There’s an intriguing line in the new Credit Suisse and McKinsey & Co. report on the growing interest among institutional investors for financial products that protect ecosystems, drive sustainable commodity production or reduce carbon emissions.
Among mainstream investors, the report says, “The conservation impact of a product is generally of little importance.”
The report, “From Niche to Mainstream: The Building of an Institutional Asset Class,” forecasts a private investment opportunity for conservation finance products of $200 billion to $400 billion over the next five years. That’s a huge ramp from today’s annual private investment of $10 billion or so, though still well short of the estimated $300 billion in private investment needed each year to preserve healthy ecosystems and the clean air, fresh water, and species diversity they generate.
Looking for Edge
“In the current environment, investors are looking for an edge to drive excess returns — and many investors are increasingly seeing conservation impact investing as a way to achieve substantial environmental and social impact alongside market-rate financial returns,” Credit Suisse’s CEO, Tidjane Thiam, writes in the introduction to the report.
Last year’s flat market performance, combined with the new year’s stock swoon has only accelerated the search for low-risk, diversified assets. “For institutional investors, the risk-return profile of a product outweighs any other characteristics,” according to the report. “Low correlation with other asset classes helps ensure a diversification effect. The conservation impact of a product is generally of little importance.”
The report, a follow-on to Credit Suisse’s 2014 report, “Moving Beyond Donor Funding Toward an Investor-Driven Approach,” argues that conservation financing is ready to move beyond early-stage deals and novel concepts that require concessionary capital and operational support. Attracting large commitments of institutional capital requires mature business models that generate the stable revenues needed to attract mature debt and equity.
The researchers identified “a growing pipeline of in-the-money projects that are ready for scaling.” Sustainable agriculture, ecotourism and sustainable seafood, for example, all are outgrowing traditional segments in their markets. The market for FSC-certified forest products is expected to quadruple in the next five years to more than $200 billion.
The new report comes on the eve of the third annual conservation finance conference to be held Thursday at Credit Suisse’s New York offices. (For a recap of last year’s conference, see “Making Nature Pay: Bankers Work to Finance Conservation at Scale,” and watch the video.)
Replication and Aggregation
The report lays out two hypothetical models for aggregating such viable products into large-scale institutional investment vehicles. The first replicates established projects — say fisheries-management in marine-protected areas — and finances them across multiple geographies. The second bundles together multiple projects with varying risk-return profiles.
A hypothetical $200 million “Mature Conservation Markets Fund,” for example, could invest in 10 to 20 projects in the most mature conservation markets, such as sustainable forestry, sustainable agriculture, and ecotourism. The fund could generate financial returns of 10 to 15 percent from the sale of sustainably harvested timber or cocoa, as well as carbon credits and other “payments for ecosystem service.”
With premium prices for certified sustainable products, the report says, “These are just smart, economically attractive business opportunities waiting for mindful capital infusions and project developers.”
The second model builds on the growth of “green bonds” issued by the World Bank and other multilateral finance institutions as well as cities, states and corporations. Most of the bonds have funded energy and other infrastructure, but a small number are funding conservation-related projects as well.
The report proposes an “Ecosystem Green Bond” that would support multiple conservation-related activities within a large-scale ecosystem, such as a system of national parks or marine reserves. The sources of repayment would include cashflow-generating activities, such as user fees. To reduce risk, government or an international finance institution would guarantee full or partial repayment. Coupon payments would be consistent with the issuer’s credit rating.
“Iconic ecosystems, such as the Great Barrier Reef, require substantial financial resources for their long-term protection,” said Fabian Huwyler, Credit Suisse’s vice president for sustainability affairs and co-author of the report. “A green bond would be the natural solution to this particular funding challenge.”
Over time, the report suggests, conservation investments may become standard fixed-income, venture capital or alternative investments that easily fit in the portfolios of institutional, high-net-worth and even retail investors interested in large-scale, high-impact ecosystem conservation.
Credit Suisse has been a sponsor of ImpactAlpha.