Timberland certainly qualifies as an unusual investment class. Returns are similar to bonds and tend to rise in line with inflation. Correlation with equities is as low as for the most extreme hedge funds. Even putting timberland within a property portfolio does not reduce its diversifying power.
Stable returns, hedged against inflation but with little correlation to equities, sound desirable. But when it comes to investing, even trees can be deceptive. Perhaps the most dissuasive condition of holding timberland is the lengthy lock-up period. This can be longer than the seven years of a traditional economic cycle or a private equity partnership. Pension funds are supposedly long-term investors but the irony is that for novel assets such as trees, fiduciary boards would probably baulk at a 15-year commitment when tried and tested bonds and stocks can be bought and sold in a day.
A little scepticism is no bad thing. Timberland investment professionals claim that wood appreciated at 2% above inflation over the last century. This is because the change in our wood sources, from low-producing natural forests to high-producing plantations, has hardly been able to keep up with demand. Each year the world consumes 1.5bn cubic metres in wood for paper, board, housing and furniture: greater than the combined annual consumption of steel, cement, aluminium and plastic, according to GMO Renewable Resources.
The arguments seem convincing. Nevertheless, over the past 15 years, timber prices in western Europe have declined. In the US low interest rates have boosted the housing market and subsequently lowered timber prices there too. The NCREIF Timber Index returned just 4.2% annualised over the last five full years, better than cash and equities perhaps but not by much.
Is there a way to make more from forestry without undue risk? The solution is to invest globally, according to Otto Reventlow, managing director of the International Woodland Company, based in Frederiksberg, Denmark. As a general starting-point, he suggests 50% allocation to the US and 50% ex-US.
The US has the most sophisticated indices and measurements and vehicles for timberland investing. With Canada it both produces and consumes well over one-third of the world’s total annual production of wood and paper.
Those funds preferring to invest in closer to home should consider eastern Europe, as prices are more competitive. Estonia has some of the world’s most advanced sawmills, according to Reventlow, and Russia is supplying a lot of the lower-grade pulp to package China’s growing list of manufactured goods.
At the same time, the fact that trees in tropical zones such as Brazil grow up to six times faster than in Scandinavia is an argument for looking further south for some diversification opportunities.
Timberland is thus a confusing mixture of simple nature and global business. On the one side, there is absolute certainty of biological growth. Disease and weather claim a negligible percentage of plantation forestry. Throughout a tree’s growth it becomes more valuable, not only because there is more of it but because mature wood can be used in higher-margin industries such as furniture making. This intrinsic value is more secure than most stock market securities. Prudent forestry management also brings flexibility in harvesting. If demand for wood is low one year, the forest can be left to grow, attaining greater value, something that cannot be said for all the subjects of stock market IPOs. Finally, the emphasis in timberland investments can fall on the land as well as the timber. There will be appreciation of the ground itself, which may be sold to another timberland investor or to be put to a different use, perhaps agriculture or housing. A stark example involved a joint venture including International Woodland Company on behalf of Danish retirement institutions which acquired plots in the west of Ireland during the early 1990s to grow sitka spruce. Ireland’s subsequent property boom meant that it made most sense to sell land on for housing. In fact, the land had appreciated 400%. But as Reventlow ironically pointed out, the plot would have been more profitable to the house builders had no trees been planted on it.
If nature offers a reliable source of income, forestry definitely needs supplementing from active allocation. This is not the preserve of eco-warriors but professional investors searching for opportunities globally. Naturally, transportation costs are a major consideration. Apart from getting the lumber, or felled trees, to a sawmill, others costs incurred are stumpage, harvesting and overheads [see graph on comparative national_costs]. The mix of costs varies from country to country, according to Finnish consultancy, Indofur. For softwood pine to be turned into pulp, stumpage prices in the US alone are greater than the entire cost of Russian production. Spain has higher transportation costs than any other pine-producing nation – reflecting the relative lack of pulp production facilities – and higher overheads even than Sweden.
Finland may be the EU’s most forested member state but, according to Indofur, it has the highest costs to bring softwood to mill, higher even that Germany and Austria with their heavy labour costs. It may be no surprise then that pulp and paper manufacturers in Finland and Sweden such as Stora Enso have spun off their forestry management to independent companies.
Such spin-offs might seem to deny investors one route to accessing timberland’s properties via securities exchanges. Proxies for timberland are thin on the ground, unlike natural resources such as oil and commodities such as gold. Who buys oil itself when one can invest in BP or Shell?
However, although Europe’s paper and pulp manufacturers might be reliant on wood as the base of their business, even they are not a good proxy for forestry investment, according to Linus Larsson, pulp and paper equity analyst at Alfred Berg/ABN Amro in Stockholm. He points out that the pulp and paper sector is rather tied to the fortunes of advertising.
In which case, is it possible to access forestry without making a commitment of many years as a direct investor? There are very few quoted timberland stocks. In the US thee number of timberland investment management organisations (TIMOs) is growing, but they are professional investment companies which do not offer shares publicly. They are suitable agents to invest in forestry but not as timberland proxies within a broad securities portfolio.
The message to European investors seems to be a clear one. Forestry is a long-term commitment but one that can yield attractive returns and diversification. While the NCREIF Timber Index achieved just 4.2% annualised over the last five calendar years, GMO’s Composite Renewable Resources Timber Funds achieved a gross 9.7% internal rate of return. Since inception International Woodland Company’s composite return has been even better: 11.6% net of fees, more than double the benchmark.
Yet pension funds in Europe allocate a negligible amount of their assets to this class. In a period when so much money is being given on trust to more opaque alternative investments such as hedge funds, can we see the wood for the trees?