Natural Capital as an asset class

As awareness of sustainability as an investment prerequisite grows, natural capital—valuing Earth’s resources—is becoming a growing asset class, essential for economic growth, ecological health, and investment portfolio diversification.

Key takeaways:

      • Natural capital is a crucial asset class for environmental sustainability and economic growth.
      • Investments in natural capital offer benefits such as risk mitigation, diversification, long-term returns, and regulatory compliance.
      • The integration of natural capital into investment strategies is increasingly driven by the growing importance of ESG considerations and nature-based solutions.
      • Australia’s diverse natural assets offer unique opportunities in sustainable agriculture, carbon farming, biodiversity offsets, and renewable energy.
      • The market for natural capital investment is broadening, enhancing access for investors.

Investment strategies are undergoing a significant transformation, recognising the planet’s natural assets—forests, water, soil, and air—not only for their inherent environmental value but also as viable investment options. This shift is particularly relevant in Australia, where extensive natural resources and a unique ecological landscape offer substantial opportunities.

What is Natural Capital?

Natural Capital is defined as ‘the stock of renewable and nonrenewable natural resources (e.g., plants, animals, air, water, soils, minerals) that combine to yield a flow of benefits to people’.[1] These natural assets are critical for producing food and fiber, regulating the climate, and more.

Combining aspects of emerging markets with traditional ones, especially agriculture, natural capital is becoming an increasingly significant part of the investible universe. The world’s natural capital is estimated to be worth $125tn (1.25x Global GDP).[2]

The Rise of Natural Capital Investment

The growing emphasis on Environmental, Social, and Governance (ESG) criteria has led to new investment strategies focused on reducing carbon emissions and achieving net-zero goals. Nature-based solutions (NbS) and Natural Capital are becoming crucial elements in sustainable investment frameworks, especially in Australia.

Investment firms are increasingly creating divisions dedicated to natural capital, focusing on assets that provide both environmental and financial returns. This trend goes beyond corporate social responsibility, recognizing that sustainable natural resources are vital for long-term economic growth. Tools like the Taskforce on Nature-related Financial Disclosures (TNFD), the Greenhouse Gas (GHG) Protocol, and natural capital accounting are helping investors better identify and quantify portfolio risks.

Working on finances

The investment case

Natural capital investments are appealing for several reasons:

      • Risk Mitigation – Natural capital investments provide a hedge against environmental risks in the face of climate change. Investments in sustainable land management, clean water, and air can reduce the risks associated with environmental degradation.
      • Diversification – These investments help diversify portfolios and offer protection against market volatility. Unlike traditional assets, the value of natural capital often moves independently of financial markets. From a portfolio perspective, natural capital strategies also offer inflation-hedging capabilities and superior environmental benefits compared to conventional real asset strategies.
      • Long-term Returns – Investing in natural capital can yield substantial risk-adjusted long-term returns, particularly in its agricultural sector. This is supported by the global demand for sustainably produced food and the shift towards a low-carbon economy. Sustainable forestry, as another example, provides timber revenues, carbon credits, and biodiversity benefits.
      • Regulatory Compliance – With increasing environmental regulations worldwide, investing in natural capital helps ensure compliance and avoids potential penalties.
      • Additional benefits – Investors are increasingly viewing natural capital strategies through the lens of infrastructure and real assets, recognising the added ESG benefits and associated reporting advantages.

Investible opportunities (in an Australian context)

Real assets such as forestry and farmland, NbS, and private equity investments in supply chains, technology, and innovation represent key avenues for capital deployment into nature today.

Australia’s rich natural assets, from agricultural lands to marine ecosystems, provide a foundation for capital investments that deliver goods and ecosystem services like carbon sequestration, biodiversity preservation, and water purification.

Investments that positively impact the environment, such as renewable energy projects, sustainable agriculture, and conservation efforts, are becoming more prominent. This includes:

      • Sustainable Agricultural Practices – Innovations that promote sustainability in agriculture.
      • Carbon Farming and Carbon Credits/Offsets – Practices that sequester carbon and generate carbon credits.
      • Biodiversity Offsets – Investments aimed at compensating for biodiversity loss.
      • Farmland and Farm Operating Platforms – Investments in agricultural lands.
      • Timberland – Investments in existing forests or new plantations for commercial timber or forest carbon.
      • Other Environmental Assets – Investments in peatlands and mangroves, generating carbon credit income.

Allocations as an asset class

Natural capital can be integrated into a diversified portfolio allocation in infrastructure or real estate or stand alone as a separate allocation within a well-diversified institutional investment portfolio.

The unique potential of natural capital to enhance portfolio diversification, long-term wealth creation, and positive environmental outcomes makes it an essential component of a diversified investment portfolio in an increasingly environmentally conscious world.

Yet, natural capital, which is fundamental to global economic output and directly represents approximately 4.5% of global GDP, remains severely underinvested. Allocations to natural capital strategies are estimated to account for just 0.2% of total AUM globally,[3] highlighting a significant growth opportunity.

Current hurdles

While there is a surging appetite for this asset class from pension funds, endowments and other institutional investors, it still faces standard challenges associated with emerging asset classes:

      • Access – Predominantly available at the institutional level.
      • Illiquidity – The main barrier to investment.
      • Emerging Market – A shortage of opportunities poses a challenge, along with barriers to large-scale investing.
      • Scaling and Market Infrastructure – The need for market infrastructure improvement and scaling in the ecosystem.

However, amidst these challenges, there are several favorable tailwinds. These include government incentives that promote investible innovations, the establishment of public and private market mechanisms such as carbon pricing, and a growing pool of capital driven by increasing stakeholder demand and expectations for sustainable investments.

The road ahead

Integrating natural capital into investment portfolios will become increasingly essential. This transition is not only economically sensible but also crucial for the planet’s sustainability. Investment firms are leading this movement for institutional clients, setting a trend that will likely extend to broader investor bases.

Natural capital is poised to become a significant global investment trend in the coming years. Australia’s unique ecological assets offer novel investment avenues that combine financial returns with environmental and social benefits, marking natural capital as a key focus for future investment portfolios.

Insight authored by: Leylan Neep

Footnotes:

[1] Capitals Coalition (2016) Natural Capital Protocol.
[2] Institute and Faculty of Actuaries, Natural Capital – an actuarial perspective, 26 April 2021.
[3] JP Morgan and Schroders.

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