Using investment tools to defend nature is one thing. Building investment products around nature is another.
Two major funds, each including a leading nonprofit in partnership with a multi-billion-dollar asset manager, are showing how natural assets can boost capital.
Managers from each fund spoke with our reporter about the challenges, and far horizons, in this discipline.
Earth may be hurtling towards a climate-driven economic disaster in as little as 7 years should we deplete our planet’s carbon budget. So, why has more private capital not stepped in to try and avert disaster or at least give us some more time? While $100 million gifts to universities to study potential paths forward are certainly appreciated, it would seem that for-profit institutions would be more eager to find solutions themselves.
The world is certainly not bereft of projects that need investment or capital to invest – global assets under management topped $100 trillion for the first time in 2020. However, the process of attracting a greater piece of that $100 trillion pie towards investments that are both environmentally and economically sound, such as natural capital assets, has proceeded slower than experts estimate is needed to address urgent environmental issues like climate change. Yet despite dire warnings related to environmental crises, natural capital-focused funds have not traditionally been fielded at large scales. Many of these funds fail to top $75 million in assets under management – well below the level needed to make a material positive dent on the world’s environmental challenges or meet some of the investment requirements of large institutional investors. However, that may be beginning to change.
Two recent investment projects are raising significant money to try to show that taking natural capital investment to the next level is not only possible, but potentially a key piece for future institutional asset managers to include in a balanced portfolio.
No matter how you slice it, to get a piece of that $100 trillion pie, asset managers must be able to demonstrate how their investment strategy or thesis will help their clients fulfill their goals. An increasing emphasis on impact metrics does bode well for natural capital investments, but financial and market forces nonetheless persist. So, while earlier funds have done a good job touting the impact aspects of their natural capital investment theses, until recently they have not been able to raise funds with the hundreds of millions of dollars necessary to attract serious interest from institutional investors.
“The difficulty with many of these vehicles is that they target very specific aspects of natural capital which often make them difficult to scale.” says Martin Berg. Berg is the Head of Natural Capital Impact Strategy at HSBC Pollination Climate Asset Management, a joint venture formed between the British bank and climate change investment specialist Pollination. The newly formed asset management firm has announced its intention to raise up to $3 billion to deploy towards natural capital and carbon abatement focused investments, and is one of the funds that is pioneering the effort to bring natural capital investing to a level that attracts institutional interest.
Climate Asset Management has developed a different approach to deploy funds towards natural capital projects. By placing the natural capital at the center of their investment theme, they are able to create value through a combination of scale, return, and impact. Berg said: “We want to use impact not only as a reporting tool…but also as a project selection tool. When we’re evaluating potential investments, impact will be just as important to us as potential returns.”
“We want to use impact not only as a reporting tool…but also as a project selection tool."
Each investment would not only need to meet financial and impact criteria, it would also incorporate the value of the underlying natural capital into an asset’s valuation. As an example, consider an investment in an agricultural operation that utilizes sustainable practices versus traditional ones. Accrued natural capital benefits such as soil health not only generate value now but will likely be increasingly valuable in the future. Generating higher yields, especially relative to traditional competitors, can lead to an increased underlying asset value. There is also potential for new revenue streams as new markets emerge that value ‘ecosystem services.’ Soil carbon and biodiversity credits are just two examples of this. The explicit inclusion of such valuation is starting to change how investors of all types, especially at the institutional level, look at these products.
Berg said that with smaller funds “In many cases there is not a very clear return profile. Some of them rely on [cash flows from] payments for ecosystem services where the ecosystem services at the moment have no or extremely limited value - or its extremely difficult to get these [projects] to the point where they have value.” Furthermore, Berg points out that even when these smaller funds generate impact it is “not necessarily a systematic approach to assess, quantify, or value their natural capital.” He believes that Climate Asset Management’s funds will help address those issues.
As with any pioneering type of product, some customers will be early adopters and others will be skeptical. A large part of Mr. Berg’s challenge is to help investors figure out where capital invested in a venture like Climate Asset Management fits in with their goals and outlook.
“The first thing [potential institutional investors] want to understand is what bucket of their asset allocation this fits in.” says Berg. Traditionally institutional investors may allocate parts of their portfolio to something like a non-correlated forestry or agriculture investment and perhaps even a small portion to an ESG impact fund, though generally these are thought of as separate buckets. With Climate Asset Management, the impact and financial strategy is combined, which can create a certain degree of hesitation from asset owners.
“The challenge is whether [investors] are really buying into it or not.” says Berg. “Some think this is an interesting approach, while some are concerned that it does not really fit a clear allocation. So it’s a process with investors to convince them to look at the allocations they may already have in a slightly different way.”
One of the ways to help accomplish this may be to leverage the expertise gathered by non-profit organizations with experience piloting projects in the impact investing space. These organizations can help for-profit asset-owners invest with more confidence while also delivering ecosystem and climate mitigation benefits. One of the most well-known environmental non-profit organizations has recently done just that. The Nature Conservancy (“TNC”) recently partnered with Los Angeles-based RRG Capital Management (“RRG”) to develop a $927 million Sustainable Water Impact Fund (SWIF).
Dr. Eric Hallstein, a Deputy Managing Director at TNC, led the partnership with RRG. Dr. Hallstein said that institutional investors have long been deploying capital in areas such as California’s Central Valley to grow crops with high water needs, often at the expense of local water resources. However, as the climate changes and these areas become more water depleted, agricultural investments and communities are increasingly threatened worldwide. Investors and asset owners have a vested interest in using natural solutions to help maintain the productivity of their land. That’s where the TNC-RRG partnership can help.
The fund focuses on acquiring land and improving surface water, groundwater, and agricultural management to more effectively meet the needs of people and nature. The goals of these investments include helping make land more financially and ecologically sustainable, which can, in-turn, continue to benefit an entire community. In addition to restoring agricultural value, SWIF projects aim to provide a wealth of biodiversity and ecological benefits to the area in the form of seasonal migratory bird habitats, carefully timed water releases to local streams, and the restoration and protection of local ecosystems.
Dr. Hallstein said that getting investors to buy into this idea was a core challenge for TNC as well but that combining the experience and science acumen of The Nature Conservancy with the agricultural and water experience of RRG was key to making SWIF a reality. While Dr. Hallstein acknowledges that we still have much to learn about how to best incorporate the still-evolving science of regenerative food and agriculture systems into an ecological and financial framework, he also argues that to a certain extent we will have to learn through experimentation and by rigorously monitoring the results.
Ultimately the Climate Asset Management and SWIF partnerships are evidence that institutional investors are recognizing the significance of these types of funds. However these projects also show that there is a long way to go before environmental impact can become a central tenet of mainstream institutional investment principles.
Paving the way forward is often a difficult proposition. But these projects show how partnership can push goals forward and help grow the pie for everyone. Just as earlier impact investment firms have formed the basis for what Berg, Hallstein, and their colleagues are pioneering now, these projects can provide a template for future allocations of the enormous economic resources wielded by institutional investors. Large asset management firms like Morgan Stanley, BlackRock, and Vanguard have already announced ESG and sustainability investment goals for the coming years. Climate Asset Management and the SWIF are just two examples of how fund managers that can meet these targets by generating the type of scale, return, and impact benefits that drive long-term environmental, social and financial gains.