Fennell Betson examines the argument for investing in this different asset class
Forestry investment is a fringe activity as far as European pension funds are concerned. It happens on the fringes of Europe and is carried on as fringe activity by only a fringe of investors. But there are some compelling reasons why it could become a more mainstream activity for Europe-based institutions.
Hasse Nielson, who runs the international consultants Alcifor Advisory Associates, based in Denmark, is a proponent of forestry as a real opportunity for longterm investing institutions. He also sits on the board of the International Woodland Company (IWC), a Copenhagen-based company that provides advisory services to Danish investors interested in forestry investment both at home and internationally. It is owned by two Danish institutions, LB, an insurance company for teachers, and DIP, the pension fund for civil and academic engineers.
“We are noticing much more widespread interest among Danish institutions,” he says. That does not surprise him, as at last the arguments for in-vesting in timberland are being ac-cepted and understood. “Investors are realising that it is an area that needs to be treated seriously and, if they want to do it, they must do it professionally.
“Our view is that it should be re-garded as a separate asset class, as it has very specific characteristics. In particular, it has low or even negative correlation with other asset classes.”
He adds: “Over time the facts are that institutional investors will have to look at alternative asset classes for their returns.” Given the nature of their liabilities, timber investment is a good fit. “When you look at the structure of pension funds, a 40-year in-vestment seems very interesting! My view is that it is an opportunity for long-term money to be invested as-suming you are spreading risks in terms of geography and types of timberland.”
IWC has been advising Danish investors for the best part of 10 years, but its main activities have been outside Denmark. As managing director Otto Reventlow explains: “In Denmark you have to wait 50 to 60 years for trees to grow - even softwoods, due to the lack of rain.”
The initial preferred location has been Ireland where over the past de-cade DKr130m (E17.5m) has been invested in 3,000 hectares of land that has then been planted. But the land ac-quired is not marginal land. “You pay more for land in Ireland than in Scotland, but you get faster growth and more flexibility. Not only do trees ma-ture quicker, but they are healthier and we have a longer period to harvest them.” This flexibility over the time in which trees have to be harvested, means that the realisation time is less dependent on the market conditions at a point in time, which lowers the risks.
But IWC has also arranged investments in France, where a DKr50m standing oak forest has been bought. It expects investors sights to be spread even wider in future years.
Since the mid 1980s there have been moves in Ireland to encourage investment in forestry by Irish institutions. Two investment groups, Allied Irish Banks Investment Managers and Irish Life both set up portfolios and between them built up investments for domestic investors, of which perhaps 90% was pensions related.
Then in 1994, explains Brendan Lacey of Irish Forestry Unit Trust in Dublin, the two groups got together with the state-owned forestry company Coillte, with the aim of boosting the level of forestry investment by pension funds. From this initiative by the three groups, the Irish Forest Unit Trust was created (see box).
“Now we reckon that about 90 Irish pension funds are invested; sometimes these are through managed funds,” says Lacey. The proportion of funds’ holdings in forestry will vary from the minuscule to as much as 3% in one case.
The aim is to build up a fund of around Ir£250m. “That would give us critical mass. If you consider Irish pension funds have a value of around £25bn, you are looking at a figure of 1% of pensions assets. This is a target for ourselves, but also in the context of the pension fund portfolios, as we see forestry fitting in as part of a core holding of assets, which would not be trad-ed, but would provide steady growth, complementing the more actively traded elements of the portfolio.”
Lacey describes forestry as “almost like an index linked investment - very low risk, fully asset backed, with low volatility, and giving a secure rate of return.”
The fund due to its tax exempt status is only open to Irish pensions investors and the development of the home market is seen as priority for the fund. The natural perspective then would be to UK pension funds, where it might be possible to offer the fund on an exempt basis, says Lacey. He also speculates if there could be opportunities in Europe, with the arrival of the euro and the development of pension funds. “We think that European funds could at least understand the concept of forestry and long-term investment.”
The UK forestry investment scene seems to have hit the doldrums as far as institutional investors are concerned, with little interest from larger pension funds. If anything, they may be net disinvestors. “Forestry has been pigeonholed with property by pension funds and they have been reducing their holdings,” says Barry Gamble of Fountain Forestry in Banbury, which manages 400,000 acres of forestry in the UK and US. “ If a pension fund wanted to come into the market and place £50m in forestry, there is no way that this could be placed.”
According to many managers, new planting of forest has come to a virtual halt, due to the high cost of suitable farmland, which has made it uneconomic, so investment has closed from that perspective.
The forestry management companies talk of deals of £2 to £5m as being typical , and there are not too many of those in the current climate. Another part of the picture is that the Labour government halted the £10m of so of sales the Forestry Commission, which owns around 50% of UK’s forest stock, used to make annually of its forestry holdings.
What pensions interest there is comes from investors of small self administered schemes(SSAS), or self invested personal pensions (SIPPs), where the ir investments needs can be accommodated. The other main investors are individuals, including overseas investors mainly coming from Scandinavia.
At FIM Services in Burford,Richard Crosbie Dawson reckons that the market upper limit for an investment would be in the £7 to £10m range. “We invest about £15m a year for corporate clients in plantations, though not all in the UK. He also notes the lack of vehicles to allow indirect investment, though there are some limited possibilities through ethical and green funds. He also refers to an associated forestry investment company Highland Timber, which is quoted on the London alternative investment market AIM, with a market value of about £11m. Highland invests some 40% of its assets in New Zealand, where FIM is also active. “This is a good way to gain access to forestry through a quoted vehicle,” says Crosbie Dawson.
Fountain’s Gamble sees ongoing difficulties because the UK market is not able to absorb the substantial investments that institutions usually make. “Therein lies the problem. Because there is no turnover in the market , it is difficult to get a real sense whether the appetite for purchasing could be could be satisfied in a reasonable two-way flow. We travel in hope that the Forestry Commission might recognise that were they to make properties available, either by sale or by offering management agreements, this might be the key to freeing the market up.”
By contrast, Fountain says that the group has brought British pension funds over to invest in US forestry. “The striking thing is that on the other side of the Atlantic they take a contrary view to the received wisdom about forestry over here. The increasing feeling there is that if equities continue to go up, then it is no bad thing to have other exposures. Forestry seems to behave contracyclically to other markets.”
Among US investors, no one is more committed to forestry than CalPERS, the world’s biggest pension fund, which has $1.5bn of timberland assets. Chuck Valdez, chairman of the fund’s investment committee, points out that it is the second largest individual owner of forestry in the US after the government. His view of forestry is to the point: “We like timberland investing.” Not too surprising perhaps , as the asset class has produced returns of around 30% per annum over some periods, though the figures have been in the 18 to 20% range more recently. “Over the years, it has been our best performing portfolio in our real estate,” he says.
CalPERS, started in 1986 with a $250m initial tranche invested through advisers Hancock Timber. The fund is looking to invest outside the US and is appointing UBS Brinson to handle this move.
UBS Brinson is one of the main providers of timber funds to US investors. Altogether, US investors have invested $6bn in forestry funds of which UBS have raised $1.1bn and a Hancock Timber $2.8bn, Scott Hancock of UBS in the US points out.
There is increasing interest by US pension funds and other investors, such as public funds and university endowments, in forestry investment, particularly over the last five years, says Hancock. “We are seeing the growing interest coming in the asset class, because it has stable investment returns, that are not correlated in any significant way, and in many ways is negatively correlated to other classes of assets.”
But Hancock says about 60% of the UBS activity in timberfunds is now offshore and 40% in the US. “Altogether, we have two funds investing in New Zealand, one in Chile, a publicly traded fund for Argentinean pension funds, one in Uruquay and in Australia.” Two years ago the group launched the RII Weyerhauser World Timber fund, which raise $524m to be invested in planted forests in the southern hemisphere. The attractions of investment in this region is that the land prices are lower, explains Hancock. Trees grow much faster in these areas, he points out.
He reckons investors should think of a 10-year investment period. “Our philosophy is to invest at the younger to middle stages of a forest’s growth. This allows us to add value, as we can do things to make the forest grow more rapidly and increase its value.” That is not a two-year process, he points out because it can five to seven years to see the benefits of these sylviculture regimes take hold. “We are active managers, we supervise all those activities. Part of what our fee includes is not just managing the process of acquisition and so on, but the financial modelling of the forest and handling the final disposition.”
Only larger funds, such as CalPERS, can invest directly, Scott maintains. “If an institution is quite large, then it could feel comfortable in building its own portfolio. But if it wants to get exposure overtime, it might be more prudent to buy a series of funds over a period of years, to obtain geographic and time diversification. Funds are efficient for that.” The typical investment from an institution is to a fund is in the $5 to $10m. The main interest for the offshore funds comes from US, Australian and Middle East investors, he says. “We believe Europe holds great promise, but it has not been as interested to date as other investors.”
The group is currently seeking investors for both domestic and offshore funds.
In normal times, Scott reckons that the class will produce returns between bonds and equities. “An index based on our funds longterm have been about 14% per annum compound. It is competitive, though not the same as Nokia or Microsoft.”
Outside the US, there is much more uniformity among advisers and managers as to what to expect, and it is much lower, even accounting for the fact that the US are nominal return figures. Danish firm IWC says to expect 15 to 20% is unrealistic and it pitches returns at 6% per annum above inflation. From an Irish perspective, Lacey of IFUT reckons a yield of between 5 and 7% above inflation on an ongoing basis. Most of the UK groups also put the figure in the 5 to 7% real return bracket.
All the groups advising on investment believe it is just a matter of time and education before the investors in Europe will come their way in increasing numbers. “It is a question of education to make people familiar with investment in the area,” says Lacey. “Why we were set up for the pensions market, is that it was felt, they would understand the concept of longer term investment.”
At IWC Nielson says: “Forestry investment is basically a question of information.” Hancock of UBS sees the issues as being very much line with what his group is offering in the new investment regions: “Once the investors understand the nature of the investment, they will seek out the faster growth rate areas.”
While at Fountain Forestry, Gamble says: “We would like to talk to pension funds in mainland Europe. They might share the rather more longterm perspective which is clearly necessary for forestry investment. This is in contrast to the investment institutions in London, which tend to take a short-term equity perspective.”