UK local government pension funds turn to nature - but are cautious on carbon credits

The UK's LGPS funds are currently undergoing a tri-annual process reviewing their strategic asset allocation and natural capital is on track to become one of the most sought-after asset classes, although many remain deeply cautious of carbon credits.

Natural capital is growing in popularity. Nearly 40% of LGPS investors, which collectively hold some £400bn in assets, plan to increase allocations to the asset class, according to the latest LGPS Investment Survey conducted jointly by Room151 and Schroders, making it the second most popular asset class after renewable infrastructure.

The growing investor appetite is also reflected in a number of recent fund launches. Last year, London CIV announced the launch of its first natural capital fund in a bid to meet its net zero by 2040 target. The strategy is backed by a £75m commitment from the London Borough of Barnet. Other examples include East Riding and West Yorkshire, which earlier this year contributed a combined £27m to Foresight’s natural capital strategies.

Meanwhile, the LPPI pool launched an environmental opportunities fund with scope to invest in natural capital, while LGPS Central is working on a timberland and agriculture strategy.

However, Room151’s survey also revealed that 42% of respondents would not invest in natural capital strategies that rely on carbon credits. This reflects widespread investor caution about the credibility and return profile of such claims.

Transactions in the voluntary carbon market have fallen to a six-year low this year amid negative media headlines and allegations of greenwashing.

Many natural capital funds distributed to UK investors contain some exposure to carbon credits, although these are often combined with other sources of return such as sustainable timber management.

London CIV’s Natural Capital strategy has scope to invest in carbon credits but remains cautious for the time being. The pool’s head of private markets, Vanessa Shia, said earlier this year: “The carbon credit market is still maturing. There is nervousness around the verification and monetisation of credits, so while the structure and regulation are improving, it is not yet a key driver for most managers.”

She predicts that some future funds may be launched where carbon credits become the main return driver, although for now they remain an additional source of return rather than the primary focus.