Allocating to agriculture and farmland can help improve the performance of diversified institutional portfolios, but the asset classes are also evolving to combine wider concepts relating to natural capital, delegates at the IPE Real Assets Infrastructure & Natural Capital Conference in Munich heard last week.
“This is a really important question now, especially as we’re seeing more investors coming into the asset class, when we’re making allocations for the first time to natural capital,” said Gwen Busby, head of research and strategy at Nuveen Natural Capital.
Busby said the lack of correlation with capital market cycles and the relating diversification benefits were major drivers for allocations to natural capital. Others included “the consistent ability to hedge inflation, as well as the return profile, the stable income return from real asset yields, as well as the capital appreciation from asset sales for an increasing number of investors”.
She said: “We’re also seeing a broader set of drivers. We’re seeing nature, climate and people-related motivation for investment in the asset class. And this could be a whole range of things – it could be biodiversity conservation values, it could be the low carbon intensity of the asset class, or it could be the potential to generate carbon credits.”
She cited Nuveen’s latest survey of 800 public and private pension funds, insurance companies, endowments and foundations. “What the 2023 survey told us was kind of similar to previous year’s results – that 12% to 13% or more than 100 out of those 800 total responses of institutions are looking to increase their allocation to natural capital, to timberland and farmland. What the survey results also told us is that investors are indeed looking for this broad set of benefits from their allocations,” Busby said.
“They’re looking for both the portfolio-level benefits, as well as environmental impact, positive environmental impact, and that’s really good, because it happens that we have a few challenges ahead of us. We are looking for ways to invest in an environmentally friendly way, in a socially-responsible way, feed a growing global population and we need to produce more timber for a whole range of wood products to meet growing demand, expected to increase by about 50% between 2020 and 2050, as well as hitting our international climate and biodiversity targets.”
Later that day, Olly Hughes, managing director of Forestry at Gresham House, explained how sustainable forestry investments were becoming “the backbone” of an evolving natural capital asset class.
“This isn’t a new asset class,” he said. “What we are experiencing is an evolution and a development”. Sustainable forestry “remains a compelling investment” and plays “a central role in a natural capital allocation underpinning many of the investible natural capital themes”.
But, he added, while there are exciting opportunities in the “more nascent areas of carbon credits and biodiversity”, investors should “tread with caution” and ensure that “the risks are balanced with more established markets such as sustainable timber”.
How natural capital has delivered portfolio level benefits
Busby said, that over the past 30 years or more, “portfolio level benefits have been borne out”. While the US equity markets were volatile during 2022 and 2023, with the average return in barely in positive territory at 1.8%, and with US bonds, global stocks and global bonds delivering “on average negative performance over those two years”, timberland and farmland “performed very consistently positive in both years”.
Busby said: “Timberland averaged 11% with a 3% cash yield, and farmland came in at 7% average, with a 3.3% cash yield. We also have continued to see a positive correlation with timberland and farmland and inflation, so consistent outpacing of inflation over time, and that was even the case in 2022 when inflation came in at 7% in the US.”
She added that US timberland and farmland has remained “within an average range of three to 5% over CPI over the past 10 years”.
Forestry practices and farmland practices can be improved in ways that generate quantifiable climate and nature benefits, Busby said. “And then finally, most impactfully, we can restore landscapes, restore ecologically important areas, like wetlands, like streams, like endangered species habitat. In all three of these cases, along the spectrum, there are rigorous metrics and KPIs that quantify those positive environmental impacts,” she said.
Arnaud Filhol, co CEO, France Valley, said investing in timber helps create an asset portfolio “which is actually matching the liability structure of the underlying business”.
He added: “I think there’s a couple of factors which are relevant for all portfolios, no matter how the structure looks like. And I think one of those factors is definitely diversification and risk management, so that is really key for us. Inflation hedging capabilities of the assets are very, very important, but also the regulatory compliance, because, you need to be able and allowed to invest into particular asset classes or also geographies and regions.”
Allocating to natural capital, he said, “makes the portfolio more efficient from a risk return perspective, and it has made the portfolio also more resilient in terms of the capability to deal with certain risks, and not only economic risks, but maybe also climate risks, all kinds of operational risks we face”.
Carl Atkin-House, head of natural capital at Climate Asset Management, said: “Corporates are coming to this from a different perspective. Usually it’s around the outcomes, and they want access to credit through carbon credits – and diversity credits or other ecosystem services – that they can use as part of their their wider obligations. So the way that we’ve designed our strategies has been very deliberately different.”
Aleksandra Holmlund, CEO of Qarlbo Biodiversity, which invests in forestry with a focus on biodiversity, talked further about the role of carbon credit markets and the role that they play in helping to realise climate benefits from investments in timberland or other land.
Holmlund said: “I think that carbon markets definitely play a very important role. However, there are problems with that market, voluntary carbon market, and they’re all volatile. The prices are going up and down. There are some reputational issues and so forth. However, as forest investors, we see carbon as one of the potential cash flows that build our return.”
Joerg Weydanz, senior investment manager at Allianz Investment Management, added: “When we get introduced to opportunities, very often there isn’t embedded carbon credit optionality in traditional timberland investments. But it could help to make cash flow speeds more resilient and less volatile, which is then helping the overall portfolio or the investment. So I think it is for the asset class, very positive.”
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