Natural Capital: A Growing Conversation in Institutional Investment

More institutional investors are considering investments in natural capital, because of their lowly correlated returns, positive environmental outcomes and long-term value through operational improvements. But benchmarking and integrating natural capital into an existing investment framework can be a challenge, Frontier Advisors says

Natural capital is a term that will increasingly surface in conversations among asset owners and their asset allocation consultants. It is not a new asset class, but rather a reframing of existing land-based investments – such as forestry, agriculture, and water rights – under a unified theme.

Dan Cave, Senior Consultant at Frontier Advisors, has a deep interest in natural resources and describes these investments as ‘natural real assets’, an umbrella category that captures timber, agriculture, and water.

While each sector has its nuances, he says their return drivers and required skill sets are sufficiently similar for them to be considered together.

Frontier Advisors believes natural real assets offer diversification, inflation protection, productivity-driven growth and exposure to fundamental demand trends – features often under-represented in broader institutional portfolios.

“It makes sense to bring timber and agriculture together,” Cave explains. “A small number of Australian funds already invest in forestry, but these are often classified under infrastructure rather than treated as part of a cohesive natural capital strategy.”

Canadian Pension Funds Lead the Way in Natural Capital

Although the concept is still in its infancy among Australian super funds, large global institutions have already embraced natural capital as a blended allocation.

Canadian pension funds have been particularly active in this space, with major investors such as Public Sector Pension Investment, Ontario Teachers’ Pension Plan, and Alberta Investment Management Corporation committing significant capital to Australian farmland and water rights.

Their strategy is clear: to access lowly correlated returns, deliver positive environmental outcomes and unlock long-term value through operational improvements.

This same trend has extended to timberland, where investors see the dual benefits of harvesting both wood and carbon credits. These investments come under what these Canadian investors call ‘natural resources’.

Within Australia, only a handful of super funds and the Clean Energy Finance Corporation have direct exposure to agriculture or timber – very occasionally to both – and the overall allocation remains modest. Aware Super has agriculture and water, while the Future Fund and UniSuper own timberland.

Cave notes that many funds struggle to justify the commitment of time and resources to a sector they are less familiar with.

“There’s no career risk in saying no,” he says with a smile. But benchmarking and integrating natural capital into an existing investment framework can be difficult, he adds.

Facing Structural Challenges: Where Does Natural Capital Fit?

Super funds also face structural allocation challenges. Should agriculture, for instance, be classified under property as a land-leasing strategy? Or should it sit within private equity or alternatives if the approach is higher risk and operationally intensive? This ambiguity can slow decision-making.

Cave suggests that a thoughtful, diversified, manager-led approach is the most practical entry point for large investors. Smaller and mid-sized funds, meanwhile, may have an advantage in agility and specialist knowledge, allowing them to take a phased “crawl, walk, run” approach by starting with diversified mandates.

Cave outlines potential return ranges:

• Timberland: 5–8 per cent core returns over the long term, with additional upside from carbon credits.
• Agriculture: 6–8 per cent for land leasing models, 7–9 per cent for own-and-operate strategies, with further gains possible from dairy, livestock, permanent crops and value add activities.
• Water rights: volatile, but potentially high returning, often best suited as a smaller, satellite exposure within a portfolio.

Specialist managers such as Riparian and Kilter Rural have built expertise in agriculture and water markets. However, Cave cautions that the sector is inherently volatile, with water prices and farm yields heavily influenced by droughts, floods, and broader climate patterns.

“Many agriculture investors hold water rights as part of their strategy, creating value through more efficient water management. But weather extremes mean volatility is inevitable,” he says.

ESG Considerations in Natural Capital

Beyond financial returns, global investors are increasingly allocating to natural capital as part of their ESG and net zero strategies. Timber and agriculture investments can provide measurable environmental benefits, such as carbon sequestration and biodiversity preservation, that help institutions meet their sustainability commitments.

Even so, Cave stresses that the fundamentals must stack up:

“For most investors, risk-adjusted returns, should be the starting point. But those with an explicit impact mandate may prioritise different outcomes. In practice, you can design the return profile, much like with infrastructure, by layering exposures and diversifying across strategies. From there, hiring experienced managers is critical.”

Manager selection carries particular weight in natural capital, where operational expertise and local knowledge can make or break returns. Cave warns that early-stage projects – such as forestry plantations where trees have not yet been established – carry additional “core plus” risk compared to acquiring mature assets.

The long-term thematic underpinning agriculture is straightforward: demand growth. As global populations expand and living standards rise, the appetite for higher-quality food—particularly protein—continues to increase. At the same time, arable land is shrinking due to urbanisation, soil degradation, and climate change.

“Over time, productivity must keep improving,” Cave says. “That’s the real value creation opportunity. Better land use, soil improvements, larger-scale operations, and professionalisation are all key. As agriculture industrialises, productivity per hectare increases.”

This trend, he argues, will continue to support agriculture as a strategic long-term allocation.

Natural Capital Under YFYS

In Australia, an additional hurdle for super funds is how natural capital investments measure up against the Your Future, Your Super (YFYS) performance benchmark.

Because benchmarks are typically aligned to listed assets or traditional private market strategies, land-based real assets may be disadvantaged, complicating internal approvals.

“There’s also the internal challenge,” Cave notes. “Scale may not necessarily be your friend if you’re entering agriculture for the first or second time. Larger funds need to allocate meaningful amounts of capital, but that isn’t always easy in fragmented markets like farming or water rights.”

Despite these barriers, experience from long-term investors has reinforced the viability of natural capital as an asset class. Forestry, agriculture, and water rights have already proven their ability to generate attractive returns, provide diversification, and deliver impact.

For Australian super funds, the key lies in building familiarity, clarifying allocation frameworks, and partnering with the right managers. As ESG obligations intensify and global peers expand their allocations, natural capital may evolve from an experimental niche into a larger component of institutional portfolios.

__________

[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.