In case you missed it, this week we’ve published some articles about institutional investors accessing US ecological restoration investments, an area also known as conservation investment or mitigation banking.
Ecological restoration or conservation investment involves selling credits to local governments, developers and industries to help them mitigate the impact of their building works or industrial activities. These credits are largely earned by preserving, enhancing, restoring or creating natural habitats and protecting endangered species.
The sector is growing as the US government continues to roll out new environmental regulations in the wake of mounting scarcity of certain natural resources; water temperature and soil carbon levels are just two credit markets in development.
Wetland mitigation and conservation banking is already estimated to be a $3 billion-per-year market. Meanwhile, Dave Chen, principal at sustainability-focused fund platform Equilibrium Capital, thinks that water temperature credits, earned by cooling water systems impacted by industrial wastewater, could be worth as much as $5 billion alone.
And there are other ways to generate returns from conservation, one of which was highlighted last week at the Morgan Stanley Sustainable Investing Challenge in London. A competition for MBA students to create ‘institutional-quality investment vehicles that seek positive environmental or social impact and competitive financial returns’, the winning pitch was ‘Blue Forest’, an investment vehicle aimed at alleviating drought and reducing forest fire risk through a strategic forest thinning programme. The vehicle yields returns by effectively selling the saved water to local public utilities and from fire suppression benefits awarded by the USDA Fire Service.
With increasing sub-sectors within the niche area, there are also debates emerging about the best way to operate. Ecosystem Investment Partners, a private equity fund manager with $208 million in assets under management in this area, buys the land it works on which makes it a real asset play for investors, argues Adam Davis, a partner at the firm.
But Equilibrium’s Chen thinks there’s no need to own the underlying land. “A better model may be to be a credits developer with a balance sheet who shares the profits with the landowner than become a land owner, saddled with the responsibility of a land steward and all the revenue and costs entailed to deliver your IRR,” he told me last week.
Time will tell which methods prove more successful and whether the estimated returns of around 15 percent are achievable.
But the sector certainly has the support of some large institutional investors including the New Mexico Educational Retirement Board, which is an LP in EIP’s $181 million Fund II.
“I shouldn’t say this because the more investors [there are] in the sector, the more returns are compressed – but I think there is plenty of scale to be had here,” said Mark Canavan, senior portfolio manager, real assets, for New Mexico ERB.
One of Canavan’s main reasons to support the sector is the US government policy underpinning it. While investors typically find strategies predicated on government programmes off-putting, as they worry about policy reversals, Canavan argues that environmental laws in the US are here to stay.
“[It] was a pivotal moment for me [when] I realised that the mitigation regulations, some of which have been in place for over 40 years, were not going away,” he said. “These concepts are deeply engrained in the American psyche.”
Ps I will be at The Anthologist on Gresham Street near Bank in London next Thursday April 30 from 5pm. Please come along with your colleagues to meet me and some of your agri investing peers. First round on me!