Nature is a key protagonist in the carbon story. For over 10,000 years, our planet’s natural carbon cycles have been in balance thanks to ecosystems such as forests, soils and oceans taking carbon in and cycling it back out again. However, human-induced emissions and the destruction of these ecosystems have tilted the system out of kilter and curbed nature’s ability to sequester – or capture and store – carbon.
By investing in natural capital – in other words, the world’s stock of natural assets, including its geology, soil, air, water and all living things – investors can promote more sustainable management practices that restore ecosystems and increase opportunities for carbon sequestration.
Unlike philanthropic conservation strategies, natural capital strategies target land used for commercial purposes (namely farmland and timberland). These strategies offer opportunities for attractive financial returns as well as positive environmental and social impact. At Redington, we believe natural capital strategies can offer our clients a unique investment opportunity; hence, they’ve been the focus of significant research over the past few months. Here are some of the things we’ve learnt so far.
Supporting net-zero goals
It’s expected that we’ll need to remove large quantities of carbon from the atmosphere to limit temperature increases to below 2°C. According to the Coalition for Negative Emissions, the estimated number is between 6-10 billion tonnes of CO2 per year by 2050. However, current artificial carbon-capture technologies fall far short of the scale required and come at a very high cost. The world’s largest carbon-capture plant (recently opened in Iceland) is forecasted to capture 4,000 tonnes of CO2 per year – just three seconds’ worth of humanity’s current emissions. The good news is that we already have access to a proven means of large-scale carbon capture – nature, which is anticipated to play a fundamental role in the path to net zero. With the right management practices, nature could provide over one-third of the CO2 mitigation needed by 2030 to limit warming to within the 2°C threshold. This is illustrated by the diagram below from The Nature Conservancy:
Source: What the Paris Agreement means for carbon pricing and natural climate solutions: A business guide, Christopher Webb The Nature Conservancy and Zubair Zakir Anthropocene.io, March 2019.
But is there an opportunity for private capital to get involved?
We believe there is – through natural capital real-asset strategies.
By investing in natural capital private investors can support the transition towards more sustainable land management practices that enhance nature’s ability to sequester carbon and improve biodiversity while generating a positive financial return. At Redington, we define natural capital as investing in real assets that deliver both financial returns and nature-based solutions for climate change and biodiversity loss.
What is a nature-based climate solution? The WWF defines nature-based solutions as “ecosystem conservation, management and/or restoration interventions intentionally planned to deliver measurable positive climate adaptation and/or mitigation benefits that have human development and biodiversity co-benefits managing anticipated climate risks to nature that can undermine their long-term effectiveness.”
What is the financial opportunity?
Natural capital strategies invest in commercially viable land-based or ocean-based activities, such as timber or farming. Income is typically generated through harvesting, but new forms of income streams such as carbon credit sales (whereby carbon credits are earned for sequestering carbon and are subsequently sold) are emerging. The yield varies based on the crop type, geography and quality of the carbon credit. This provides an opportunity for clients to diversify their income and gain exposure to commodities and carbon markets, to which clients currently have little to no exposure.
As more companies and investors seek carbon offsets, the income from (and potentially the value of) carbon sink assets such as sustainably managed land is expected to rise.
What is the impact opportunity?
If managed appropriately, natural capital strategies can positively affect several unique environmental and social issues. Moving away from industrial methods and towards more sustainable land management practices can lead to higher carbon sequestration, improved biodiversity around and within the farm, better water management (including water filtration and flood defences), improved soil health and a positive impact on local communities.
The impact opportunities vary and are highly dependent on the management practices adopted by the local operators. Therefore, impact due diligence must consider the underlying operators to understand how their philosophy and practices affect the land from a social and environmental perspective.
Impact metrics and tools to track deforestation, carbon sequestration, biodiversity improvements and soil health are being developed, with new technologies, such as precision satellite imagery, rapidly emerging. Investors can also ask for greater transparency on the management practices used through metrics like employment, chemical usage, tilling regime, felling regime and water usage.
Overall, we expect managers in this space to be able to target 8 out of the 17 UN Sustainable Development Goals:
The carbon sequestration opportunity through foresty has been attracting attention recently, and for good reason. A diversified portfolio of forestry (including afforestation) can represent 2.3x higher net-negative carbon emissions versus renewables. Another nuance worth highlighting is that forestry enables carbon sequestration (removal from the atmosphere) while renewables avoid carbon (by displacing more carbon-intensive technologies).
Source: Redington, 2020 and Gresham House, 2021.
What is the liquidity profile of these assets?
A key consideration of natural capital is the investment time horizon, which is typically 10+ years. We expect natural capital solutions to be particularly well suited to long-term investors seeking to benefit from the expected rise in carbon pricing, align their portfolio with their net-zero objectives and/or address biodiversity loss.
The opportunity set for investing in natural capital has grown significantly over the past few years, with a surge in fund launches as client interest rises. The universe of natural capital funds consists of both existing farmland and timber managers launching impact-oriented strategies, as well as boutique impact firms who have always focused on sustainable land management practices. The strategies vary by geography,asset type and impact approach – namely a manager’s approach to carbon reporting, biodiversity, carbon credits and other environmental and social factors.
Our manager research team is currently looking at over 20 different strategies in this space to create a high-conviction Preferred List of managers for our clients to invest with. Over the next few months, we’ll be conducting detailed research into this specialist manager universe – undertaking site visits and assessments of their impact and financial credentials. We expect to have a finalised list of best-in-class managers to take to our clients in the New Year. To illustrate the level of analysis carried out by our natural capital research team, here’s a snapshot from a recent road trip…
Redington’s forest visit
In October, we had our first onsite natural capital visit, where we were able to well and truly get our boots dirty. Up in the misty, damp and grey Scottish countryside, we got a first-hand view of the forestry process in action, visiting a new afforestation project over 2,500ha. From planting to harvesting, the process takes over 10 years – depending on the trees. The harvesting site we visited was clearing spruce trees that were 55-years old.
Over the past few years, investors in this space have been well-compensated for their patience, with global timber prices soaring during the pandemic due to increased home renovations and growing demand for more sustainable building materials (e.g. lumber over concrete). The growth of carbon markets is also driving a series of new investments in afforestation projects.
The sustainability guidelines for planting and managing forests are evolving every year as researchers, local authorities and standard-setters (such as the Forest Stewardship Council, or FSC for short) enhance their understanding of how we can recreate and/or preserve the ecosystem services provided by natural forests. These evolving standards should help support the shift away from extractive and destructive land-management practices and towards sustainable practices that enhance nearby ecosystems and communities.
While the standards are useful guideposts, scrutinising the manager’s approach to impact is crucial
Through our research so far, we’ve found that a key differentiating factor between natural capital strategies is the depth and authenticity of their impact approach. One common misconception is that any natural capital strategy is positively impactful. Our view is that the reality is far more complex and that scrutinising each manager’s approach to impact is essential. Key factors to consider include the diversity of crops and species on the land, chemical and fertiliser usage, water management, soil quality, tilling practices and community involvement, to name a few. Assessing the impact approach of managers is therefore a key factor of our research.
If you’re interested in learning more about the opportunities in this asset class and how natural capital could help you to achieve your financial and impact goals, please speak to your consulting team or get in touch: jaspal.phull@redington.co.uk
Thanks to Ben Tattersall and Jaspal Phull for their contribution to this blog.
Unless indicated, these are the views of the authors and may differ from those of the firm.
