Sustainable forestry now an asset class

This article first appeared in Wealth, The Edge Malaysia Weekly on April 22, 2024 – April 28, 2024

When investment company New Forests Advisory Pty Ltd was founded, sustainably sourced timber was not common and the focus on sustainability and environmental, social and governance factors was not as intense as it is today.

Founded by David Brand in Australia in 2005, the company provided institutional investors with exposure to investment returns from sustainable timber production and growing market demand for carbon, biodiversity and water strategies. Interest grew, but almost twenty years later the company’s investment strategy has become the center of global attention.

New Forests now has more than US$7 billion (RM33.44 billion) in assets under management, with more than 1.3 million hectares of sustainably managed forests and agricultural land. It has six offices in Australia, New Zealand, the US, Singapore and Kenya.

Part of the growing interest in New Forests’ assets comes from maturing carbon markets around the world. This has become an additional source of income for New Forests, in addition to income from the sale of sustainably grown timber, forest-related goods and services, land value appreciation and improved agricultural land management.

“If you look at our US operations, we were one of the largest issuers of carbon offsets in California [for its compliance market]. We were also the first issuer of an Australian carbon unit [for its compliance market]and we regularly issue carbon credits for the New Zealand Emissions Trading System (ETS),” said Geoffrey Seeto, managing director at New Forests Asia.

In short, compliance carbon markets are countries where the government sets a limit on the amount of greenhouse gas an entity can emit. To exceed that limit, the entity must purchase carbon credit allowances through the ETS.

For many Asian and emerging markets where carbon compliance markets do not exist, New Forests is considering generating carbon credits for voluntary carbon markets (VCM). VCMs allow entities to voluntarily offset their emissions by purchasing carbon credits instead of being forced to do so by the government.

VCMs’ carbon credits are generated from activities that reduce, remove or avoid carbon emissions. These can be nature-based solutions, such as reforestation, or technology-based solutions, such as renewable energy generation.

Many companies and countries have pledged to achieve net-zero emissions by 2050. As the deadline approaches, demand for carbon credits, especially from the VCM, is expected to increase.

“We already have projects underway across Asia through our second fund to drive positive climate outcomes and VCM units for our clients. This represents a new source of income, in addition to everything else we invest in [sustainably grown] wood,” says Seeto.

In March 2022, it announced the first close of its Tropical Asia Forest Fund 2 (TAFF2) with $120 million in capital commitments from investors including sovereign wealth funds, corporate, philanthropic and development finance sources. TAFF2 is expected to develop sustainable forest plantations in Southeast Asia (SEA), including Malaysia, for end markets such as timber, rubber and carbon. The first investment – ​​in a peatland conservation and restoration project in Thailand – was made in February 2024.

Demand for sustainably produced products, especially raw materials linked to deforestation, is another driving factor for the company’s investment strategy. This is further supported by the European Union’s Deforestation Regulation, which bans the import of raw materials such as timber, rubber and oil palms that have led to deforestation or forest degradation.

New Forests published its forestry investment outlook in December 2022, in which the company highlighted a number of positive factors for the asset class: rising demand for forest products such as timber from Asia; the use of forests for carbon storage and removal; and replacing crucial minerals with biomass-based materials.

“What we are seeing is a circular bioeconomy starting to develop around wood and wood products, climate change mitigation and other benefits. Forestry also provides biodiversity and community livelihoods, so this asset class can have a lot to offer. Because the markets are where they are, this can be done in a profitable way,” says Seeto.

Asia, especially China, has the fastest growing demand for wood products, including hardwood and softwood logs, wood chips and plywood. India is the world’s largest market for teak, and Malaysia and Vietnam have significant export-oriented furniture industries, according to New Forests’ regional profile for SEA.

Demand for wood products is positively correlated with gross domestic growth and economic activity, and has a low correlation with other asset classes, the company says.

Despite this growing demand, the development of commercial tree plantations for high-value uses in SEA has lagged behind other regions such as South America. The company expects SEA’s share of timber production to increase from 39% in 2013 to 62% of global plantation production in 2050.

“Forestry as an asset class has all the advantages of things like infrastructure and real estate. The returns are comparable. You’re looking at the type of returns for middle-aged to older teens (about 16% to 19%) [in emerging markets]. Forestry also has benefits such as diversification and long-term protection against inflation,” says Seeto.

“What the other asset classes don’t have is the optional carbon emissions and other things that we can offer in the future that could potentially be monetized. That is our ability to generate alpha on top of your core forestry returns.”

A big difference is that New Forests wants to meet the increasing demand for forestry products while ensuring they are sustainable.

“We have now introduced forest certification for all our assets, and we are one of the first institutions to do so. We also brought belongings and [set up] joint ventures with local parties to help them make that transition to a sustainable investment,” says Seeto.

For example, the company helps local forestry companies obtain Forest Stewardship Council (FSC) certification, which bans deforestation and requires sustainability practices, as well as respect for the rights of indigenous peoples, communities and workers.

“But it goes further than FSC. We also integrate the International Finance Corp Performance Standards and we have our own policies that include zero deforestation, sustainable supply chains, [protect] living on the land and so on,” he says.

Is a premium paid for sustainably produced wood? Western markets such as Europe and the US generally prefer FSC-certified wood products, Seeto notes.

However, the growing demand for wood comes from Asia. But he believes it is becoming increasingly difficult to exploit natural forests, and there is growing sustainability awareness in these markets. The companies that purchase these raw materials for production also want them to be grown sustainably.

Sustainably managed forest plantations can also deliver positive outcomes for biodiversity, ecosystem restoration and supporting rural livelihoods, allowing carbon credits to be generated and sold.

Seeto gives an example of an investment it has made in Asia using the mixed landscape approach. Part of the land is reserved for an industrial tree plantation that supplies wood.

“Other parts are nature conservation and biodiversity areas, which can generate carbon [credits]. Another part of the country could have a processing plant where we can provide local employment and capacity building,” he says.

‘In Laos we have a piece of land where we have community programs [the locals] we grow trees, we buy it and we build a processing plant that employs 200 people. That provides some community benefits and they can get to work. Our environmental and social manager [there] is a local [community member]. Generating impact is part of our investment thesis.”

But one thing to note is that projects that generate carbon credits have come under a lot of criticism for greenwashing, which has dampened interest in VCMs.

To this end, Seeto emphasizes that the company has a Carbon Credits Integrity Policy, which regulates how it creates carbon credits and which protocols – such as Verra’s Gold Standard and Verified Carbon Standard – it follows.

On the demand side, it will assess potential buyers of carbon credits on whether they take credible climate action before finalizing the sale.

“We use a risk-based approach. Ideally, the carbon we sell to buyers will be used for their own purposes; they would have a credible climate action policy that includes the hierarchy of climate mitigation,” he says.

“We have a zero-tolerance policy for any type of reputational risk. You will see that we ensure that we do not do any greenwashing or deforestation. [For instance] In our first fund we had a timber plantation in Sabah and we applied those principles. It is an FSC-approved timber plantation.”

Save by subscribing to us for your print and/or digital copy.

P/S: The Edge is also available on Apple’s App Store And Android’s Google Play.