Four challenges stifle natural capital investment

Limited awareness of what is meant by natural capital and a fluid carbon credits regulatory landscape are among the difficulties in steering money towards the fledgling strategy, says Olly Hughes of Gresham House.

Biodiversity, flower, bees

As more data emerges around natural capital degradation and biodiversity loss, investors increasingly understand the impact of these threats on the planet, as well as for portfolios.

The World Wide Fund for Nature has reported a 69 percent loss in wildlife populations since 1970, while more than half of the world’s total GDP is estimated to be dependent on nature.

However, most pension funds are still not considering biodiversity and habitat degradation as separate concerns to climate change, and, as such, are not investing directly in solutions that address these issues.

For asset managers offering specialized investment solutions in these areas, this means there is educational work to be done – alongside the day-to-day challenges of running natural capital focused strategies. Below, we outline some of the difficulties that urgently need addressing if we are to facilitate direct investment into this space and avert a worsening nature crisis.

Limited awareness

In a June Pensions for Purpose research paper commissioned by Gresham House, 62 percent of asset owners interviewed said they have not yet invested in natural capital solutions that also target positive outcomes on nature.

Among some investors, there remain doubts that natural capital investments can deliver meaningful positive impacts without compromising on returns. Among others, there is confusion as to what constitutes natural capital, owing to its myriad aspects.

Natural capital investments, which contribute positively to the environment, have been concentrated in more mainstream areas such as agriculture and traditional productive forestry, with many investors unaware of specialized solutions including habitat banks and vertical farming, for example.

Additionally, investors are unsure how to categorize these investments, as some share similarities with infrastructure assets, while others display return profiles resembling real assets or fixed-income instruments.

With the asset class still in its infancy, it is crucial for managers to maintain an ongoing dialogue with clients. This is necessary to raise awareness of existing investible products and help institutions to understand how to embed them into their investment strategy in a diversified way.

Ever-changing carbon credits landscape

For managers focused on assets that deliver carbon credits, navigating the uneven regulatory landscape requires heightened concentration. There are 19 different forms of carbon offset mechanisms used worldwide, creating layers of complexity for managers operating across jurisdictions. These taxonomies are also at varying stages of development. Less established frameworks remain subject to potentially significant changes, whereas markets such as New Zealand have more mature structures.

The fragmentation of the regulatory environment creates two challenges for asset managers. First, managers need to closely engage with regulators and monitor discussions on any future changes to carbon methodologies, to ensure their approaches are aligned with best practice.

In addition, managers must consider how they can offer diversified return streams that can generate income regardless of the future regulatory environment. One way of doing this is to combine the sale of carbon credits with the sale of sustainable timber.

We would welcome greater alignment and stability, as uncertainty about carbon verification methodologies risks deterring investment in forestry at a time when this is vital for addressing the climate crisis.

Stronger measurement systems

Meanwhile, the standards and processes around measurement and valuation for natural capital are far less developed than for climate. Not only is it difficult to assign a monetary value to nature, the metrics used to measure the additional impact of natural capital investments can differ vastly depending on the asset and its location.

Attempts have been made to establish certain criteria, such as the UK’s DEFRA Biodiversity Metric. However, in the absence of more standardized regulation, asset managers must themselves put in place objective protocols for measuring and reporting their assets’ impact on nature.

For example, we have implemented annual biodiversity surveys across all our forestry assets in the UK. One recent instance of this research showed more than 300 invertebrate species and 20 mammal species within just one small area of forest, including several species that had never been found in the UK. Adopting this type of granular data-driven approach should enable managers to adapt to regulatory standards as they evolve.

Robust risk assessment

Forestry and other natural capital assets typically face very different risks to traditional asset classes. Disease, fire and natural disasters are the primary risks to contend with, and managers must take a proactive approach to mitigate these threats throughout the investment process.

In the early stages of planning forests, we evaluate a wide range of potential risk factors, considering both short-term and long-term threats to ensure we select sites that can remain resilient over our 30-year time horizon.

To reduce the risk of pests and diseases, we also use aerial, drone and satellite data to monitor our forests for early warning signs, while effective water management – including the maintenance of drains, streams, rivers and ponds – is a crucial part of the day-to-day process.

By robustly tracking these risks, asset managers will be able to better understand the resilience of certain types of natural capital investments to continued nature degradation and climate change.

Olly Hughes is managing director, forestry, at Gresham House