BNP AM

The sustainable investor for a changing world

Are forests the next big asset class for sustainability? Robert-Alexandre Poujade argues that nature-based solutions are an underexposed area for investors to support the net-zero transition.

Reaching the aims of the Paris Agreement and limiting the global rise in temperatures to well below 2C will require cutting CO2 emissions to net zero by 2050.

Net zero has become a key focus of organisations, governments and businesses worldwide. Countries are strengthening their climate pledges in advance of the COP27 meeting in Egypt later this year, and governments are designing regulations to help achieve these pledges – for example, by enshrining net-zero goals in law.

Cutting emissions requires a major focus and effort across the economy. The Intergovernmental Panel on Climate Change says we must invest in activities that remove CO2 from the atmosphere if we are to meet the Paris aims. However, it is also important to stress that natural carbon cycles and nature-based solutions will be a key part of the response to climate change.

Forestry – Part of the solution

Forests are central to the global carbon cycle, acting as the Earth’s lungs by removing and releasing CO2 in tune with the waxing and waning of the seasons.

Deforestation has interrupted this cycle by releasing CO2 into the atmosphere, while there are no trees to store the CO2 again through regeneration. Protecting mature forests and engaging in reforestation can help to maintain stored carbon and/or increase nature’s capacity to draw it back down.

Recent research has indicated that between 2001 and 2019, global forests acted as a net carbon sink through natural growth, removing around 7.6 gigatonnes of CO2 per year from the atmosphere.

Clearly, this is a crucially important ecosystem service. Beyond the lens of net zero, forests provide other benefits such as biodiversity preservation and water management.

Thinking along these lines, and in a world where CO2 is increasingly valued, the dynamics of forests as an asset class are changing. Traditionally, forestry was viewed as a source of predictable cash flows from products such as wood, pulp and paper and has been used to hedge against inflation.

Now, forests have become a key means of addressing carbon footprints. There are other reasons to rethink forest assets. If managed sustainably, forests can provide bio-based products that reduce the reliance on emissions-intensive equivalents – for example, cross-laminated timber in buildings rather than steel, concrete or plastic alternatives.

Furthermore, there is the generation of carbon offset credits. Owners of forests can recognise and capitalise on their annual carbon storage through these carbon credits.

Investors in forests therefore can take credit for any carbon offsets generated by their investments, reducing residual emissions in their portfolios.

Surplus credits generated could be sold to third parties. In such a case, only the buyers of the credits could then recognise the potential offset.

 A market in carbon offsets from forests could reach USD 800 billion by 2050, driven by investors and corporates interested in offsetting unavoidable emissions. [1] BloombergNEF predicts offset prices could reach up to USD 215 per ton in 2030 from an average of around USD 2.50 today.

It is important, however, that forest carbon credits are generated carefully and verifiably according to recognised standards to ensure a real-world CO2 reduction. This is needed to avoid poor quality projects that result in ‘junk’ credits entering into circulation. This problem has plagued offset markets. Initiatives that bolster trust such as the Taskforce on Scaling Voluntary Carbon Markets should help.

Wildfires – like those seen recently in France and across Europe – represent another threat to carbon offsets and the permanence of stored CO2, and will need to be taken into account when designing effective offset projects.

A strategic asset allocation

It is becoming clear that achieving net-zero only through the reduction of CO2 emissions by large corporates is unlikely to suffice. Unavoidable emissions will remain despite best efforts given the existing technological constraints. Therefore, significant investment in reforestation, afforestation and nature-based solutions will be critical to achieving net zero.

We believe forestry represents a strategic asset class to which institutional investors are underexposed. Currently, investors have around USD 100 billion dedicated to forestry compared to around USD 4 trillion in private equity.

In our view, forests are attractive thanks to portfolio diversification. They offer the prospect of positive returns through carbon price increases and through rising demand for wood from sustainable sources.  Recent rounds of timber inflation underscore the financial value of this important commodity. [2] Forests also support carbon reduction and biodiversity.

To boost the appeal of forests as an investment, one will need to consider the opportunity and risks from traditional forest product sales as well as new ones involving carbon offsets. This is particularly the case in emerging markets as 71% of the unrealised CO2 sequestration potential exists in tropical ecosystems.

It is also important to consider how policy related to these assets will change in the future. Similar to a broader Inevitable Policy Response (IPR), there could be opportunities for investors in a significant inevitable forest finance response. Net-zero commitments together with the relative affordability and scalability of nature-based climate solutions can help reverse the current deforestation trend.

IPR’s Forecast Policy Scenario sees net forest cover loss cease by 2030, and 350 million hectares of afforestation and reforestation occur by 2050. Consideration will need to be given not only to the availability of land for reforestation but also to the impact on food production and biodiversity hotspots.

We believe there is significant unrealised potential and an opportunity for investors when it comes to forestry – both to diversify portfolios and to support carbon reduction efforts. 

References  

[1] An investor guide to negative emission technologies and the importance of land use (unpri.org)

[2] https://markets.businessinsider.com/news/commodities/inflation-hedge-asset-timber-wood-lumber-hike-rates-fed-cpi-2022-2 

Disclaimer

Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience. Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

Related insights

To reach net zero, overhaul the built environment
US climate spending – How does it reduce inflation?
BNPPAM

In the U.S., this material is for Institutional use only – not for public distribution. This material is provided for educational purposes only and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be and should not be interpreted as recommendations. Reliance upon information in this material is at the sole risk and discretion of the reader. The material was prepared without regard to specific objectives, financial situation or needs of any investor.

These documents and video clips may also include information obtained from affiliated investment management companies within BNP Paribas Asset Management, the brand name of the BNP Paribas group’s asset management services. The documents and video clips are produced for informational purposes only and do not constitute: 1. an offer to buy nor a solicitation to sell, nor shall they form the basis of or be relied upon in connection with any contract or commitment whatsoever or 2. investment advice. Any opinions included in these documents and video clips constitute the judgment of the author/ presenter at the time specified and may be subject to change without notice.

This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, and estimates of yields or returns. No representation is made that any performance presented will be achieved by any funds, or that every assumption made in achieving, calculating or presenting either the forward-looking information or any historical performance information herein has been considered or stated in preparing this material. Any changes to assumptions that may have been made in preparing this material could have a material impact on the investment returns that are presented herein. Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.

The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BNP PARIBAS ASSET MANAGEMENT USA, Inc. to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy.

The information provided here is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation. Investment involves risk including possible loss of principal. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are often heightened for investments in emerging/developing markets or smaller capital markets.

FOR INSTITUTIONAL AND FINANCIAL PROFESSIONAL INVESTOR USE ONLY. THIS MATERIAL IS NOT TO BE REPRODUCED OR DISTRIBUTED TO PERSONS OTHER THAN THE RECIPIENT.

BNP PARIBAS ASSET MANAGEMENT USA, Inc. is registered with the U.S. Securities and Exchange Commission as an investment adviser under the Investment Advisers Act of 1940, as amended. BNP PARIBAS ASSET MANAGEMENT USA, Inc. is a registered trademark of BNP Paribas or its subsidiaries in the United States and elsewhere. All other trademarks are those of their respective owners. © 2022 BNP PARIBAS ASSET MANAGEMENT USA, Inc., All rights reserved.

BNP PARIBAS ASSET MANAGEMENT is the global brand name of the BNP Paribas group’s asset management services. © 2022 BNP PARIBAS ASSET MANAGEMENT USA, Inc., All rights reserved.