| Timberland Investments: Biological growth pays off |
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| 30/07/2006 | |
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Timberland, an off the wall pension investment idea? Not for large pension funds such as the New Zealand Superannuation Fund, the Ontario Teachers Pension Plan, CalPERS or AP3, the Swedish reserve fund, which have all invested substantial amounts into "forests for a profit". Pension funds looking to timberland investments as an alternative within the alternatives do so for various reasons. One of the primary reasons for institutional interest in timber is its long term nature, taking into account that it can take anywhere between 20 to 80 years to grow a tree to maturity, making it an illiquid asset that usually falls within the real estate or private equity portfolios. Timberland provides diversification from stocks and bonds since timber prices tend to move independently of stocks according to various studies. "Put another way, trees don't read the Wall Street Journal (or the Financial Times).They do not concern themselves with events like the war in Iraq or statements from the Federal Reserve Chairman," jokes Jon Caulfield, director of research at the RMK Timberland Group. From 1987 through 2005, the NCREIF Timberland Index, a widely used benchmark for U.S. timberland returns, had correlations of 0.07, 0.08, and 0.12 with U.S. large-cap stocks, U.S. long bonds and non-U.S. large cap stocks (MSCI EAFE), respectively. While one would expect the timber price - which is highly dependent on the construction and paper industry, and in turn subject to cyclical swings - to move according to economic growth, managers can shield themselves from equity bear markets by placing their timber "on the stump", that is, by delaying the crop until market conditions improve. In the meantime, land value is likely to continue improving, making it a second source of capital gains for the investor. In any case, a delayed crop yields higher returns thanks to more mature wood. This is because trees increase their value as they grow. In other words, larger trees, which can be used as softwood lumber or saw timber, are more valuable than smaller trees, whose main use is for pulpwood. It is estimated that about 65% of timber return comes from biological growth, regardless of the state of the markets. As part of a diversification investment policy, managers usually buy timberland with a variety of tree ages and species to ensure continuous productivity and cash flows. Benchmarking Nevertheless, timber performance remains a thorny issue given to lack of transparent and exhaustive information sources on this market that bears many similarities to private equity. The best-known index, the National Council of Real Estate Investment Fiduciaries (NCREIF) Timberland Index, has an exclusive focus on the US market, and is weighted at 75% toward the US south. According to the Hancock Timber Resource Group, investments in timberland have provided total historical real returns (net of inflation) of 6-10 percent, and nominal returns of 9-15 percent, beating the yearly returns of the S&P 500 (9.3%) with an average return of 10% between 1993 and 2002. And it did so with less risk since the standard deviation of timber was 7.5% during this decade, and 19.7% for the S&P 500. Timberland Index – Total Returns  Source: National Council of Real Estate Investment Fiduciaries (NCREIF) That's not to say that timber is a risk-free asset. On top of being a commodity subject to wide price fluctuations due to macroeconomic cycles such as the health of the housing market, and also to sudden government decisions to privatise new public lands for commercial exploitation, timberland is a relatively illiquid assets compared to stocks and bonds as the absence of an organised timber exchange can make it difficult to find a buyer. The component of risk that is almost exclusive to timberland is the environmental and physical risk such as forest fire, weather, or disease that can severely damage the timber to be collected. "Contrary to popular opinion, physical risks tend to be very small," explains Mr Caulfield. "For a timberland portfolio that is appropriately diversified in terms of geographic location (i.e. a number of properties purchased in different timber market areas) and age structure (i.e. young, middle age and mature trees), losses from physical risks average about 20bp over the course of the investment life." Investors can get exposure to timber either indirectly through the private market by investing in a closed limited partnership vehicle managed by a TIMO or through the public market in a Timber Real Estate Investment Trust (TREIT), a REIT that is dedicated to timberland investments. An investment in a TIMO fund usually requires a larger investment that in a TREIT such as Plum Creek in the United States. Plum Creek, which is listed on the New York Stock Exchange, as a traditional REIT would do, buys land, but instead of developing it with properties, it gets most of its income from timber exploitation. In the US, well-known TIMOs include the RMK Timberland Group, Global Forest Partners, the Hancock Timber Resource Group, as well as GMO Renewable Resources. Julien Laplante |
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