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Radha Kuppalli

Shaping investment strategy in natural climate solutions - a critical pathway to net zero

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Climate change is a major consideration for the strategic asset allocation decisions of some of the world’s largest investors, with a growing number committing to net zero emissions across their investment portfolio by mid-century. As they seek to invest in climate solutions, investors increasingly recognise that the only credible pathway to net zero greenhouse gas (GHG) emissions must include investment in “natural climate solutions” (NCS) — the protection of threatened forests, improved management of forestry and agricultural production systems, and reforestation of landscapes.

This transformation in land use will require the mobilisation of hundreds of billions of dollars of investment to reach net zero by 2050.

An informed portfolio allocation and asset management approach to NCS is critical to get right. As carbon prices rise in different parts of the world, forests, agriculture, and other land assets become increasingly valued for their climate change mitigation potential. Investors need to understand how to value and manage the climate benefits of NCS as an asset, including both the protection of at-risk carbon stocks as well as an increase in “emission removals” through carbon sequestration. 

Understanding how to value and manage climate benefits of NCS — particularly through standardised GHG accounting and participation in government-regulated and voluntary carbon markets — is rapidly becoming a core aspect of investment strategy and portfolio decarbonisation decisions with respect to allocations in forestry, agriculture and land use. The reality, however, is that GHG accounting for the land sector, carbon credit markets, net zero standards and climate regulation, all of which impact NCS investments, are also evolving in real time, creating a complex environment for investors to navigate.

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We recently published a guide for investors that aims to support investors’ understanding of how to quantify, value and manage investments in forestry, agriculture, and land for their climate change mitigation benefits. Achieving portfolio decarbonisation while maximising returns and climate change mitigation benefits from forestry and land assets requires understanding of GHG accounting, carbon credit project development, and how carbon pricing is transforming the forestry and agriculture sectors. We believe that there are different strategies depending on whether investors seek to apply the benefits of NCS toward their own portfolio decarbonisation objectives, or to gain exposure to new investment opportunities in NCS. 

Our guide points to important questions that investors need to ask themselves to determine the approach they want to take, including: 

  • How does the investor value the climate impact benefits of forestry and land assets, and how do these benefits influence portfolio allocation? 

  • Does the investor want to use the carbon asset for their own portfolio decarbonisation objectives versus selling and transferring the property right to that carbon asset to a third party, where feasible, to generate financial returns? 

  • What is the investor’s forward view on carbon pricing in various government-regulated and voluntary markets? How will that forward view shape the investor’s understanding of expected returns in forestry and land use?

Investors’ views on these questions are shaping new investment models in forestry and land use. While investment in activities associated with NCS can be pursued from a variety of asset allocations within an institutional portfolio, from a real assets perspective we see three investment models emerging in the forest sector: (1) integration of carbon credits into commercial forestry investment strategies to generate higher incremental returns; (2) investment into forestry assets primarily for climate change mitigation value; and (3) project financing for carbon credit projects on third-party land.

Through these new models, investors are exploring ways in which they can benefit from the carbon asset associated with NCS including:

  • Taking a portion of their investment returns as carbon credits through sale to third parties in the relevant market; 

  • Directly acquiring the carbon credits that may be generated from assets in which they have a shareholding through a negotiated price mechanism; or

  • Forgoing the sale of carbon credits in exchange for claiming the climate benefits on the GHG balance sheet of the investor and applying them toward an investor’s portfolio decarbonisation objectives.

It is an important time for investors to take notice of critical developments in the policy and market environment as they seek ways to grow allocation into NCS as part of portfolio decarbonisation and climate-aligned investing. We recommend that investors start viewing management of landscapes for multiple values including sustainable production of timber and agricultural products integrated with forest conservation, reforestation and ecosystem restoration. This new view of integrated landscape management will require reallocation of capital and dynamic re-optimisation of returns linked to climate impact and portfolio decarbonisation. 

Radha Kuppalli, managing director, impact & advocacy, New Forests

Shaping investment strategy in natural climate solutions - a critical pathway to net zero

Climate change is a major consideration for the strategic asset allocation decisions of some of the world’s largest investors, with a growing number committing to net zero emissions across their investment portfolio by mid-century. As they seek to invest in climate solutions, investors increasingly recognise that the only credible pathway to net zero greenhouse gas (GHG) emissions must include investment in “natural climate solutions” (NCS) — the protection of threatened forests, improved management of forestry and agricultural production systems, and reforestation of landscapes.

Radha Kuppalli
Radha Kuppalli
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Neil Griffiths

Neil Griffiths

Neil is the Deputy Editor of the wealth titles, including ifa and InvestorDaily. 

Neil is also the host of the ifa show podcast.

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