Seeing the wood for the trees
Timberland is growing in favour as distressed sales make the investment affordable. Nina Röhrbein discusses the sustainability aspects
Asset classes that are perceived as safe tend to do well in times of crisis. Forestry is widely believed to be able to weather any financial storm. But have investors recently gone to the woods? And is it automatically a sustainable investment?
“Timberlands produce a stable total return over the long term with only low volatility,” says Reid Carter, managing partner at Brookfield Asset Management. “They have a low correlation with almost all major indices as they grow independently of capital market and macroeconomic cycles. But unlike bonds and equities, they have a strong positive correlation with inflation, and due to the large amount of monetary expansion going on globally, inflation-linked real assets are in reasonably strong favour. On top of that they are one of only a handful of truly sustainable investments with a low carbon footprint.”
“As an investment class timberland is very good at capital preservation,” says Kimberly Tara, CEO at FourWinds Capital Management. “If the market conditions for wood sales are unfavourable, investors can simply harvest at a later date.”
But according to Carter, only 30% of US pension funds - and an even lower percentage of schemes globally - have any weighting in timberland. “However, over the last couple of years pension funds have increasingly been analysing and allocating to timber,” he says. “In the last six months we have seen a strong continued interest in timberland relative to other asset classes. But most institutions are still very slow to make capital commitments in the current climate.”
After a difficult start, Pictet’s open-ended timber mutual fund, which launched in September 2008, has more than doubled its assets under management to $23m (€17.3m) since the end of February, while FourWinds has noted more interest in private equity structures, such as limited partnerships, since the crisis struck began.
Investors typically have two options with timberland investments: listed funds and direct investments with managers. Direct investments with managers were historically more common but funds have become increasingly popular over the last five years, says Carter. He estimates that 60% of all allocations are now done via funds, with the momentum still in the funds’ favour.
“Most timberland investment opportunities are larger rather than smaller,” he says. “But due to economies of scale, funds can allow smaller contributions that would be impossible on a direct investment basis. “
“Listed funds have more regulatory oversight and the possibility of liquidity over shorter time periods,” says Tara. “But larger investors often favour private equity-type structures because they value at net asset value. However, they tend to be 10-year structures with no liquidity during that period.”
The DKK400bn (€55bn) Danish labour market supplementary pension fund ATP sees its timber investment as part of its climate reduction strategy. It also took a slightly different approach when it made its first timberland investment in March. It created its ATP Timberland Invest K/S subsidiary, which bought the Upper Hudson Woodland in New York State, for DKK180m directly. “We did not invest through any structures because we wanted to have full ownership of the forest,” says Henrik Gade Jepsen, vice-CIO at ATP and CEO of ATP Timberland Invest K/S. “Full ownership equals full control, which has a number of advantages. We are able to certify the sustainability of the forest and can change management if we want to. In addition, we can control the harvest levels, which is fundamental to optimising long-term returns. On top of that, there are a number of technical issues which benefit us, such as being able to minimise the risk of double taxation.”
However, the fund still has an external investment manager in charge of the forest operation and helps with the specialist due diligence.
Jepsen deemed the timberland market was too expensive until the economic downturn created the first opportunity for ATP to buy. The pension fund plans to invest a total of DKK3bn as part of its first commitment.
FourWinds believes it is a good time to purchase timber properties because many forest owners are forced to sell. “Some very high-quality assets are available at semi-distressed prices because of their owners’ liquidity problems,” says Tara. “Additionally, lumber sales have been impacted by the economic crisis so it is not a good time for them to be harvesting.”
And certainly for ATP, the purchase was a buy-and-hold investment. “It is an investment that we expect to show value over the long term,” says Jepsen. The pension fund hopes to generate returns of inflation plus 4-5% per annum.
Generally, returns depend on the jurisdiction of the investment.
“Real returns in the US have declined towards or even below 6% because US timberland investments are much lower risk,” says Carter. “Investors in New Zealand and Australia can expect returns of around 8%, and in Brazil around 11%.”
Tara puts the average timber return over the life of a fund at around 10-15% per annum. “Private equity returns can be even higher, although there tends to be a J-curve due to legal and execution costs at the start of the investment phase,” she says. “However, over time higher returns will smooth the return profile.”
Investors tend to focus on the physical risks to the plantations, such as fire, insects and disease. But Carter says this tends to be less than 1% a year. “The real risks concern demand and prices, in other words, whether the market is moving into a period of surplus or a shortage of fibre,” he says.
Water flow slows but tide expected to turn
One of the earliest funds to invest in water - Pictet’s water fund - has, like many others, been affected by the financial crisis. It faced outflows and underperformance, leaving it with about €2bn in assets under management, compared with the €4.5bn it had accumulated at its peak.
“The situation is tough for thematic investments as they cannot avoid being hampered by the markets in the short term,” says Denis Schmidli, product manager at Pictet. “However, water scarcity is a fact and that is why the investment case for water-related businesses is very much intact over the long term. We recommend our investors to be invested for about seven years, during which the fund should outperform as, long term, the water business grows at about 8% per annum.”
Pictet reacted to the global downturn by aligning its water fund more defensively. Historically, the majority of the fund’s exposure was in water supply businesses but this decreased from 38.1% to 37.7% between April 2008 and April 2009. However, exposure to water technology rose from 37.6% to 41.6% over the same 12 months in the wake of the financial crisis, with the remaining 20% split between environmental services and the bottled water business.
“We have had to become much more short term with regards to how we position our portfolio vis-à-vis the market,” explains Schmidli. “We now focus on specific sub-regions in specific segments, such as more US exposure to companies in the water supply business. But we still believe in the huge potential of emerging markets - that is why we keep a close eye on international water suppliers that provide such services in the developing world.”
And new ventures into the water markets have not been put on hold. Research, rating and index company ECPI launched its sustainable Global Blue Gold Equity index in April. The equally weighted index aims to give investors exposure to 30 publicly traded firms active in the water treatment, infrastructure and distribution space.
It has received interest from banks keen to create products based on the index, according to Paolo Sardi, managing director and CEO at ECPI International. “We believe this is a good time to enter the market because as a result of the financial crisis we expect more investors to take a sustainable approach in a long-term macro trend,” says Sardi.
But Schmidli admits that many investors are still reluctant to invest. “However, due to the long-term investment drivers it is just a question of time until people return to water and similar themes,” he says.