Sustainability-focused forestry funds are likely to continue outperforming traditional counterparts in the decades ahead as climate change initiatives highlight timber’s role in reducing carbon emissions, according to the Global Impact Investing Network (GIIN).
In a report released last month, GIIN examined the market for forestry strategies that differ from conventional funds by incorporating longer time horizons and more social and environmental governance factors into investments. In addition to timber sales, sustainable forestry funds also derive revenue from carbon offsets, conservation easements and other mechanisms, according to the report.
Based on data from 37 investment vehicles and 24 interviews with timber mangers, their LPs and service providers, the report contains profiles of Criterion Africa Partners, The Lyme Timber Company and other firms.
Vehicles examined in the report produced IRRs ranging from 7 to 18 percent. A 2017 GIIN study, carried out in collaboration with Cambridge Associates, found that the top quartile of impact-focused timber managers produced net returns of 8.6 percent or higher, surpassing convention peers’ returns of 4.2 percent or higher.
In last month’s study, GIIN found that while interest in sustainable forestry is growing, low returns, investors’ exaggerated perception of risks and a relatively limited universe of funds are among factors that have produced a persistently challenging fundraising environment.
In the report, GIIN suggests that managers utilize blended finance to drive investment into new timber strategies, establish partnerships with conservation organizations for land rights sales and pursue vertical integration to offer a wider variety of ecosystem services.
Peter Murphy, a manager at GIIN and one of the report’s authors, told Agri Investor that after the previous study revealed stronger returns from timber funds with a sustainability focus, investors encouraged GIIN to study the reasons for the out-performance.
In the report, GIIN wrote that both GPs and LPs reported that ecosystem services provided by timber are fundamentally undervalued and likely to bolster cashflows within the next decade as such services are more fully understood and carbon market and reforestation efforts move forward.
Demand for such forest services is often tied to regulatory schemes specific to particular countries, states and municipalities, Murphy said. He added that both asset owners and fund managers expect that as the UN’s Sustainable Development Goals and Paris Accord come to have a greater influence on policy, increased income from ecosystem services will likely contribute to the value of timber assets.
“In a world where population is increasing, deforestation is increasing and the need for conversion of forests to agricultural land is also increasing, forests provide value as the only commercially-viable means of sequestering carbon,” Murphy said. “Those trends converge towards a relatively obvious supply and demand curve where the demand for these types of ecosystem services will have to be higher, the supply is shrinking and so the cost will go up.”
A move towards sustainable timber strategies is also supported by commercial factors, according to Murphy.
Timber managers reported significant changes in the end-markets they look to supply that have been brought on, in part, by the declining circulation of newspapers and dwindling paper demand, Murphy said. Timber managers have responded by increasingly focusing on value-added products that require higher-quality, more sustainably-managed trees.
“One of the asset managers that we spoke to noted that 70 percent of the products made by one of their processors were new products within the past 10 years, which speaks to this shift in consumer preference,” Murphy said, highlighting the paper straws that are increasingly replacing plastic straws nationwide as an example provided by GIIN’s interlocutors.
Murphy added that in its research, GIIN noted a need for additional guidance in measuring the social impact of forestry investments and is currently developing a set of such metrics that will be published in a future edition of its Navigating Impact series.