Why natural capital is the next great frontier for climate investing

Writing in the late eighteenth century, French economist François Quesnay famously put forward his tableau économique, according to which agriculture is deemed to be the most productive and most noble form of commerce, and that societies would be “seduced” by the luxuries of industrial production at their peril.

Fast forward over 250 years later, amidst pervasive fear that the acceleration of information, technology and robotics will decimate segments of the labour market, the agricultural ecosystem remains a key pillar of post-industrial economies around the world. Worker shortages, export controls, rising trade frictions, and supply shocks resulting from energy crises across the globe have prompted policy officials to direct a renewed focus towards food security and even stockpiling of local stores of food. Meanwhile, extreme weather events are spurring structural shifts in food production: even the age-old process of vinification – so glorified in Quesnay’s time – is slowly moving northward in Europe, spurred by changing weather patterns.

The global food system is also recognized as a critical front in collective efforts to mitigate climate change. The UN estimates that it represents nearly one-third of global greenhouse gas emissions – food waste alone represents more carbon emissions per year than the entire aviation sector. Set against this backdrop, some of the world’s largest food producers and prominent family offices have steadily increased capital allocation to regenerative agriculture – that is, improving soil health, and restoring natural water cycles, enhancing biodiversity within local ecosystems, and at the same time, improving crop productivity and reducing carbon emissions.

The wider agricultural ecosystem – including timberland, forestry, farmland and the restoration of natural habitats – has magnetized an increasing flow of capital from some of the world’s largest alternative asset managers, now captured under the larger umbrella of “natural capital.” Pension funds, insurance companies and global investment houses have found that long-term investing in natural capital (and what is termed nature-based solutions, or NbS) has the potential to fulfill several clear portfolio needs: namely, capital preservation; investing in real assets as a hedge against inflation; and also, the potential to create impact by boosting local employment, enhancing water security, and by generating carbon offsets and biodiversity credits.

In fact, some of the world’s largest corporations are behaving like private investors by deploying to natural capital funds over multi-decade horizons. By pursuing a strategy of carbon removal – in order to offset mounting emissions by energy-avaricious data centres – tech companies are also actively investing in regenerative agriculture by buying soil carbon credits.

As we shall see, investors and corporate executives – operating with an investment mindset – would do well to follow suit by steadily increasing portfolio allocations to natural capital. While many business leaders and policy-makers are focused on enhancing resilience from climate change, investors should also consider the resilience of some of their portfolios against the changing winds of politics.

The lifespan and return horizon of many real assets often extend far beyond one electoral cycle – and certain infrastructure or real estate projects might be subject to cancellation by changing preferences of central governments. However, with a focus on conservation, local employment and the most “noble” form of commerce – agriculture – natural capital presents a manner to pursue ecological investing for the long term, one that may be insulated from the changing vagaries of policy-makers within polarized political landscapes.

The top 50 natural capital investors currently manage about $155 billion in Nbs assets. The largest players include insurance companies, global investment banks, global systemic important banks and alternative asset managers. With a focus on capital preservation, a hedge against inflation and market volatility, and environmental impact, their investors include high net worth individuals, family offices, university endowments and some of the world’s largest corporations. Investors can often select funds with a specific strategy (such as timberland production or reforestation) or co-mingled assets (such as farmland with regenerative agriculture practices, or powered by renewable energy). Some natural capital funds have historically offered about a 7-8% return on investment, with a top end of around 13% for certain strategies.

Some of the largest markets include the US and Latin America – which have not only generous land mass, but also a supportive regulatory environment for agriculture and forestry, and ventures in regenerative agriculture and biotech. Australia and New Zealand are also budding markets for natural capital. In Europe, the Nature Restoration Regulation aims to direct capital towards the more than 80% of EU natural habitats that are degraded, and in the UK, the government’s decarbonization goals are underscoring a shift from voluntary to mandatory carbon markets, prompting a shift into Nbs. Indeed, recent research indicates that over half of family offices in the UK have invested in natural capital.

In considering natural capital within the wider context of alternative assets (alts) and private capital, a dominant theme within alts is asset class convergence. That is, in order to generate alpha (or superior returns) today, fund managers may often need to look to where specific asset classes can converge – such as by blending private capital with public funds, or by breaking down silos between real estate and infrastructure, or by seeding capital to ventures that might amplify the performance of an underlying asset. In regions of slower structural economic growth – such as the UK, the eurozone and Japan – pension fund managers will need to identify such opportunities of convergence within alternative asset investing, in order to meet mounting needs to grow private pensions amidst rising levels of public debt.

Accordingly, as a pillar of alternative investments, the umbrella of natural capital presents a harmonious opportunity for asset class convergence. For example, ecosystem restoration in the UK may be viewed as infrastructure alongside real estate investment in gentrifying urban areas. The theme of “nature as infrastructure” also affords fund managers and end investors with a clear way in which to scale impact, as working towards ecological restoration can improve livelihoods in communities.

Investors may also discover that certain advancements in agtech and biotech – such as by enhancing root system architecture – can improve crop yields and sequester a greater volume of carbon into the ground, thus achieving greater profitability as well as climate change mitigation at the same time. By dedicating parts of funds towards ventures in improving roots and crop yields, large fund managers can also present their limited partners (LPs) with opportunities to invest in innovation, which can be scaled across multiple geographies to create efficiencies in agriculture.

Deepening and widening polarization within certain advanced economies has some long-term investors focused on the durability of their assets over a long horizon. Specifically, the rise of the right and its ideological association with climate skepticism has meant that some institutional investors and financial institutions have had to manage the cancellation of clean energy projects – thus hampering returns of long-term infrastructure investments.

However, some policy officials on the right have focused on the environment – or ecology – voicing a need to enhance conservation. Natural capital presents institutional investors and family offices with a way of investing in sustainability which accords with some of these “eco-right” ideals. In fact, reforestation, farmland restoration, and regenerative and “climate-smart agriculture” – including soil sequestration – are a rare arena for current bipartisan policy support in Washington. By enhancing agriculture through “nostalgic” investing and by restoring ecological systems, natural capital investors have the potential to generate local employment, reinforce local communities and contribute to climate change mitigation in a sub-asset class that unifies the left and the right – a feat that, in itself, might generate value far beyond portfolio returns.