This Impact Lens paper highlights the results of a research project seeking to assess where UK asset owners, in particular pension funds, are on their journey of incorporating biodiversity and natural capital into their investment decision-making. It also shows why they are considering natural capital in investments – for example, to reduce biodiversity loss and restore nature.

The report was commissioned by Gresham House, a specialist alternative asset manager focused on sustainable investments, with expertise in managing natural capital assets and impact investments.

To collect the data, Pensions for Purpose surveyed a range of asset managers and interviews were carried out across stakeholders – for example, asset owners and investment consultants. A summary of the main questions addressed in this report and their responses are shown below.

HOW DO ASSET OWNERS AND THEIR CONSULTANTS VIEW NATURAL CAPITAL?

1. Conceptualisation
To encourage systemic change, we believe monetary value must be assigned to nature. Natural capital is finite, yet our economy depends upon it with almost no financial attribution save for cost of exploitation. Unless we place a value on nature, we will not incentivise behaviour that supports its protection and restoration. While oil and gas are technically elements of natural capital and stewardship is crucial to mitigate the risks of biodiversity erosion, this paper's conceptualisation of natural capital investment should focus on natural capital assets. Our research has found investing intentionally in natural capital solutions is a step few leading asset owners have taken along the journey of incorporating nature-related issues into investment decision-making.

2. How to measure biodiversity and other nature-related themes
Pension schemes need to accept metrics will change across different natural capital investments. To some extent, this is already an issue funds face when investing in social impact – for example, affordable housing, where the deliverables may vary by sub-sector. We also expect qualitative information to play a role in explaining the impact of natural capital investments alongside quantitative data – nature is often too complex to be succinctly explained in a single metric.

3. Biodiversity and climate change 
Most pension funds are not considering biodiversity as a separate concern to climate change. To date, the level of interest in biodiversity and natural capital solutions has mainly been driven by pension funds implementing climate mitigation strategies. For most funds, natural capital investment is seen as part of their journey towards net zero.

4. Natural capital – creation versus protection
The asset owners who participated in this research largely focused and engaged on topics such as deforestation and water pollution, with investors seeking to reduce or avoid exposure to nature-related risks and harm to nature. Many are only just starting to think about solutions-based investing in natural capital, primarily due to barriers to investing in private markets and lack of knowledge. Careful consideration of the ecosystem externalities is crucial when investing in created natural capital. (An externality is a positive or negative outcome of an economic activity that affects a third party that is not directly related to that activity.)

5. The role of investment consultants
Some consultants are better informed on biodiversity than they were when pension funds first started to consider the climate. A number have invested significant resources to develop expertise on environmental, social and governance (ESG), sustainability and impact investment. They are well placed to help pension funds understand the concepts of natural capital and biodiversity, as well as how to embed them into an investment strategy.

WHAT IS THE MARKET FOR NATURAL CAPITAL INVESTMENT?

1. The situation today
Natural capital investment is still a nascent market. While some of the barriers mentioned by asset owners are typical of a new investment – for example, risk, track record, illiquidity and fees – others are more unique to natural capital investment – for example, challenges associated with nature-related data, lack of specialist knowledge, lack of understanding of financial drivers and evolving carbon markets.

2. How asset owners want to incorporate natural capital
Although many have not incorporated natural capital into their investment decisions and few have directly invested in natural capital assets, 54% of our asset owner interviewees are starting to use nature as a theme for engagement. As with many assets, the financial gains from natural capital investment are likely to be most substantial to those investors who make their first commitment ahead of the crowd.

WHY ARE ASSET OWNERS INVESTING IN NATURAL CAPITAL?

1. What are the drivers?
The drivers for asset owners to invest in natural capital are varied, some are more financially focused while others see biodiversity as a route to net zero.

2. What sustainability outcomes are asset owners looking for?
Most asset owners investing in natural capital solutions focus on their positive contributions to climate mitigation. However, they should treat biodiversity loss as a similar systemic risk to climate change and consider sustainability outcomes beyond carbon emissions reduction.

3. Is it important that natural capital investments yield carbon credits?
The topic of carbon credits elicited strong views from asset owners, some saw them as a mechanism to achieve net-zero targets and others saw carbon credits as a ruse through which actors can continue to pollute with no change in behaviour. Although they comprise a volatile market, investors perceived the financial premium available from carbon credits made these investments potentially attractive opportunities.

4. Are frameworks or commitments capturing investors' interest?  
Currently frameworks are not driving asset owner interest in natural capital investment but they are inspiring discussion among trustees. We hope the Taskforce on Nature-related Financial Disclosures (TNFD) regulation and international agreements such as the Kunming-Montreal global biodiversity framework put these issues onto the policy table and will catalyse natural capital investment.

5. Do pension funds have a responsibility to invest in natural capital?
Pension funds are divided on this question. Schemes that felt they do not have a responsibility to invest in natural capital tended to focus more on the obligation and role of their own investment portfolio. Those who do have a responsibility, tend to think more progressively about the future of investing and often consider wider implications such as how to secure a better world for their members to retire into.

FINANCIALS

1. What returns are asset owners looking for and what risk are they willing to accept?
Our interviewees were expecting returns from 5-8%, although some were flexible on the return if the assets can offset their own carbon emissions. Geographical diversification was considered a key way to manage risk.

2. What are their time horizons in assessing the success of their natural capital investments? 
To ensure the permanence of carbon sequestration, some funds are looking beyond medium-term performance assessment. This is important to maintain the sustainability benefits of natural capital investments.

3. How are asset owners thinking about natural capital investments within their portfolios?
With few investing in natural capital, the required level of generated return may change over time as more investors commit capital, and as the carbon credit and other natural capital markets develop. The role of natural capital in a pension portfolio is multi-faceted and may differ from fund to fund.

To the extent that anything in this report constitutes a financial promotion it is exempt from the general prohibition in S21 of FSMA on the basis that the report is only intended for investment professionals as such term is defined in S19 of the Financial Promotions Order. Please note that Pensions for Purpose does not provide consultancy services, advice or personal recommendations on any of the investment opportunities mentioned in this research. We collaborate on research projects with our members, we do not endorse any underlying funds.

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