Why invest in natural capital?


## **Introduction**

In today's volatile and rapidly changing market landscape, traditional asset classes alone may not be sufficient to meet the requirements of investment portfolios. Global commitments to transition to a low-carbon economy, combined with recent market turmoil, highlight the need for diversified investment strategies. This is where natural capital investments come into play. Natural capital investments, such as timberland and farmland, offer unique advantages that not only enhance financial performance but also contribute positively to global sustainability goals.

## **What is natural capital?**

Natural capital refers to the Earth's natural resources, including land, air, water, and all living things. It provides various services, known as ecosystem services, that are vital for human survival and well-being. These services include food, water, materials for fuel and construction, medicines, climate regulation, natural flood defenses, carbon storage, and pollination. When natural capital is mismanaged, it becomes a liability, not only for the environment but also for society and the economy. Overexploitation and poor management can lead to biodiversity loss, reduced ecosystem productivity, and increased vulnerability to extreme events like floods and droughts. This can have severe consequences for human communities, including starvation, conflicts over resources, and displacement of populations. Therefore, it is crucial to sustainably manage and protect our natural capital for the benefit of both the planet and its inhabitants.

## **Investment characteristics of natural capital investments**

### Low volatility and stable cash yield

Unlike traditional asset classes, timberland and farmland investments have demonstrated considerably less volatility and consistent returns throughout economic cycles. The stability of cash yields is driven by long-term contractual commitments and relatively inelastic demand for timber and agricultural products. This low volatility contributes to capital preservation through economic downturns.

### Competitive returns

Natural capital investments have historically delivered competitive returns, outperforming traditional asset classes. Timberland and farmland investments, with their long-term market fundamentals and steady demand for food, fiber, and timber, have averaged annual returns of 9.2% and 10.9% respectively since 1992. Even during periods of market volatility, such as the recent inflation-induced downturn, timberland and farmland returns remained strong at 12% and 10% respectively.

![Graph comparing 20-year performance of timberland, farmland, and US equities](https://hedonova.b-cdn.net/Hedonova%20images/%20All%20Hedonova%20blogs/Why%20invest%20in%20natural%20capital/timberland-and-farmland-have-half-the-volatility-of-u.s.-equities-min.webp)

### Inflation hedge

Timberland and farmland assets offer a compelling alternative for protecting the purchasing power of investment portfolios. These investments have a positive correlation with inflation, as they produce raw materials for products in the Consumer Price Index (CPI) basket. As prices increase, cash yields and asset valuations rise, providing a hedge against inflation. Over the past 30 years, private timberland and farmland investments have consistently outperformed inflation by an average spread of +6.9% and +8.5% respectively.

![Graph showing NCREIF timberland and farmland's outperformance over CPI inflation over the last 30 years](https://hedonova.b-cdn.net/Hedonova%20images/%20All%20Hedonova%20blogs/Why%20invest%20in%20natural%20capital/private-timberland-and-farmland-have-outperformed-inflation-over-the-last-30-years-min.webp)

### Diversification potential

Natural capital investments offer diversification benefits due to their low or negative correlation with traditional asset classes. Private farmland and timberland investments, which are not traded in public markets, reduce exposure to speculative market movements. Additionally, returns from payments for ecosystem services and the low-carbon intensive nature of land-based assets contribute to portfolio diversification and stability.

![Graph depicting the low correlation of record music spend with personal consumer expenditures (PCE) from 1994 to 2019](https://hedonova.b-cdn.net/Hedonova%20images/%20All%20Hedonova%20blogs/Why%20invest%20in%20natural%20capital/low-correlation-of-record-music-spend-with-personal-consumer-expenditures-pce-_-1994-2019-min-1-.webp)

## **Global trends and market fundamentals**

### Expanding population and economic growth

The world's increasing population and economic growth drive long-term demand for agriculture and forest products. With over 83 million people added each year, the global population is projected to reach 9.7 billion by 2050. This demographic trend, coupled with rising incomes and a growing middle class, fuels the demand for food, shelter, and wood products. The consumption of industrial roundwood is expected to grow by 2% annually over the next three decades.

![Chart showing projected 2% Compound Annual Growth Rate (CAGR) for the consumption of industrial roundwood](https://hedonova.b-cdn.net/Hedonova%20images/%20All%20Hedonova%20blogs/Why%20invest%20in%20natural%20capital/consumption-of-industrial-roundwood-to-grow-at-2-cagr-min.webp)

### Supply constraints and sustainable solutions

Meeting the growing demand for agriculture and forest products poses significant supply constraints, including the high social and environmental costs of expanding farmland and timberland frontiers. To address these challenges, institutional investments and public spending are directed towards sustainably managed natural capital assets. By enhancing efficiency and adopting sustainable practices, existing productive areas can increase output without the need for additional land.

![Chart illustrating the need for a 48% increase in agricultural output to meet population growth by 2050](https://hedonova.b-cdn.net/Hedonova%20images/%20All%20Hedonova%20blogs/Why%20invest%20in%20natural%20capital/48-more-agricultural-output-needed-to-meet-population-growth-by-2050-min.webp)

## **Natural capital benefits and environmental impact**

### Sustainable land use

Investing in sustainably managed timberland and farmland promotes responsible land use practices. Sustainable forestry and agriculture techniques help preserve natural ecosystems, maintain biodiversity, and prevent deforestation. These investments contribute to the long-term health of the land, ensuring its productivity for future generations.

### Climate benefits and GHG emission reduction

Natural capital investments have the potential to generate quantifiable climate benefits by sequestering carbon dioxide through reforestation and sustainable forestry practices. Moreover, sustainably managed farmland can implement climate-smart agricultural techniques, reducing greenhouse gas emissions and enhancing carbon sinks in the soil. These initiatives align with global climate goals and contribute to mitigating climate change.

### Nature-positive initiatives

Investments in natural capital also support nature-positive initiatives by restoring degraded ecosystems, protecting wildlife habitats, and promoting biodiversity conservation. These initiatives help address the loss of natural capital and contribute to the preservation of the earth's ecosystems and the services they provide.

## **Conclusion**

Incorporating natural capital investments into portfolios offers a sustainable and resilient approach to financial performance while making a positive environmental impact. The inherent characteristics of low volatility, competitive returns, inflation hedging, and diversification potential make natural capital investments attractive options for investors seeking stable, long-term growth. Furthermore, these investments align with global sustainability goals, contributing to responsible land use, climate change mitigation, and the restoration of natural capital. By embracing natural capital investments, institutional investors can navigate market uncertainties while actively participating in the transition to a more sustainable and inclusive economy.


Natural capital investments, such as timberland and farmland, offer unique advantages for investment portfolios, providing financial stability and contributing positively to global sustainability goals. Natural capital refers to the Earth's natural resources, and sustainable management of these assets can yield competitive returns with low volatility. These investments act as an inflation hedge and offer diversification benefits due to their low correlation with traditional asset classes. With a growing global population and economic expansion, there is a rising demand for agriculture and forest products, making natural capital investments a promising avenue. Moreover, these investments promote responsible land use, climate change mitigation, and biodiversity conservation, making them environmentally impactful choices for investors seeking long-term growth and sustainability.

Why invest in natural capital?

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