Investment in projects and strategies that put nature at their heart to yield societal, environmental and economic benefits — so-called natural capital — is emerging as a serious contender to be a stand-alone asset class among pension funds, with U.K. retirement plans in particular exploring the blossoming opportunity.
With more than half of global GDP estimated to be dependent on nature in some way, nature-based investing may seem like an obvious and important place to commit cash.
Sourcing suitable projects for investment, monitoring them and ensuring credibility and a market for monetizing the assets — such as carbon or biodiversity credits — must be carefully considered, industry sources said. And external agencies such as governments and regulators have a role to play in creating a truly investable market.
Nonetheless, the topic is getting more attention. In November, investment consultant Redington hosted an teach-in event with a number of U.K. local government pension funds to talk about natural capital. That event followed news that London CIV, a pension fund pool that managed £14.3 billion ($17.7 billion) of London borough public fund assets as of March 31, had hired Redington to help it explore an allocation.
In March, the Environment Agency Pension Fund, Bristol, England, carved out a 4% strategic allocation to natural capital, said Marion Maloney, head of responsible investment at the £4.1 billion pension fund. And the £2 billion Cushon Master Trust, London, announced it was exploring natural capital in January.
Working closely with money manager Schroders, Cushon is now in the final stages of due diligence to bring its first natural capital partner in North America on board, investing in sustainable timber production and management starting next year, said Julius Pursaill, scheme strategist. The natural capital allocation is about 1.5% of the portfolio, and sits within Cushon's private markets — illiquid real assets — with a target exposure of 15%.
Executives "haven't quite sized" exactly what the natural capital allocation will be, as it will depend on variables including how sensitive the mandate is to carbon and the carbon price. His intuition is that the exposure will be somewhere between 2% and 5%, he said.
Cushon is also talking to two other natural capital managers "as we pursue investments in this high-potential sector," Pursaill added.
"There's a ton of interest from investors who … are going to be interested in the possible revenue streams that could come from this," said Connel Fullenkamp, professor of the practice of economics at Duke University. "The opportunity or the motivation is really tremendous: You've got natural assets that have a tremendous capacity to absorb carbon, and they also provide lots of other kinds of environmental services that we are increasingly understanding the value of. At the same time, we have this tremendous threat to biodiversity — species are vanishing, habitats are vanishing. I think … one of the things that makes it super attractive to investors is that you get this multiple benefit from investing in natural capital," Fullenkamp said.
Money manager Schroders' Institutional Investor Study 2023 of 770 global investors representing $34.7 trillion in assets found that natural capital and biodiversity were deemed the best-suited asset classes within private assets to deliver on their sustainability and impact objectives. And 26% of respondents expect to increase or significantly increase their allocation to natural capital over the next 12 months.
Investment consultants and money managers agreed that interest from the investment community is growing.
About 45% of the $12.4 billion assets that Nuveen's natural capital unit manages is for parent company TIAA's general account. The remainder of those assets is run on behalf of investors including pension funds.
Martin Davies, global head of Nuveen Natural Capital, said 2% of the TIAA general account is invested in natural capital assets covering farmland, timberland and nature repair.
The allocation dates to 2006 when natural capital was more thought of in terms of the provisioning of ecosystem services — food, fiber, timber and water provided by a farm or forest — rather than in its fullest sense, Davies said.
"Today, we think about all the other dimensions that come with natural capital assets," including regulating services, such as carbon sequestration, flood control, water sanitation and cultural benefits. Markets have been developed "whereby we can derive value from other ecosystem aspects — regulating aspects of carbon sequestration," monetizing and selling carbon credits, for example.
"Thinking about this holistic and integrated approach is pretty critical — we are not going to solve the problems we face today if we look in isolation," Davies added.
Russell Investments' manager due diligence teams have been monitoring for the emergence of natural capital trends and solutions, said Kris Nelson, Russell's senior director and head of ESG investment management, in an email. "We are tracking a small but growing set of listed products (i.e. equities and green bonds) which are aimed at investing in companies or projects which promote biodiversity or efficient natural resource usage, but this is still a very small universe. More often, we see these types of investments included in more broadly designed climate or environmental solutions strategies. This creates a more investable opportunity set, allowing for a better balance of risk and reward."
The firm is also sourcing opportunities in private markets, including where natural capital is core to a strategy, such as sustainable timber or organic farming.
Natural capital sits mainly within pension funds' illiquid or private markets activities, with a greater focus on equity investments, said Angus Whiteley, CEO at real assets and private markets firm Stafford Capital Partners. "Allocations are increasing, work is being carried out, but there is relatively little money in the ground under a natural capital label at the moment."
Whiteley agreed that a few institutions have earlier timber allocations, which were implemented as real-asset diversifiers with stability and income.
Agriculture allocations were made for similar reasons; "but this predates the current drive for natural capital solutions. We expect to see commitments to both pooled funds and segregated allocations, with the latter reserved for the more mature strategies. When contemplating newer strategies, pension funds tend to take comfort from a collective approach through pooled funds," Whiteley added. Stafford has about $8 billion in AUM.
For those considering an allocation, a diversified approach is "critical," and typical natural capital allocations should be built around four pillars, said Anastasia Guha, global head of sustainable investment at investment consultant Redington: sustainable forestry; sustainable agriculture; credits of all types — buying or leasing land, improving it, taking up sequestration benefits, converting harvested or former woodland back into woodland, improving the biodiversity of an area, getting those credits verified and selling them on the open market to make returns; and the blue economy or oceans-related capital.
"If you think of those four as the main pillars of some sort of natural capital strategy, you should have some exposure to all of them," Guha said.
Sources reiterated that while saving and regenerating nature is important, a pension fund's fiduciary duty takes center stage in any decision to allocate to an asset class.
Davies said that with an investment strategy based around core farmland and timberland assets, investors could expect to reap an internal rate of return between 7% to 10%, and an income return of 2.5% to 3% for timber, and up to 4% or 5% in agriculture.
"It is possible, based on our experience, to add another 100 to 250 basis points of return from monetizing those other ecosystem services," Davies said.
Other benefits that natural capital offers are the level of diversification and low correlation to other assets, sources said.
It's not as simple as just deciding to invest in projects that are nature-based and financially positive. Investing in any new asset class is tough, but nature and relying on the monetization of these natural assets adds a new dimension, sources said.
Investors needs to be mindful of weather risk, climate-change risk, government intervention and price movements in assets, for example. "So, you have to diversify — by country, crop type, tree species — and in the case of agriculture, diversify the way we operate the assets," Nuveen's Davies said.
Even managers with a pedigree of running real assets are cautious about rushing into natural capital investments.
While the likelihood is that natural capital will become a stand-alone asset class, "this is a nascent asset class, and the risks within it need to be understood," said Tony Dalwood, CEO at private markets specialist Gresham House, which had £8.3 billion in AUM as of June 30.
"We have 25 years of data on forestry — but when you move into more nascent products, carbon credits as an example, data is short and it's volatile," he said. "The jury's out as to where it sits on the risk/return curve."
Gresham is "a significant player in sustainable real assets — I like to think we're ahead of the curve with the first battery storage fund and biodiversity net-gain investments — but even we're saying you've got to be careful as you go through this whole analysis," Dalwood said.
Investors need to "treat some areas like VC — lots of very small bets, recognizing a lot will not work," when it comes to natural capital, he added.
Betting on returns from biodiversity credits, for example, could be undermined by a lack of policy, sources said. In terms of external factors, Redington's Guha wants to see regulatory certainty.
"There is a lot of flipping and flopping" across policymaking, depending on the jurisdiction, and voluntary carbon markets also need to become more transparent and believable, she said.
And while it's good to see net-zero commitments from investors, it's also important to start accounting for Scope 4 emissions — so-called avoided emissions, or those that occur as a result of the use of a product but fall outside of its life cycle or value chain, she said.
Greenwashing is also a concern, Nuveen's Davies said. "Our view is we need to have a natural capital balance sheet for all the assets we have" and for a strategy, which can be used to report performance to investors — from both nature and financial points of view.
Hazel Bradford contributed to this story.
