Following the news earlier this week that Stafford Capital’s carbon offset fund had reached a first close, New Private Markets checked in with Sarita Gosrani, director of ESG and responsible investment at investment consultant bfinance, to get her perspective on how the market is seeing natural capital. Here’s what she said:
What is the general view from LPs regarding natural capital?
We have seen an uptick in activity around timberland and agriculture mandates over the last 6 months. This has been fairly varied in terms of both investors’ risk profile (core or value-add) and objectives (whether purely financial or carbon offset driven, or both). There is however an education gap that needs to be bridged to move more investors to implementing these strategies and seeing the potential benefits of doing so particularly from a positive impact perspective.
Are you aware of many carbon offset funds (ie funds which have carbon credits revenue built into its return profile)? Why might local authority pension funds be keen to invest?
We now see more than 20 funds with this return profile, more than half of which are timber or forestry driven.
Local authorities have the long-time horizon needed for this type of investment which also provides diversification. Secondly as investors make net-zero commitments these strategies can play a role in providing offsets which can be used in later years. This is facing some controversy at the moment with the net-zero asset owner alliance potentially moving carbon credits off the tool kit.
What kind of returns are these funds promising their LPs? Are such returns realistic?
Target net IRR or total return among these funds ranges from 5-14 percent dependent on geography and the type of carbon project targeted. The returns come from commercial end life of the strategy as well as carbon credits.
There is a level of uncertainty as with anything on the returns derived from offsets. Projected returns rely on a manager’s own estimation of carbon pricing which will need to be crystallised in the future were we have no certainty.
In fact, we often see managers base the target return solely on the financial returns projected but providing some scenario analysis on total returns based on estimated carbon pricing.
There are new strategies in the market (especially in the UK and broader Europe) which target natural capital investments which do not deliver a consistent financial revenue stream, including those projects which are focused exclusively on conservation/restoration activities of agriculture land, woodlands and coastal mangroves. For these strategies, the entire financial return will be on realising these credits, or in holding the equivalents to offset their own portfolio. We see a mixture of fund approaches on giving LPs the optionality here, or in selling the credits to realise returns at the end of the fund life.
We will likely see new entrants in the natural capital market, dependent on the carbon pricing and the consistency of these prices. As an example, agriculture managers are behind the timberland market in terms of quantifying carbon credits deliverable and marketing the target the offset potential of investments, but many have suggested they will enter the market in the US based on carbon pricing reaching a certain threshold.
Do you think we will see more managers incorporating voluntary carbon credits into their products?
There will need to be a solid investment case for this. There’s an aspect of speculation. In any case it is more important to see how managers are engaging with their underlying companies to reduce emissions rather than buy offsets and continue with BAU.