Columnists

Why pension funds should try out forestry investment

forest

Commercial forestry has the potential to bridge the wood deficit in the country and increase forest cover. FILE PHOTO | NMG

Summary

  • In Kenya, the Retirement Benefits Authority’s investment policy guidelines allow for broad asset allocation or diversification.
  • The advantages of investing in forests are multiple. Forestry investment can offer financial as well as environmental, social, and governance (ESG) benefits.

According to the Organisation for Economic Co-operation and Development (OECD), an estimated $47 trillion is invested by the world's pension funds globally. This is approximately 50 percent of all the money invested in the global financial system.

This means that pension funds have enormous leverage within the global economy, and the choices made on where they are invested have a significant impact on many aspects of life, including climate change.

But there has been limited participation by retirement funds in inclusive green investments to date, even though there are no macro-regulatory barriers hindering their participation.

In Kenya, for example, the Retirement Benefits Authority’s investment policy guidelines allow for broad asset allocation or diversification, including investment in alternative asset classes such as private equity, asset-backed securities, real estate investment trusts, collective investment schemes, and green bonds.

These investments are already incentivized through capital market guidelines and tax breaks.

Attractive returns

The advantages of investing in forests are multiple. Forestry investment can offer financial as well as environmental, social, and governance (ESG) benefits. Investments in sustainably managed forests can support rural livelihoods, produce multiple environmental benefits, and create attractive risk-adjusted returns for investors.

Most forests have relatively long production periods, which can provide for investments of long financial durations. As a result, forestry investments can be attractive to pension plans, which have long-dated liabilities and social and environmental objectives, along with their financial obligations.

Despite these generally favourable characteristics, pension schemes’ investment in forestry has mostly been limited to OECD countries, including the United States, Canada, Sweden, Germany, Denmark, Finland, Germany, France, Spain, Australia, New Zealand, Korea, the UK, Brazil, and Uruguay.

According to a 2019 study by TimberLink, total institutional investment in forestry investments totalled $48 billion, of which public pension plans held $23 billion and sovereign wealth funds another $3 billion.

With pension funds increasingly looking at the impact of their investments, as well as the financial returns needed to pay out pensions, the time is right to take another look at forestry as an asset class.

Barriers to entry can be addressed through capacity-building and partnerships between experienced international pension funds and their domestic counterparts in emerging markets.

Based on sufficiently supportive country and market enabling conditions, forest restoration pledges, and the size of domestic pension assets, there are most certainly several countries offering potential investment opportunities for international and domestic investors to explore.

Initially, over 90 percent of the forest investments by institutions were in the US. However, as this market has matured, increased competition for assets and a decline in returns have occurred.

As a consequence, investors have increasingly sought new investment opportunities in non-US markets, especially Latin America, Australia, and New Zealand, as well as modest interest in Asia, Africa, and Europe.

According to the Kenya Forestry Research Institute, forestry contributes to 3.6 percent of Kenya's GDP, excluding charcoal and direct subsistence uses. The research indicates that forest and tree resources support the country's most productive sectors, particularly agriculture, fisheries, livestock, energy, wildlife, water, tourism and trade.

Wood deficit

However, as the country's population grows, the future of wood has been grim with increasing demand for various wood products against a diminishing resource base. Wood deficit in Kenya stands at 10.3 million cubic metres.

Kenya can only meet 70 percent of its demand through sustainable supply meaning, small and medium-sized enterprises are forced to operate below capacity. Meeting this deficit has led to unsustainable extraction of wood from natural forests and informal imports.

In this regard, commercial forestry has the potential to bridge the wood deficit in the country and increase forest cover. Success lies in extending commercial forestry to private, community lands and arid and semi-arid lands that constitute over 80 percent of the total land in Kenya.

Investing in forests provides a significant opportunity for pension funds seeking to address climate change, protect nature and create jobs, in a single intervention.

Additionally, forests have a net carbon absorption of around 7.6 billion tonnes of carbon per year. Responsible forest conservation and restoration can be a cost-effective solution to help remove atmospheric carbon and build climate resilience.

As forests are also home to 80 percent of the world’s terrestrial biodiversity, they are an essential landscape in our efforts to preserve habitats and protect natural heritage.

In addition, the sustainable management of forests and tree farming could create $230 billion in business opportunities and 16 million jobs worldwide by 2030.

Furthermore, investments in forestry are an effective hedge against inflation. Returns from the asset class have a positive correlation with inflation, largely due to biological growth and how timber prices and land values track prices in the overall economy.

By investing direct equity in forest conservation and restoration projects, pension funds in developed markets generate carbon credits, which are bought and sold through regulatory compliance markets or voluntary carbon markets.

As the market architecture for the carbon markets is strengthened and stronger standards are introduced to ensure demand and supply integrity, carbon finance can pay for conservation and forest protection.

New revenue stream

Many investors in the carbon and timberland space are predicting that the price of carbon will soon stabilise, creating a new revenue stream to fund forest conservation and restoration projects globally, while also delivering market returns on these investments.

East Africa, and indeed most of sub-Saharan Africa, offers great potential for forest-sector development based on greenfield plantations.

Advantages include considerable land not currently used for food production is apparently available; the high innate productivity of this land; population and economic growth driving strong growth in domestic demand; much of Africa’s energy needs are met by wood and many countries import considerable amounts of wood products.

Between 1995 and 2008 three privately funded entities gained assess to 355,000 ha of nominally vacant, productive and plantable land in Mozambique with the intention of establishing high-yield plantations of pines and eucalypts both for domestic consumption and export.

The entities include Green Resources, a Norwegian company headquartered in Tanzania and first financed primarily by Norwegian investors; Global Solidarity Forestry Fund, an investment entity started by the Swedish Church, Diocese of Vasteras.

Other investors included the large Dutch pension plan APG, the Harvard University endowment, and a Danish pension plan advised by the International Woodland Group, a well-experienced Danish timberland investment advisor.

Teak grower

Closer home, the Maris Group, an investment holding company, diversified across five key economic sectors in nine countries, has invested in forestry in South Sudan. It is the country’s only sustainable forestry plantation and is Africa’s second-largest teak grower with 2,000 hectares.

In 2016, the Maris Group also set up Equatorial Teak Products, Kenya’s leading supplier and manufacturer of high-quality, finely crafted teak products. These include flooring, decking, doors and windows, outdoor furniture and treated teak.

With Kenya’s private sector commitment to climate action, commercial forestry presents an ideal space to take action. Helping stakeholders catalyse the growth of the Kenyan commercial forestry sector could have a significant impact. It would create jobs, raise incomes and increase tax revenue while achieving the climate action objectives.

Kili is the CEO of the CPF Group, which offers retirement benefits administration, insurance, ICT and property services