Nature as an Asset Class: Financing the Transition to a Regenerative Economy
Thursday, August 17, 2023
August 2023
Nature as an Asset Class: Financing the Transition to a Regenerative Economy

Natural capital investment can protect biodiversity while delivering financial returns and diversification for investors

By David Sternlicht, Head of Nature Investing

Key Points

  • There is growing momentum behind natural capital investing, which aims to support projects and businesses that regenerate ecosystems and protect biodiversity while delivering financial returns for investors.
  • Positioning this category as an asset class can help investors understand its value in a portfolio, opening it up to a wider audience of potential investors and more consistent allocations over time. Nature isn’t a fad.
  • An additional $830 billion (estimated) in annual capital is required to flow towards nature this decade to scale efforts, making this positioning and the resulting investor participation especially important.

I’m writing this in the horrific aftermath of yet another “natural” disaster bred by human-caused ecosystem degradation. On August 8, 2023, Lāhainā, Hawai’i burned to the ground in a wildfire fueled by hurricane-force winds. As of this publishing, the death toll had surpassed 100 people. Economic costs will likely far exceed the $5 billion it will cost to rebuild, given the psychological and cultural toll this disaster will take. And local ecology played a part in exacerbating the damage: the abandoned 36,000-acre sugar farm turned breeding ground for nonnative, invasive grasses, which served as kindling for the spreading fire in the worst way at the worst time. 

In my previous article on the need to value and invest in nature, I discussed how we’re only just beginning to understand the economic consequences brought by the loss of biodiversity and erosion of ecosystem services. This tragic story shows what can happen when 4 of the 5 widely recognized drivers of the nature crisis converge — invasive species, climate change, land use changes, and direct exploitation — and it shows that humans do not appreciate the risks we’ve created.

A recent report from research provider BloombergNEF found that an additional $830 billion (estimated) in capital is required to flow annually toward nature this decade in order to begin to bend the curve on nature loss and restore degraded landscapes like Maui’s. Investors will play an important role in that capital mobilization. I believe it’s critical that nature be positioned as an emerging asset class in order for investors to quickly get comfortable with natural capital investments. 

So, what exactly does it take to become an asset class? In this article, I’ll offer a succinct definition and describe the qualifications of this emerging asset class while reiterating the important role investors will play in the transition to a regenerative economy.  

What is an Asset Class?

An asset class is a grouping of investments with similar characteristics that are subject to the same laws and regulations. There should be an element of each asset that is unique from other assets in the portfolio, and each one’s performance should be relatively uncorrelated with the others. This implies that different asset classes provide exposure to different market forces, such as growth, inflation, and scarcity. Yet the Yale Investment Office, which pioneered the Yale Model, a framework for institutional investing that has become the industry standard, contends that the “definition of an asset class is quite subjective, requiring precise distinctions where none exist.” This makes pinpointing the birth of a new asset class challenging. 

Combining definitions brings some clarity. The assets that historically composed portfolios like the Yale Endowment were stocks, bonds, and cash equivalents. Those assets are generally uncorrelated; in other words, typically when stocks go down, bonds go down less (or even go up). Over time, nontraditional asset classes, like private equity, real estate, venture capital, and even cryptocurrency, have emerged and gained prevalence due to a number of factors, including growth prospects and promises of diversification. 

Practical considerations are just as important:

  • An asset class must be large enough to be worth an investor’s attention. The first venture capital (VC) firms showed up in the 1940s, but it wasn’t until the end of the 1970s that the total VC market eclipsed $1 billion.
  • There needs to be an avenue for investors to achieve liquidity or sell their position. Without liquidity, only those with a limitless time horizon can invest, and that pool of investors is limited.
  • And finally, there should be enough breadth to provide diversification within an asset class. For example, if Yale was looking to build a balanced hedge fund allocation, it might want one hedge fund that invests in technology companies, another in healthcare, and another in consumer goods.

What Do We Mean by “Nature as an Asset Class?

We’re referring to investments in land- and water-based projects or businesses that are pursuing financial returns alongside ecological and social impacts. These impacts are achieved through nature conservation, ecosystem regeneration, regenerative uses of productive landscapes, and reductions in the drivers of biodiversity loss. These projects are monetized through the sale of high-quality carbon offsets, biodiversity credits, ecotourism, endangered species credits, lumber, food, consumer products made with local ingredients, and more. The markets are varied, but the theme is consistent.

As I mentioned in my last article, we anticipate the market to place a strong emphasis on productive land and seascapes, as these areas require 73 percent of the estimated $830 billion in annual funding for the transition to regenerative farming, and fisheries. Many projects will focus on sequestering carbon, improving measurement of biodiversity indicators, or addressing other climate and biodiversity-related outcomes. 

How Might Nature Qualify as an Asset Class?

If you were making a checklist of criteria in the “What is an Asset Class” section, you would hopefully come away with something like: uniqueness, size, liquidity, and breadth. Let’s explore how those criteria map to the nature space:

1. Uniqueness 

  • Details: Historical data suggests that carbon markets have a low to negative correlation with other asset classes. Timber also has low to negative correlations with most other asset classes, but a reasonably high correlation with farmland. Each of these serves as a good proxy for the markets that will drive this asset class.
  • Bottom Line: Nature projects should help diversify even sophisticated investor portfolios.

2. Size

  • Details: There is currently no appropriate measure of market size. Farmland covers nearly 40 percent of the global surface area, and only a small share is farmed regeneratively. Bloomberg projects that carbon markets may reach $500 billion by 2050. The capital need is immense, but there are limited options for the world’s largest asset owners to invest in natural capital at their required scale.
  • Bottom Line: The opportunity for directing capital toward regenerative projects and land stewards should continue to develop as all participants in the sector mature.

3. Liquidity

  • Details: Typical projects have a lifespan measured not in years, but in decades. The funding ecosystem for nature projects is not as mature as in other asset classes, where there are generally buyers available to provide liquidity to early and risk-tolerant investors (e.g. real estate developers selling to long-term owners/operators). 
  • Bottom Line: This is a work in progress. Several means to monetize natural capital and otherwise provide transfers of project ownership are already in development.

4. Breadth

  • Details: A range of existing financial products provide investors exposure to regenerative agriculture, sustainable timber, nature-based carbon credits, ecotourism, and combinations of the above. 
  • Bottom Line: Investors can already build sufficiently broad allocations within their Nature sleeve.

Looking Ahead

There are several barriers to overcome before natural capital goes mainstream, but I view the opportunity with optimism and I’m inspired every day by the continued innovations of the pioneers working to break down these barriers. Every participant in this emerging asset class must bring diligence, passion, and intellectual honesty to their endeavors. As investors, we’re ready for that challenge. As a species, we have no choice but to overcome it. 

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Ethic’s Biodiversity & Ecosystems Pillar makes it easier for you as an advisor to translate your client’s passion into a personalized investing strategy. You can use it along with our suite of Sustainability Pillars to help your clients develop an investing strategy that fits their values and helps them connect more deeply with you in the process. You may be surprised by how many of your clients are emotionally invested in nature. Now you can help them invest in it financially, too. Reach out to your Ethic relationship manager to learn more. 

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Sources and footnotes

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Contributors

David Sternlicht's entire career has been dedicated to addressing social and environmental challenges with investment capital. He has published research reports, launched and managed private investment funds, and advised startups and fund managers in the impact space. He has assembled a team of industry leaders in finance, science, technology, and storytelling to build out nature as an asset class for Ethic.