Taking to the woods
Investment in forestry has historically demonstrated stable and attractive real returns with low volatility. These characteristics were already generally recognised in the US when the Danish Pension Fund for Engineers (DIP) started forestry investments 10 years ago. It was also important that such investments included both an element of bare land, which historically shows price stability, and production of a raw material with numerous potential end-uses, consumption of which is highly correlated with economic growth. In consequence, forestry investments have been a hedge against inflation, and returns seem to have low or negative correlation with returns from traditional assets such as quoted bonds and stocks. Finally, these investments are for the long term – 10 years plus, thus matching DIP's pension liabilities.
DIP made its first small investment in forestry in 1989 in Denmark. It soon became clear, however, that domestic opportunities were limited. So when another Danish institutional investor, Teachers Insurance (LB), in 1990 asked it to join a E7m venture in Ireland, DIP accepted.
The Irish project, DanWood, involved buying land and planting it with fast-growing sitka spruce. The local management and administration is done by Woodland Investment in Galway, and the control and communication is led by International Woodland Company (IWC), a company jointly owned by DIP and LB and set up in 1992. IWC advised on the set-up, land acquisition and plantation design. Generally, responsibilities are divided into three categories: legislation (DIP/LB), practice (Woodland Investment) and control (IWC). This arrangement has worked to the satisfaction of all parties involved for almost 10 years. Woodland Investments and IWC work closely together in choosing the sites, and because of our long-term interest plantations have been established with the best planting material available, producing a biological yield 10% higher than conventional plantings.
In 1996 another investment programme of E6m was set up in Ireland. Irish Forestry Investments is 100% owned by the Danish Irish Forestry Investments Holding. The participants are three Danish institutional investors – PFA, PenSam and DIP.
From the start sustainability has been taken into account. Interest from local people in buying houses or fields has been accepted, areas have been left unplanted and different species used in trials to allow a more diversified choice of species in the next rotation of trees. None of these practices has affected the investment negatively. On the contrary, it has motivated the people working with the trees to give the forests high priority and improve their quality.
The rate of return was modest in the first years as it took time to build up the portfolio. We have experienced drastic changes in land prices, which have tripled over the period. The acquisitions made from 1993–98 have been particularly successful. New investments in Ireland are not being made at present because of this surge in land prices. In the past two years, where the investments have been evaluated, the accounted rate of return has been 7% a year.
The move into Ireland involved important steps towards a more professional approach to forestry investments. Today we acknowledge the following characteristics of such investments:
q An expected real rate of return between 6 and 12% pa;
q An upside opportunity on the investment from a rise in world market timber prices in real terms by 1 and 2% annually;
q Forestry is a relatively new type of asset for institutional investors. Considering the global growth and international spread of institutional assets the relative risk premium of such investments seems favourable;
q Professional management can contribute to increasing returns;
q Professional portfolio management can contribute to increasing returns and reduction of various risk aspects.
In 1997 DIP committed a $10m (E9.8m) investment to a limited partnership forestry fund: RII World Timberfund, managed by US-based investment manager UBS Brinson. This fund invests in softwood plantations in the southern hemisphere and so far DIP has had a return on that investment of 10% plus pa. The investment is overseen by IWC on behalf of DIP.
IWC has been given the role of adviser on general forestry matters, including the scanning of global markets and associated activities, in order to advise DIP on how to construct a long-term forestry investment portfolio. In late 1999 DIP together with the teachers pension fund agreed the following objectives for forestry portfolio investments through an alliance called Timber Invest:
q An annual real rate of return of at least 6% before tax on the total forestry portfolio and with a low risk profile.
q An investment period of at most 15 years.
q An expected low cashflow during the initial investment period.
q A diversification of the portfolio based on geography, tree species and wood characteristics, wood market, age distribution and management.
q The investments have to be managed at a certain sustainable level.
DIP has as a start committed Dkr100m (E13.4m) to investments through Timber Invest. This brings total capital committed to forestry investments to about E30m out of total assets of E2.7bn.
The types of investments that have been or will be used are:
q Direct investments, where DIP through IWC can maintain a direct influence on the ongoing management of the timberland including buying and selling of assets.
q Taking part in pooled investments with a focused strategy.
q Buying shares in existing companies focusing on the timberland assets.
It is not difficult to invest in forestry, but like any other investment the difficult part is to identify the most attractive investments and to diversify in order to achieve a high rate of return with low volatility on your overall forestry portfolio. Satisfying these objectives will certainly add value to DIP´s total portfolio.
Otto Reventlow is managing director of the International Woodland Company in Frederiksberg