It seems like every month another forest or nature-based solutions funding initiative is announced – each heavily promoting sustainability and its ability to deliver climate benefits. If you are a Fund or Asset manager that has been wondering where to start with a forest or natural capital investment strategy of your own – this article is for you. If forest investment is something you’re already familiar with – much of what this article discusses will be old hat, but you might be reminded of a thing or two if you’re looking to build a new strategy either in a new market or with different objectives than your existing mandates. It may also give you some conversation starters with your LP prospects.
This article looks at the basics of forest investment, where before you design your forest investment strategy – there will be some reconnaissance you need to conduct. Highlighted are some key elements you will want to consider before your full strategy role out, with a deep dive in understanding your motivations for forest investment.
Forest Investment Reconnaissance
Think of your strategy reconnaissance as the basic, low-resource commitment research you need to conduct before the drafting of your investment strategy. The output of this will be what you present internally to muster support for full strategy development, which will entail the allocation of significantly more resources.
In your reconnaissance, you will want to do some research and reflect on the following points to understand the direction your investment strategy development will take:
- Motivation for investing in forests – What higher level investment objective does your organization intend to achieve through a forest investment strategy,
- Forest asset class – What forest assets do you envisage – managed plantations, semi-natural or natural forests? Is it important to integrate non-forest land use into your asset mix – such as for agroforestry or wetland restoration?
- Investor sentiment – Assuming that you are raising capital for your Fund or similar investment vehicle, who is your target investor and what are they looking for in a forest investment? What is their risk-return profile? What are their concerns?
- Geography and end markets – What are target investment regions for your organization, do you have a preference for core or emerging markets, are there specific end markets you are after (like structural timber, pulp, bioenergy, carbon credits)?
- Regulatory and Voluntary Standards considerations – Does this strategy fit part of a larger organizational directive to comply with, for example the EU Sustainable Finance Disclosure Regulation (SFDR), and be classified as an Article 8 or Article 9 Fund? Does your organization already commit to voluntary best practice standards, such as UNPRI or TCFD disclosures, GRI reporting standards, or IFC Environmental and Social Performance Standards?
- Macroeconomic elements – You will want to understand the macroeconomic enablers and disablers relating to your end markets. Understanding target region wood production and harvesting data, development of the processing sector, forest products trade and wood prices, legislation and regulatory status and changes around forest management and markets (including carbon markets)
Each of these topics can be elaborated, but in the interest of not writing a book here, this article will focus on the first point, Motivation for investing in forests.
Motivation for Forest Investment
Why establish a forest investment strategy? There’s a reason you’ve been tasked with or have taken the initiative to explore forest investment. What is your reason? What might seem a simple and straightforward question will have big implications for the assets you eventually invest in. Consider the following motivations to identify with the reasons that best apply to your organization.
- Timberland returns
- Climate returns or impact
- Nature and Biodiversity returns or impact
- Sustainable development and social investments or impact
Within this brief list, there are also the cross-cutting motivators that fit across these categories – like circular bio-economy or green transition, impact investing, ESG investing, sustainable investing, sustainable forest management, and anti-deforestation.
1. Timberland Returns
Conventional timberland investment has a strong investment case for providing investors with access to wood markets, which are becoming ever more important as a low-emission and renewable commodity, especially when compared to high emission alternatives like concrete, steel, and plastics. The attractive investment characteristics of timberland are below.
- Diversification – Forest investments often have low correlation with traditional asset classes and can provide further diversification within your organization’s existing real assets, alternative investments, impact investments, or climate investment strategies.
- Long-term returns – Typically not a strategy for venture capital or investors with short time horizons. One of the benefits of forest investment is the long-term stable income streams.
- Biological Growth – Forest assets appreciate by being left to grow – of course active management is necessary, but by and large – nature does most of the work.
- Cash-flow Flexibility – Because of the biological growth characteristics, generally investors can be opportunistic in following the market to harvest when prices are high, and hold-off when wood prices are low.
2. Climate Returns or Impact
Does your organization have a climate investment strategy? This is becoming prevalent as investment managers look for options to balance the carbon footprint of their portfolio, or develop new products aligned with the EU Sustainability Taxonomy, increasingly sought after by investors. Climate motivators and how forest investment supports these are described below.
- Access to carbon markets – Well-designed forest investment strategies can provide investors access to both traditional wood markets and voluntary and/or compliance carbon markets. If your forest investment strategy is additional – that is creates carbon benefits above and beyond the status quo forest management that derives wood products, additional returns can be realized.
- Climate change mitigation – Forest investments are a natural choice (pun-intended) for investment managers with sustainability objectives aligned to the EU Taxonomy and for general climate goals. Forest assets contribute to this goal either by removing emissions, as trees draw down CO2 from the atmosphere, or by avoiding emissions, through protecting forest carbon sinks from deforestation and degradation.
- Climate change adaptation – Private investors are challenged to find investable solutions for climate change adaptation, an aspect of the climate challenge often associated with public funding. Forest investments with the right strategy, can contribute to climate change adaptation objectives – for example through providing jobs for the green transition, supporting regenerative agriculture through agroforestry, and forest management to avoid and mitigate wildfire severity.
- Circular bio-economy – As introduced above, by investing in sustainably managed production forests, you are contributing to the growth of low-emission, renewable and circular bioeconomy products. Wood products have several uses, from structural building materials to paper and packaging, to renewable biomass energy. If this is important to you, your strategy can contribute to both primary wood markets, and secondary wood markets – like harvesting and milling residues going to wood chips for bioenergy.
3. Nature and Biodiversity Returns or Impact
Nature and biodiversity are terms that are often used interchangeably. As an investor, you may have biodiversity objectives (a subset of nature) or a more broad nature objective, which additionally covers elements of water, oceans, soils, and atmosphere. I wrote about forest investment impacts on and from nature in my last article. If you have nature and biodiversity objectives, these might be your motivations.
- Biodiversity – Biodiversity includes genetic, species and ecosystem diversity. As an investor, your biodiversity objectives may be to protect intact biodiversity, or to restore degraded biodiversity. Forest investments provide opportunities for both, and both can exist in the same investment strategy – where for example you acquire assets that contain intact forest ecosystems where you will work to protect the aspects of genetic, species and/or ecosystem diversity that are important to you.
- Soil and water integrity – Forests are excellent at regulating soil and water systems. Trees serve as an excellent pump, cycling water as well as nutrients and minerals from the sun and soil through both the above and belowground biomass. Forest root systems provide excellent stability for soils, preventing erosion. Forests can both uptake water – reducing soil saturation and landslides, and transfer water in dry soils preventing desertification.
- Emerging Biodiversity Markets – Though still in its early stages, there is an emerging market for biodiversity credits. As with carbon markets – the sale of biodiversity credits may allow for upside market potential in a more traditional timberland investment, or they may develop to be the sole forest management objective of some forest assets – like vulnerable and intact high conservation value forests.
Sustainable Development and Social Investments or Impact
Though the UN Sustainable Development Goals are now nearly 10 years old – we are still a way off the 2030 ‘deadline’ and there is much work to be done. If your organization is looking to contribute to the UN SDGs or more generically contribute to sustainable development, forest investment provides many opportunities, particularly in emerging markets. Here are some of the more social development objectives that forest investment can contribute to – where SDG 13, climate action and SDG 15, life on land are addressed above.
- Decent work and economic growth (SDG 8) – green jobs, green transition, and rural development are all benefits of investing into forests.
- Responsible consumption and production (SDG 12) – Renewable wood products, and a forest industry that further supports secondary industries, such as bioenergy and even Bioenergy with carbon capture and storage (BECCS) allows for responsible consumption and production, so long as forest investments are conducted under a sustainable forest management regime.
- Reduced inequalities (SDG 10) – Indigenous Rights and the acknowledgement that Indigenous peoples are often the best stewards of the natural capital is important progress towards sustainable development. In many forest investment jurisdictions, working together with indigenous peoples presents a huge opportunity for mutual benefits. See this recent example of a partnership between different Vancouver Island First Nations and a leading forest company from British Columbia.
Tying together your Motivations for Forest Investment
It’s likely that several of these struck a chord with your motivations for exploring forest investment. Several of these motivators are complementary, several can exist in different degrees of priority, and others still in some cases, may conflict. If you would like to learn more about how these different objectives can be weighed and how they can translate into both a profitable and impactful forest investment strategy aligned to your overarching motivations, please reach out – it’s a jungle out there (again, pun-intended 😉)!