Funding the wood for the trees: UK investors turn to timberland to decarbonise their portfolios
Aysha Gilmore explores how UK asset owners are investing in carbon offsets such as timberland to help them transition to net zero
As the threat of climate change becomes more evident, many asset owners are putting a greater emphasis on decarbonising their portfolios, with some pension funds looking to invest in natural capital to achieve this goal.
Investment in timberland plays a growing role for the UK's £359bn Local Government Pension Scheme (LGPS), with both £9.6bn Essex and £5.7bn Leicestershire pension funds being prime examples.
Currently, Essex Pension Fund has invested £368m into timberland and plans to commit a further £136m, while Leicestershire has £194m invested in the asset class.
According to Essex, its investment into timberland offers the fund long-term, stable and inflation-linked returns, whilst also helping it achieve net zero by 2050.
Susan Barker, chairman of Essex Pension Fund’s Strategy Board and Investment Committee, explains that as part of the fund’s commitment to net zero, it decided to allocate £1bn to impact investing solutions, with one of these solutions being timberland.
“The timberland sector presents an opportunity to invest in an asset class that has a negative carbon footprint – in other words, it sequesters more CO2 than is emitted each year. This is a characteristic almost unique to timberland and one which allows it to play a significant role in
reducing the aggregate emissions profile of our broader portfolio,” she says.
Both Leicestershire and Essex invested in timberland through various funds managed by Stafford Capital Partners, with one being Stafford Capital Carbon Offset Opportunity Fund, which has aggregate commitments of $242m and a fundraising target of $1bn. The fund generates a supply of verified carbon credits each equivalent to one tonne of CO2.
Marek Guizot, principal at Stafford Timberland, says: “The logic behind a carbon offset and the value that you can sell it for is to really to attract capital into projects and activities that will either reduce emissions or remove emissions from the atmosphere.
“Specifically, projects that would not have occurred without access to such funding.”
Barker adds: “By securing a supply of carbon offsets, we [Essex Pension Fund] also have greater flexibility on how we might choose to deal with those residuals, harder to abate emissions across our portfolio as we transition to net zero.”
A spokesperson from Leicestershire Pension Fund, which aims to achieve net zero by 2050, adds that the fund’s commitment to timberland “presented an attractive investment opportunity as returns are generated by the growth of sustainable timber materials and sales of verified carbon offsets”.
“There is an added benefit of supporting the fund’s net zero ambitions through the planting of new forests (afforestation) and reforestation which comprise of 80% of the trees projected to be planted through this investment,” the spokesperson continues.
According to Barker, at the start of 2023, Essex Pension Fund’s timberland portfolio extended to 88,000 hectares of land and sequestered over 2.7m total CO2 emissions annually across the area. In addition, the fund’s investments into timberland have provided an aggregate net return of 7.3% in pounds sterling as of quarter two of 2023.
PPF's £1bn investment
Outside of the LGPS, UK asset owners such as the £38bn Pension Protection Fund (PPF) are also investing in timberland, with the fund committing over £1bn to forestry and continuing to look for other opportunities within the asset class.
PPF explains that its investment in forestry is part of its wider sustainability strategy, which includes targets such as reaching net zero in its operational supply chain and travel emissions by 2035 or sooner.
A spokesperson said: “Forestry is a key element of our responsible investment strategy as it can help to mitigate CO2 emissions by storing carbon. It’s one of the few viable nature-based investment solutions in the journey towards a net-zero carbon world. Well-managed forests can also increase biodiversity and are more resilient to climate change. Forestry investments are really a win-win. In addition to the climate benefits, they continue to deliver strong returns for the benefit of our members, even in this high inflation environment.”
However, Linda McAleer, senior investment consultant, investment defined benefit at Hymans Robertson, explains that despite timberland as an asset class providing a steady income stream, it is ultimately a growth asset and a “very” illiquid investment.
She highlights that income has historically been the largest return driver for timberland investments and the price paid will influence the yield to investors.
“Limited land supply and growing demand from investors seeking investment in natural capital to achieve environmental, social and governance benefits has resulted in some significant price increases for attractive investments.
“The extent to which demand and price increases continue will have to be considered carefully as this could potentially alter timberland’s risk and return profile over the coming years,” McAleer adds.
Another financial risk in relation to the price of timber is that the value of the investment will decrease if timber prices fall. In addition, if investment is made into timberland to generate carbon offsets, like Essex and Leicestershire have done, the changing price of offsets adds risk to the investment if the plan is to sell the offsets.
McAleer says: “Short-term fluctuations in carbon pricing and carbon pricing not evolving in line with expectations is a risk that investors need to be cognisant of. This risk can be mitigated by having a flexible strategy when looking to sell carbon offsets.”
Unlike other assets, timberland investments also face the risk of natural disasters, such as fire, wind and disease.
“The best risk mitigation tool is diversification. By diversifying exposure across different geographies, species and age, investors can spread their dependence on specific end markets and exposure to political risks and physical risks,” McAleer adds.
This feature was first published in the Q4 edition of the Private Markets Profile, which you can read here.