UK pension schemes are increasingly treating natural capital as a mainstream asset class, according to research, which also shows some investors are targeting an internal rate of return of as much as 20%.
The research, carried out by Pensions for Purpose and commissioned by impact investment firm Palladium Group, explored how areas such as forestry and sustainable agriculture are moving from investors’ risk register into their portfolios.
The analysis found that most schemes investing in these asset classes are aiming for an internal rate of return of 8% to 10%, while higher returns are sought by more experienced investors in emerging markets.
Bruna Bauer, head of impact lens at Pensions for Purpose, said: “Nature has become not just something to manage risk around, but increasingly something to actually invest in.
“Our research shows pension funds with experience in natural capital are developing greater confidence in its financial characteristics. As familiarity increases, funds are expanding across sectors and geographies, while maintaining a disciplined approach to returns.”
The analysis also found that most pension funds exclude potential revenues from carbon markets when underwriting returns and instead rely on core operating income.
It found that investors are drawn to this asset class primarily for its low correlation with equities and bonds, as well as its potential as an inflation hedge. Those allocating to emerging markets do so due to faster biological growth rates and lower land costs, rather than greater risk tolerance, the research stated.
However, while momentum is building, Pensions for Purpose emphasised that the natural capital market was still in the early stages of development. Most pension funds with exposure to natural capital made their first allocations within the past two years, the research found, typically as small sub-allocations within private markets, infrastructure or private equity portfolios.
Future growth is likely to depend less on appetite and more on effective execution, Pensions for Purpose said, with institutional-grade structures and robust case studies required.
Martin Belcher, director of impact, climate, environment and natural capital at Palladium, said there was a growing body of expertise in nature and biodiversity-focused investing, but there was more to do to deliver investment and impact at the required scale.
