From little acorns

The old adage money doesn’t grow on trees is not always true. Timber investments, in fact, have proven their mettle over the years. Returns may have been whittled down in size due to the financial crisis but on a 20-year horizon, the asset class has outperformed its equity and fixed income counterparts. For now, it only constitutes a tiny component of an overall portfolio, but it is definitely on the investment radar screens. 

Historically, timber has been a firm favourite with US pension funds such as the behemoth California Public Employees’ Retirement System (CalPERS) and endowments including Harvard and Yale, which started to invest in forests in the 1980s. European investors were late to the game and have only begun to make allocations over the past three to four years. For example, in 2006, PME, the Dutch industry-wide pension fund for the Metalektro industry, tested the waters with a €250m (US$377m) holding in timber, which it topped up by €200m a year later. PKA, the Danish collective pension scheme for employees in the public social and health sectors, had targeted roughly €335m for investment by the end of 2007 while the London Pensions Fund Authority (LPFA) had committed €13 m to the asset class.

Activity since the financial crisis has definitely slowed, until recently. Last September, Lærernes Pension, the Danish teachers’ pension fund, allocated almost 7%, or DKK2bn (US$402.5m) of its DKK30bn assets under management to forestry. Earlier this year, Danish labour market pension scheme, ATP, announced its plans to invest up to DKK3bn in forestry via its new unit ATP Timberland Invest. 

Asset Manager GMO’s renewable resources group managing director Eva Greger, said, “There definitely was a pause. People were taking stock and were reluctant to invest in illiquid assets. However, we are seeing increased interest because of concerns over rising inflation and timber is seen as an effective hedge over the long-term. Investors also like its diversification benefits and steady returns.”

 

Growth potential

Collins Stewart’s head of investment companies research, Alan Brierley also pointed out that “timber delivers exceptional returns for investors, with a high degree of consistency, over the long term. Given its low volatility, defensive characteristics and low correlation with other investments, we believe timber has a key role to play in improving portfolio diversification.” 

According to research from Brierley, since its inception in 1987 the compound annual growth rate of the National Council of Real Estate Investment Fiduciaries’ (NCREIF) Timberland index has been 14.7% compared with 8.6% from the S&P 500. The Sharpe ratios of these indices were 1.24 and 0.34 respectively. In addition, over the past 22 years, this index has only fallen in one year, with just five negative quarters out of 90. 

Brierley noted that one of the key drivers of the returns is biological growth or the fact that the trees grow regardless of the underlying economic conditions or financial markets. When prices drop as they have done in the past year, managers will defer harvesting until market conditions improve. They will opt to what is called “store on the stump”, whereby the value of the tree increases due to both biological growth as well as “in-growth” – the process whereby trees turn into higher value products as they age. It is estimated that these factors not only account for 16% of total returns but also contribute to the low correlation with other asset classes.

A recent study conducted by Mercer, reveals that from the period between 1990 and 2008, timberland investments had a 0.05 correlation with the MSCI Europe and 0.10 with the MSCI World Free indices. 

There are of course the negatives. Alison Peeler, founder of US-based Mayhew Asset Management, said: “The cons are the investment is entirely illiquid for a long time and investors will see little or no return in the early years. Also, you need experienced, professional managers who know the markets and have established contacts and infrastructure. It’s not a business for just anyone who can call a realtor and buy land.” The group recently launched the Mayhew Timber Fund I, which allows smaller pension funds as well as high net worth individuals to invest directly in RMK Timberland Group’s Global Timberland Fund.

Overall, timber is expected to remain a small component of the portfolio. Mercer’s Frankfurt based principal, investment consulting, Reinhard Liebing noted. “Most institutions will start off with an allocation up to 1%. It is typically part of a fund’s alternative section but unlike some we do not see timber as a commodity because it has different attributes. We see it as a separate asset class where the best way to invest would be in general through a typical private equity structure. The reason is they are tax efficient structures.”

 

Asset class classification

Views differ as to where to place the asset class as well as which route to take to gain exposure. Aside from the private equity vehicles, there are dedicated as well as exchange traded funds (ETFs). The choice depends on the size, resources and risk return profiles of the particular investor. APG Investments, which manages ABP, one of Europe’s largest pension funds, has placed timber investments in its commodity portfolio keep which comprises 3% of the entire fund. The Dutch fund has taken the direct and sustainable route, setting up a Global Solidarity Forest Fund. So far, US$66m has been committed, the first acquisition being a forest in Mozambique, bought in partnership with the Lutheran Church of Sweden and the Norwegian Lutheran Church Endowment, both long-term investors in the industry. The portfolio also includes US holdings and APG is looking at Brazil where due to the climate, trees grow five to six times faster than in other parts of the world.

CalPERS, on the other hand has shifted its timber assets from its real-estate to its inflation-linked portfolio which encompasses the traditional uses of timber – lumber and paper products as well as cellulose, a component of green plants used for potential alternative energy generation. The inflation linked mix, which as of June 30, accounted for about $4.5bn, or about 2.5% of its assets, also includes commodities, inflation-linked bonds and infrastructure. The fund invests direct such as its recent 1.3% investment in US forestland in partnerships with Sylvanus, Great Eastern Timber Co. and Lincoln Timber. 

ATP also views its timber investment as part of its inflation-protected asset class, which together with real estate, infrastructure and inflation-linked bonds, accounts for 25% of its investment portfolio. The Danish fund opted to own the forest rather than invest via a fund to ensure that the operation is conducted in accordance with sustainable investment guidelines which are gaining ground in Nordic countries. The first investment was the DKK180m purchase of the forest of Upper Hudson Woodland in New York State, covering about 38,000 hectares. 

Meanwhile, LPFA recently invested in the Phaunos Timber Fund as part of its environmental, social and governance investments. Timber is increasingly seen as part of the ESG movement because it is a large consumer of carbon dioxide. For example, it is estimated that managed forests in the US consume 15.6lbs of carbon dioxide per cubic foot of tree growth which removes almost 17% of total greenhouse gas emissions, according to Brierley.

As for ETFs, the passive approach is certainly gaining traction. iShares’ director of ETF product structuring Suzanne Williams said: “We are definitely seeing demand for this product in the alternative space. For many investors it is difficult to buy timber directly but our ETFs provide a liquid, diversified and global exposure to this niche asset class.”

The iShares S&P Global Timber & Forestry was launched two years ago and has amassed $24.2m of assets under management. It aims to track the S&P Global Timber & Forestry Index and offers exposure to 25 of the largest publicly listed companies around the world that are involved in the ownership, management or the upstream supply chain of forests and timberlands. It ranges from forest products, paper products, paper packaging and agricultural product companies to timber real estate investment trusts.

According to its half-year results, published in August, Phaunos Timber had total commitments of $698m at the end of June, of which $212m has been drawn down. The fund is geographically diverse investing in Uruguay, China, Brazil, Eastern Europe, as well as the US. Last year, the funds strategy was to diversify beyond solely investing directly in forests and to also invest in timber related opportunities. Phaunos increased its share holdings in Green Resources, a Norwegian plantation, carbon offset, forest products and renewable energy company which operates in Mozambique, Sudan, Tanzania and Uganda. 

FourWinds Capital Management’s chief timber officer Liane Luke said: “We conducted a strategic review and decided to invest more in the high growth markets such as China, India as well as South America. We typically invest directly but in some countries such as India, this is not possible. Overall, emerging markets are more attractive than in North America where it is difficult to get a high yield. This is because there are so many investors chasing the product that the hurdle rate has risen.”