Investors looking to diversify their portfolios and insure their wealth against the ravages of volatility in traditional markets, will most likely have come across a range forestry investments, promising to generate superior inflation-adjusted and risk-adjusted returns for the long-term investor.
But how have timber investments performed? And how does the smaller investor participate in this interesting alternative investment asset class?
Firstly let’s look at the past performance of forestry investments, as measured by one of the main timber investment indices, the NCREIF Timberland Index; according to this basic measure of investment returns in the sector, this asset class outperformed the S&P500 by some 37 per cent in the 20 years between 1987 and 2007. When stocks delivered average annual returns of 11.5 per cent, forestry investments returned 15.8 per cent.
At the same time, returns from investing in timberland and woodlands have been proven to display a much lower volatility, an attractive characteristic for today’s investor.
Previously, the majority of investment returns from forestry investments have been mopped up by larger, institutional investors such as pension funds, insurance companies and university endowments, who have collectively placed over $40 billion into timber investments in the past decade.
So on to the second question; how do smaller investors participate in this kind of alternative investment?
According to a study by Professor John Caulfield of the University of Georgia, returns from forestry investments are three-fold;
An increase in timber volume (biological growth of trees), which accounts for some 61 per cent of return on investment.
Land price appreciation, accounting for only 6 per cent of future returns.
Increase in timber prices per unit, delivering the final 33 per cent of investment returns for timber land owners.
So the best way to harness the performance of timber investments is to take ownership of trees, either directly, or through one of the array of forestry investment funds or other structures.
Timber REITs
One way for smaller investor to participate in timber investments is through a Real Estate Investment Trust (REIT). These investment structures are like funds, in that investors can buy and sell shares in the trust on an exchange, the REIT acquires and manages timber investment properties, but unlike normal companies must pay out 90 per cent of their earnings to investors through dividends.
Some examples of Timber REITs are:
Plum Creek Timber is the largest private owner of timberland in the U.S. and the largest timber REIT with a market cap of about $5.6 billion, many investors have chosen this as their route into forestry investments.
Potlatch is also a timber investment REIT while
Rayonier generates about a 30 per cent of its REIT earnings from timber.
Weyerhaeuser has disposed of its paper and packaging businesses and will convert to a REIT by year end.
The Wells Timberland REIT is not publicly listed but may be available for purchase through Wells Real Estate Funds.
Another way for smaller investors to add forestry investments to their portfolios is to buy Exchange Traded Funds that attempt to track the performance of timber returns. This is less direct than owing timberland, or investing in a timber REIT, as the ETF may also invest in shares in companies involved in the timber supply chain including processors and distributors. This means that investing in forestry through ETFs exposes the investor to some of the volatility of equity markets.
The Guggenheim Timber ETF owns about 25 stocks and REITs involved in the global timber and paper products industry with a 30% weighting to U.S. companies.
The S&P Global Timber & Forestry Index Fund holds 23 securities and is 47 per cent invested in the U.S.
Timber Investment Management Organisations (TIMO)
Those with more capital to spare can participate in forestry investments through TIMOs, although the majority of these investment specialists require a minimum investment of $1 million to $5 million and a commitment to tie up funds for up to 15 years. TIMOs essentially trade timber land assets, acquiring suitable properties, managing them to maximise returns for investors, the disposing of them and distributing profits to shareholders.
Many experts believe that the active management style of TIMOs ensures that they can be more reactive to market conditions than REITs, and therefore don’t tend to fall and rise in line with the market quite as much.
Direct Forestry Investments
Those with access to sufficient capital and the appropriate expert advice can invest in physical properties. Commercial timber plantations are complex operations that require skill, knowledge and expertise to manage effectively and maximise returns whilst lowering risk.
For armchair investors, or those with less capital to spare, many companies offer investors the opportunity to purchase or lease a small portion or plot within a larger, professionally managed timber plantation. Investors normally take ownership of their plot and trees via leasehold, whilst the timber investment company plants, manages and often harvest the trees on behalf of the investor.
Options for investors range from species to species and region to region, with current opportunities in Brazil, Panama, Costa Rica, Germany, Nicaragua and other, more exotic locations like Fiji.
Investors should be wary as many of these direct forestry investments are frontloaded with enormous commissions for salesmen and promoters, with many offering ‘agents’ up to 30 per cent commission for the sale of plots to investors, and in many cases, no due diligence even exits.
In some cases, the Author has seen forestry investment plots in Brazil packaged and sold to investors for over £100,000 per hectare. Investor should seek advice from an independent consultant with experience of this alternative investment asset class, and who is able to present a complete suite of due diligence material, including an independent valuation of the forestry investment property on offer.
Summary
Investors choose forestry investments due to their effect as an inflation hedge, and their ability to generate non-correlated return on investment in the long-term.
Performance of the asset class is driven by demand for timber, weighed against global supplies, and in the long-term we are using timber at a faster pace than we can grow it, making timber investments an attractive asset class for the investor seeking stable, long-term capital appreciation within their investment portfolio.
Investors looking into which type of forestry investment is right for them should consult an adviser that can demonstrate experience and expertise within the sector.
DGC Asset Management Limited is an alternative investments business, identifying opportunities to invest in non-correlated assets.
David Garner is Partner DGC Asset Management Limited.