A UK pension fund has said it is “difficult to figure out” how natural capital investments fit into portfolios and warned that the returns are relatively unattractive in a high interest rate environment.
Peter Smith, investment director at TPT Investment Management, told Edelman Smithfield’s investor summit this month that while the asset class was attractive from a non-financial perspective, the risk-return made it difficult to fit natural capital into portfolios.
TPT IM is the investing arm of TPT Retirement Solutions, an £11.1 billion ($14.7 billion; €12.5 billion) UK pension fund.
Smith said natural capital is “relatively low-returning”. “It’s high single digits and you’re looking to lock your capital up for 15-20 years. In an environment where you can buy a high-yield bond and get 8 percent or more, it’s not that attractive. When rates are on the floor it’s potentially a different argument.
“Unless you have a specific [non-financial] requirement or stakeholders, I think at the moment it’s quite difficult to figure out how this fits into the portfolio.”
Tony Dalwood, CEO of Gresham House, told the summit that “making money” is always the focus with allocations. “As long as it fits in a portfolio, adds to portfolio characteristics and makes the right amount of return, you then go to the additionality around carbon sequestration, etc,” he added.
Dalwood said the UK’s largest forestry manager was struggling to gain traction among Australian pension funds due to the country’s rules around performance benchmarking under the Your Future, Your Super regime.
The €10.1 billion investor has “found some Aussie supers that are thinking outside the box” but Dalwood said this is “a real problem”.
However, Canadian and some US pension investors are more progressive in investing in natural capital assets. Canada is “well ahead” of allocations in the space, he added.
LGPS momentum
Gresham House secured its first commitment from an Australian super fund this month when NGS Super anchored its €250 million international forestry strategy alongside Worcestershire Pension Fund.
Other local government pension schemes have been active in the asset class as well.
London CIV kicked off work on its Natural Capital Fund in 2023, and it now manages £175 million with commitments from at least five clients, according to data from affiliate title New Private Markets.
The pension fund for the borough of Camden introduced a 5 percent allocation in early December, while the fund for Greenwich voted on doubling its allocation also to 5 percent.
Outside London, the West Yorkshire Pension fund has committed £25 million to Rebalance Earth’s nature-based infrastructure fund as a cornerstone investor. Darran Ward, head of alternatives at the West Yorkshire fund, said that nature-based infrastructure was “a key component of strategic investment, delivering both resilience and returns”.
Cadi Thomas, head of sustainable investment at consultancy Isio, told Responsible Investor that LGPS funds have been investing in natural capital in the form of timberland for at least five years, although for the asset class characteristics rather than any nature impact drive.
However, she said funds are increasingly interested in place-based investing, such as one Scottish fund that specifically wanted exposure to Scottish forestry.
The high price of land in the UK can make local investment pricier compared with the expected returns, she said, but the UK’s biodiversity net gain regime means that biodiversity credits could provide a boost to returns.
In the defined contribution space, Thomas said funds are approaching the asset class from a climate resiliency and biodiversity impact angle “rather than as a traditional real asset”.
Isio has worked with a number of managers to launch natural capital products with seed money from defined contribution funds, but Thomas said some managers are struggling to launch products as they need large seed investments to acquire initial assets and “aren’t getting any traction”.
“The asset size can be quite large. So what you do need is quite a lot of money to launch to start with, which is why you see either a manager succeeding and launching something with quite a bit of money, versus a manager that isn’t able to raise enough.”
The long lockup of capital makes the asset class less attractive for defined benefit schemes, and the complexity and relative novelty of carbon markets requires trustee education on the topic.
Investing in natural capital also offers exposure to an asset that is positively rather than negatively correlated with carbon prices, she said.