Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
… and why Nuveen wants ‘natural capital’
Nuveen will embrace “natural capital” as institutional demand for sustainable alternatives rises. But fighting climate change can be hard when climate change fights back.
“The challenge we have to increase the production of food, fibre and timber over the next 30 years or so is just monumental,” says Martin Davies, CEO of Nuveen affiliate Westchester, which manages around $7 billion in farmland assets. “It needs a massive flow of capital into this sector. The World Bank estimates that in agriculture alone, $350 billion annually needs to be coming into the sector to facilitate the changes necessary.”
Nuveen has recently enhanced its Real Assets Platform with the addition of Nuveen Natural Capital (NNC), which combines the capabilities of Westchester with another affiliate, GreenWood resources, a forestry specialist. Davies will lead the NNC.
“We think we can offer better solutions to our investors configuring our business around natural capital… one of the things that’s increasingly attractive to investors is the low carbon intensity of both farmland and timberland,” Davies said.
Farmland and timber have historically produced strong returns, uncorrelated to the economic cycle, and as markets move into an environment where “everybody’s getting paranoid about inflation”, Davies anticipates that the institutional interest in alternatives – and particularly agricultural assets – will increase.
Of course, farmland isn’t automatically a sustainable asset, despite the assumptions that come with the fact that it’s “green”. Commercial-scale agriculture is a thirsty industry, and impacts biodiversity through land clearing. Davies says Westchester addresses some of those concerns by planting a variety of cover crops to defend against soil erosion – such as pulses, mustard, and oats – alongside pollen and nectar strips. Some jurisdictions require conservation reserves to be held alongside the farmland, while buffer areas around natural features like water courses need to be maintained.
“It comes down to the way you operate the farms – our approach is to manage them in a very sustainable way,” Davies says. “If you run an agricultural system that’s very prescriptive and operates around blueprints, it does raise questions about the impact that you have on biodiversity.”
Farmland is one of the longer duration asset classes, and with it comes an element of squinting into the future: a future that will likely look markedly different for agriculture than it does today. Davies says climate change is “undoubtedly one of the biggest concerns in investing in farmland”, and uses the example of walnut trees, which, while they can last up to 50 years, require a significant number of “chill hours” to meet their “chilling requirement” – the period of cold weather after which fruit- and nut-bearing trees will blossom. As global temperatures rise, they may not be as viable an investment in some parts of the world as they once were.
Part of hedging against that is diversification (Westchester manages 2.2 million acres globally, with 40 different crop types under different operational systems) – while also being mindful of the potentially unforeseen and unexpected impacts of climate change.
“Ironically, there are certain locations that are going to benefit from changing temperatures,” Davies says. “The Boreal Region – the northern part of Canada, the northern part of Europe – temperatures are rising, so the prediction for the cropping zone is that it’ll move 1200 kilometres north.”
