Making Money from Trees – podcast interview with Sarah Clawson

Transcript

Maha Khan Phillips: Hello. I’m Maha Khan Phillips, editor of Professional Investor at CFA UK.

Welcome to the latest episode of the CFA UK: In Conversation podcast. This is a show for investment professionals focusing on a whole manner of topics and interesting insights that are affecting the profession today. In this episode, I’m delighted to be joined by Sarah Clawson, who is Global Head of Investor Relations at New Forests, the global investment manager of nature-based real assets and natural capital strategies.

Sarah is responsible for client relations and capital raising at the firm which includes providing strategic direction and coordination for fundraising and client services functions across investment strategies. She has over 20 years of experience in marketing, client relations and communications in the sustainable and responsible investment sector worldwide. Today, Sarah and I are going to be talking about how forestry has evolved as an asset class, some of its unique characteristics and some key considerations for anyone who is interested in allocating to the space.

Welcome Sarah, thank you so much for joining us.

Sarah Clawson: Hello Maha, thank you so much for having me and introducing this important topic on your podcast.

Maha Khan Phillips: It’s really interesting and I’m fascinated to see how this sector has grown. I wanted to start by asking you how forestry has evolved as an institutional asset class. Some of the stats are quite incredible. So, I saw a stat that said, that the sector was approximately worth 10 billion to 15 billion dollars in assets in the early 2000s and now we have stats that expected to one trillion dollars by 2050. That’s quite a substantial growth figure.

Sarah Clawson: Those figures are quite impressive, and we do think that the total amount of global institutional investment in forestry is around that 100-billion-dollar mark and we would say that this might grow at about three to five billion per year and we expect that to accelerate due to the expansion of climate finance and biodiversity in particular, rising really quickly. But to your question about how forestry has evolved, it’s consistently been evolving as an asset class and there are a few key things of this evolution, one of them is a real shift of wood supply. Where that used to come from was from intensive clearing of natural forests and that’s now turned to coming from more sustainable harvesting of timber plantations instead and moving away from the natural forests.

There’s also been a big rise of Asian timber and wood fibre demand so that’s been absolutely driving the evolution of the asset class. There’s also been a big rise in sustainability, climate mitigation opportunities. Lastly, it’s the rising importance of investment capital in the evolution of forestry and land use because if you think about it natural climate solutions are the most cost-effective evolutionary path to mitigating climate change and according to the World Resources Institute they can provide up to 30% of the emissions reductions needed by 2030 which is a pretty important sector.

Maha Khan Phillips: It’s really interesting and important. So, that’s actually what I wanted to ask you about. So how much of this is being driven by institutional investor appetite and how much of that interest is coming from the sustainability considerations there are facing considering versus the unique attributes and market fundamentals of forestry?

Sarah Clawson: Over the 10 years that I’ve been with New Forests I’ve seen a steady increase in the interest of forestry and sustainable land use from institutional investors. For many investors, it’s as you say, from the market fundamentals which really drive their interest. There’s three key ones in that – it’s a low correlation with other asset classes, it’s also a hedge against inflation and there’s a low volatility of returns. There’s an inherent optionality in timber returns and that’s up to good managers to be able to seek that out, but increasingly investors are coming to New Forests for sustainability reasons and track record in our approach to sustainability. My background is in responsible investment, I spent several years in Europe in the early 2000s in that industry and have seen it shift from what we call SRI to ESG to SDGs to impact, to net zero, to carbon and forestry. And sustainable land use investments sit squarely in all of those themes, so I think it is a combination of the two and forestry is really well placed to generate solutions for climate change, foster rural livelihoods and economies and contribute to a growing range of renewable products that are made from wood fibre.

Maha Khan Phillips: It’s interesting, I mean I remember the early 2000s in London in the concept of SRI emerging and so much backlash as to why would we sacrifice returns for this and with forestry, I mean well the whole narrative, the whole conversation has, of course, shifted and we’re looking at their diversification and long-term returns and the importance of sustainability but there is also as you say there are key attributes to forestry that make it as an investment very compelling.

Sarah Clawson: Exactly and sustainability is front and centre for that.

Maha Khan Phillips: Can you talk about some of those market characteristics and drivers that are shaping the asset class.

Sarah Clawson: Sure, my pleasure. Importantly when we look at forestry and managers investing in this space, following an acquisition or an entry evaluation for forestry asset, the traditional rule is that the two most important factors in forestry returns are going to be: 1, how fast the trees can grow and 2, what is the value of the timber. The timber value can also be affected by market cycles, currency, operating in supply chain costs and some investors have a view that the manager can’t control those things and money is largely being made by buying well and selling well. But there’s an increasing emphasis on investment managers that can execute what we call active management strategies to reduce risk and generate value for investors. But the markets for forest products are really complex, there’s many supply chains for roundwood, for wood fibre, for different wood products and energy products, so both the supply and the demand are going to be dispersed around the world and these markets have various cycles that are driven by economic conditions, by housing demand, technological changes and also public policy settings. Due to a lot of these multiple variables it’s difficult to develop an overall econometric model that can accurately predict forest market prices globally so we would say investors are well advised to create diversified portfolios of forestry and land assets to reduce excessive volatility in their returns.

Maha Khan Phillips: Wow, that’s a lot of things to contend with. That’s interesting because it brings me to the question about challenges and barriers to investing, I mean I can’t sort of just like going online and buying in equity, this is a complex asset class. So, if I was an investor what am I thinking of if I’m looking at this asset class for the first time.

Sarah Clawson: Thinking of diversification, thinking of education around forestry and the different aspects that includes because it’s not going to be just investing in a plantation, it’s going to be considering the aspects around that both the production and the conservation of the assets. It is going to include areas around water supply, biodiversity, carbon, other land uses, optimisation of those land uses, what is the highest and best use of that land. One of the largest barriers is the sustainable land use transition and this is partly about getting rural farmers engaged in the process of change around land use and really convincing them about the benefits of natural climate solutions and this is happening on a worldwide scale. Additionally, the forestry asset class is getting more and more complex and the level of analytical horsepower that’s needed to drive innovation across all of these aspects is huge. They’re going to have value propositions that might compete with each other, and you really need good managers to be able to sort that out.

Maha Khan Phillips: So where is that complexity coming from? Just from all the things you’ve already highlighted or is there additional complexities?

Sarah Clawson: I think it’s the complexity around what you do with that land, having access to land is the key and then being able to look at that piece of land and decide is this best suited for agriculture? Is this best suited for forestry? Will I be able to include a wind farm on my plantation? Are there carbon aspects that are going to help drive returns? And are there also biodiversity credits that may be an evolution in the future when we think about new financial instruments that are going to also help drive demand. So, it’s a complexity that I think is worthwhile to explore and I think good managers are doing that today.

Maha Khan Phillips: Wow, that’s a significant ecosystem in more ways than one. It’s quite challenging.

Sarah Clawson: Absolutely.

Maha Khan Phillips: And can we talk about the way the rise in forestry has linked to the monetisation of carbon?

Sarah Clawson: Yes, they’re inherently linked as forests offer such large carbon sinks and opportunities for investors to commit to strategies with a really strong climate mitigation angle. Because trees store carbon, this is proven, it’s a very low-cost technology for removing greenhouse gas emissions from the atmosphere and as economies transition to a low carbon economy, sustainable wood is a crucial material to replace carbon intensive steel and concrete in building construction. However, not all investors have the same view of how they would like to use or monetise or benefit from carbon credits. Many may want to purchase them to use internally to offset other parts of their portfolio, while others are very happy to have the asset manager manage the carbon credit sales and provide additional uplift in returns to the investors. We provide access to regulated and voluntary carbon markets across all our strategies but it’s another complex area that is inviting a lot of different conversations with institutional investors.

Maha Khan Phillips: And is there a reason why you would, or an investor would choose to have one approach over another?

Sarah Clawson: I think it depends on their internal policies and how advanced they are around thinking about how they’re going to be achieving net zero. There are many well-regarded organisations out there that are helping asset managers and asset owners in their transition to net zero. We’ve had some corporates approach us for access to carbon as well through forestry investments which is a new, interesting type of investor for us. But largely the pension funds we’re speaking to haven’t yet gotten to the point of necessarily wanting to purchase carbon credits for their own use internally they’re definitely thinking about it, but there’s a real mix of approaches here across the different investors.

Maha Khan Phillips: Interesting. Thank you. I also wanted to ask you about, I mean, we’re in facing a climate catastrophe. We are seeing forests disappearing all the time. What role can the investment industry play here in terms of impact? For example, you have your African Forestry Impact Program, I feel like this is an area where investors can really have an impact if they wanted to.

Sarah Clawson: Absolutely. In Africa, as you mentioned, there’s a very large aggregation play in forestry on that continent and the challenge with all things related to impact and conservation is perpetuating that over decades and not just focusing on it during the life of a 10-year fund for example. One way we’re addressing that is our mandate in Africa is to deploy capital across the forest landscapes in sub-Saharan Africa through an evergreen vehicle. We’ve created an open-ended vehicle with long-term perspective that means that we can integrate conservation and commercial investments over time. We’ve also created an impact incentive for us where 20% of our carried interest is subject to the achievement of very specific impact targets. This is a way that we think really sets us up to do what we say we’re going to do and we have key performance indicators that are based on that. It’s also the long-term nature of this evergreen vehicle that I think can really play a huge role in the industry across Africa and across many different regions.

Maha Khan Phillips: Thank you. If we were having this conversation in a decade’s time, I know it’s a little, it’s as you said a complex space to sort of make you large predictions, but given the massive growth we’re seeing, what is going to be fuelling that evolution? Are we going to see technological change? What is the, yeah, where is change coming from? What is it going to look like? How is this sector going to evolve? Say in a decade or beyond.

Sarah Clawson: Yes, a big looking into the future question. I think there’s going to be new structures to adapt to what we were talking about earlier around how investors coming into this. Is it around the key fundamentals of the asset class or sustainability? We set up a structure around blended finance so that has two classes of investors, those with more commercial return perspectives and those more impact return perspectives, which allows us to blend those two types of investors into one vehicle. I think that type of innovation and structures in finance are going to be key in order to get more and more capital into this industry of sustainable land use.

We talked about the complexities of all the different aspects that go into forestry, and I think the rise of analytics is going to be really important here. We’re wrestling with the transition to sustainability and competition among various land uses will really intensify so it’s timber, agricultural, commodities, carbon, biodiversity credits, water rights, wind farms and having the ability to analyse that and analyse the optionality in land use is really going to be key to the success of this sector. Often competing in the landscape, they have dynamic uncorrelated market price signals, so you really have to be able to use technology to understand what is the best use of that land. It’s creating different heat maps, for example that might show areas of farms with lower net primary productivity that could be good candidates for reforestation or heat maps of unrealised climate mitigation potential in certain areas of forests and so using the technology and innovation and analysing that is going to be key to the future of the success in the sector.

Maha Khan Phillips: So big data?

Sarah Clawson: Yes, that’s part of it.

Maha Khan Phillips: Thank you so much Sarah, this has been a really interesting and useful conversation and I’m really excited to see how the sector evolves and maybe we’ll be back having a conversation in a few years’ time.