Asset managers should lead the way in natural capital investments

July 2024

July 2024

Recent research by Gresham House and mallowstreet shows that UK pension funds, LGPS and insurance firms are increasingly looking to invest in natural capital to support the climate transition, deliver good long-term returns and align further with good stewardship principles. If the question is no longer ‘if’, how are UK institutional asset owners approaching natural capital?

Keen focus on climate adaptation, but not specifically on nature impact

Nearly three-quarters of UK asset owners see natural capital investments as a key way to contribute meaningfully to climate adaptation and mitigation. It is even more encouraging to see that a third of institutional asset owners use natural capital to offset emissions elsewhere in their investment portfolio, and almost an additional third – to enhance biodiversity and nature restoration (there is some overlap between the two groups).

Against this backdrop, it may seem surprising that only a quarter are investing explicitly to minimise nature damage and reverse biodiversity loss, and even fewer are specifically investing to support the production of sustainable resources. This is hardly an anomaly: fiduciary duties to members and policyholders often make UK institutional investors reluctant to invest specifically for impact. However, it is possible to invest in nature and still deliver a financial return.

Asset managers to pick areas for natural capital impact

Given the desire to support climate mitigation but stopping short of making a specific impact, 43% of UK institutional asset owners are neutral on impact themes in natural capital – and, importantly, will defer to their asset managers to pick the best opportunities that can deliver both a financial return and impact.

Despite this, some favourites emerge. Sustainable agriculture (of interest for 38%), sustainable urban infrastructure (33%) and afforestation (29%) are of immediate interest, likely because investors may already be familiar with these themes via other liquid asset classes. Another familiar theme is sustainable commercial forestry, which is not covered in this research but nevertheless popular among natural capital investors.

Two ways to access natural capital – as a theme versus an asset class

LGPS schemes typically invest in natural capital via illiquid assets: 33% take a real assets approach, and an additional 25% invest via private markets. As a result, they may be interested in more sophisticated illiquid investment strategies which offer direct exposure to natural capital as a real asset rather than as a philosophy across the entire portfolio.

Amongst other asset owners, natural capital is broadly seen as a growth asset: 23% of UK investors would allocate to natural capital via that portfolio, while 18% have an impact allocation. A handful have another approach via a diversified alternative assets portfolio. In these cases, it is more likely investors will take a stewardship approach to nature-related risks and/or approach it thematically.

Regardless of the preferred approach, the appeal of natural capital investments in dealing with climate mitigation and decarbonisation is clear. In terms of carbon and biodiversity credits, overwhelmingly, schemes and insurers want to generate credits directly. In fact, only 5% of all UK asset owners are keen on purchasing offsets at the moment. This may change with the evolving stance of industry bodies like the Science Based Targets initiative (SBTi), but voluntary offset markets have a long way to go to evoke more trust from investors, in particular around the actual impact of the projects they finance.

How is your scheme or organisation planning to support climate mitigation?

In such a new market, there is no rule book yet, and many investors are looking for guidance from asset managers to decide on the most important themes where natural capital investments can lead to positive impact. There is appetite for doing so globally, as well as within the UK. But with only a couple of standout leaders in this space, the natural capital market is ripe for collaborative development to create compelling solutions and best practice.

More views from Gresham House