For investors to understand the importance of natural capital, they need to first be clear on what it is. In short, it refers to the earth’s air, its lands, waters and biodiversity.
These assets, and the services they provide, help sustain life, livelihoods and well-being.
Why does natural capital matter to investors?
The most basic benefits of natural capital include food, fibre and timber, but also include a broad range of regulating, supporting and cultural ecosystem services that drive the global economy and human well-being. In fact, the World Economic Forum estimates that $44 trillion, or over half of global output, is either moderately or highly dependent on natural capital.
Economic development, however, has degraded this capital, altering ecosystems and transforming landscapes. The global decline in nature puts this economic value and the well-being of people all over the world at risk.
Institutional capital can play a role in the shift from unsustainable land use towards more environmentally- and people-friendly outcomes, according to Gwen Busby, head of research and strategy at Nuveen Natural Capital. For example:
- Sustainable land use – There are clear pathways for investments and financial flows towards more climate-resilient and restorative natural capital strategies, which include investing in sustainably-managed timberland and farmland.
- Climate regulation – The natural ability of forests and soils to sequester and store carbon in biomass and organic matter means they have a key role to play in combating climate change. Investments in timberland and farmland have the potential to safeguard existing carbon stocks and provide low-cost, scalable increases in long-term carbon storage.
- Greenhouse gas emissions reduction – Reducing emissions from agriculture and land use is another way that natural capital investment strategies can contribute to solutions. Sustainable management practices, such as installing solar panels on farms to reducing diesel used in irrigation pumping, can also help reduce emissions. Similarly, certain types of regenerative agriculture practices can reduce emissions and also lead to increased storage of carbon in the soil.
Why invest in natural capital?
According to Skye Macpherson, head of portfolio management at Nuveen Natural Capital, three long-term trends support the case for natural capital:
Growing populations will require more food, fibre and timber – According to the UN, the world’s population is currently expanding by over 67 million people per year. By 2050, food, fibre and timber production will have to support a population of more than 9.7 billion. In the face of this growth and limited land base, investment is required to make farmland and timberland more productive and sustainable, using environmentally-friendly and socially-responsible practices.
Supply constraints for forest and agricultural land and production – Both timberland and farmland face supply constraints in many geographies. Figures from the UN, for example, show the global forest area is shrinking by 4.7 million hectares per year. Remaining natural forests are increasingly protected for biodiversity conservation and climate mitigation to help combat deforestation and unsustainable management. Farmland losses in developed markets like the US are largely due to pressure from residential, business and industrial development.
- Growing demand for scalable climate solutions – As an asset class, natural capital investments such as timberland and farmland have the lowest average carbon intensity among alternative and traditional asset classes (as measured by the amount of net CO2 emissions per dollar invested). Allocations to natural capital can help balance more emissions-intensive sectors within an institutional portfolio, in turn helping to achieve climate targets efficiently and without having to sacrifice returns. Investments in natural climate solutions also have the potential to generate verified carbon credits, providing investors exposure to growing carbon markets.
Farmland and timberland: key investment characteristics
We used US data to illustrate the potential of farmland and timberland, as it provides the most comprehensive data-set available. A global portfolio of natural capital assets, however, is likely to provide the same advantages, with the additional risk mitigation that comes from diversified exposure to different crop types, timber markets and growing conditions around the world.
Figure 1: How farmland and timberland compare with other asset classes
In line with this, there are five main investment characteristics of farmland and timberland include:
Historically strong returns – US farmland performed on par with US equities and outperformed US bonds on an annualised basis over the last 30 years, providing both consistent income and capital appreciation. US timberland outperformed US and global bonds and global equities.
Attractive risk-return characteristics – As Figure 1 shows, farmland’s annual volatility lies between fixed income and real estate, yet delivers a stronger return. Timberland also exhibits higher returns than these asset classes but with slightly higher volatility.
Diversification potential – Adding either farmland, timberland or both to a portfolio enhances diversification, lowers volatility and improves returns. Both asset classes have demonstrated negative or low correlation to equity and bond indices. Payments for ecosystem services, provide an additional source of uncorrelated return and have the potential to enhance diversification benefits of land-based investments.
Inflation hedge – Farmland and timberland returns outpaced inflation in a variety of market environments and at a level that exceeds correlation between traditional asset classes and prices. Food from farmland is one of the major categories in consumer price indices. And timberland assets produce the raw materials for many products in the basket of goods used to calculate inflation (for example, building materials, furniture, tissue, paper and packaging). Over time, rising crop and product prices lift cash yields and, in turn, capital appreciation components of return.
- A store of value – The combined effect of natural capital’s investment attributes means that these assets can be a good store of value and can safeguard wealth.
Natural capital underpins the livelihoods and well-being of people all over the world. Investments in sustainably managed timberland and farmland alongside the protection and restoration natural capital offer tremendous returns for investors and for society.