, more than 700 miles of streams protected by 30,000 acres of forestry adjacent to bodies of water and 250,000 acres of wild life habitats for recreational pursuits are included in addition to the storage of 18 million metric tons of CO2 equivalents, according to the news release.

Investing in agricultural land and agricultural activities is another area serving as a diversifier for DB plans in part due to heightened prices for grain and protein products, which in turn has boosted farm income to unprecedented levels, according to Mayssa Al Midani and Alex Howson, managers of the Pictet nutrition strategy, which invests in sustainable food production. The fund has $2.5 billion in assets under management.

Though the returns are closely tied to the commodity cycle, the value of high-quality farmland has robust structural support as an investment, they said in an email.

"Global food demand is projected to grow by 60% to 2050, driven by an increase in population from 8 billion today to 10 billion by 2050, as well as from increased demand from a growing middle class in developing markets," they said. "Meanwhile, geopolitical tensions have impacted global food supply chains, increasing the importance and value in domestic production to ensure food security."

As for the largest investors in real assets, the $91.9 billion Massachusetts Pension Reserves Investment Management Board Boston, increased its year-over-year allocations to timber by over $100 million and stood at $2.89 billion as of Sept. 30.

Timothy Schlitzer, director of real estate and timberland investments and senior investment officer at Mass. PRIM said in an email that it began investing in timberland in 2002. He added that the forestry industry is one of the oldest in the United States and provides key inputs into the U.S. economy, the most important being housing.

"We have long believed in timberland's given attributes as an asset class, such as low correlation with other asset classes, inflation hedging, and the ability to 'store on the stump' while benefiting from biological growth. Finally, it is a renewable resource which sequesters significant amounts of carbon," he said.

Storing on the stump means that when timber prices are low, one can hold on to the trees one owns and instead of harvesting, allowing for them to continue to grow until prices reach a desired value, according to the Forest Research Group, which provides timberland investment consulting.

The pension funds had the most money invested in timber out of the top 200 defined benefit plans' real estate holdings, according to P&I data. The Washington State Investment Board's $149.3 billion pension plan had the most farmland/agriculture of any of the top 200 plans as of Sept. 30, at $2.83 billion according to P&I data. This was the first year P&I asked for specific farmland/agriculture allocations. Pension plans among the 200 largest plan sponsors reported $5.6 billion in allocations.