Timberland: The Natural Alternative

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Timberland: The Natural Alternative

Currently, financial markets are characterized by unusually high levels of uncertainty; equity markets have moved close to their previous highs, while fixed income yields have dropped to historic lows. Currency markets are unsettled by the possibility of the disintegration of the Euro. Prospects for emerging markets have dimmed as Europe sinks into another recession and the U.S. economy fails to build forward momentum. Looking out over the coming decade, expectations of future earnings on traditional financial assets are being curbed, forcing investors to reconsider their return targets as well as their risk tolerance. In seeking some shelter in today’s turbulent investment landscape, timberland provides an attractive option.

The timberland asset class offers investment characteristics that resonate positively in these unsettled times: good returns, low volatility, and low or negative correlation with most other financial and real assets. The first timberland funds were launched in the mid-1980s, and currently institutional capital invested in US timberland assets is estimated at $US 35 billion. The geographic focus of institutional timberland investments has been the United States, which still represents approximately 75 percent of the invested institutional capital in the asset class. Substantial institutional investments have also been made in Australia, New Zealand and Latin America (Argentina, Brazil, Chile and Uruguay). Investments usually involve the actual ownership of forestland and the trees standing on it, but can also be just the land or just the rights to the timber.

Past Performance

With thirty years of documented historical returns, timberlands have a solid track record that allows comparison with other assets. Historical nominal US Dollar returns for U.S. timberland as published by The National Council of Real Estate Investment Fiduciaries (NCREIF) have averaged 13.5 percent per year over the period 1987 To 2011, and returns on international timberlands as represented by the Hancock Timberland Index have sustained an average annual return of 13.2 percent over the same period.

Past performance does not guarantee future results. Index returns do not reflect any fees or expenses.

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Timberland: The Natural Alternative (continued)

Timberland returns derive from a combination of income and capital gains. The income component (or more correctly, distributable cash flow) comes mainly from the sale of trees. In addition to the production of timber, forestlands produce other revenue streams: recreational and hunting leases; income from leases for telecommunication antennas or wind-power installations; the sale of tracts for development or for conservation, or simply the sale of conservation rights. The capital gains portion of timberland returns result from the on-going biological growth of the trees, plus the changes in the value of the timber and the underlying land. The productivity and value of commercially managed timberland can be enhanced through the use of improved genetics and advances in forest management practices.

Diversification Benefits

Virtually no correlation exists between timberland returns and returns from financial assets: equities or corporate bonds, commercial real estate or direct energy investments. Given timberland’s low-risk profile and its minimal correlation with the movements of other assets, timberlands can dramatically boost the risk-efficiency of a mixed-asset portfolio, achieving reductions in risk without compromising return.

Investment Opportunities

The growth in institutional investment in timberland gained momentum throughout the 1990s and the first half of the 2000s, reaching a peak of activity in 2006, when $US 9 billion of new capital moved into the asset class. The sustained growth in timberland investment leading up to the global financial crisis in 2008 reflected the growing recognition by the investment community of the positive attributes that timberlands added to a portfolio. The expansion in timberland investment over this period was also fueled by a large number of properties made available to the market by forest product companies and by government agencies. Forest product companies came to the conclusion that they did not need to own and manage their own forests to be able to profitably operate their sawmills, plywood plants or pulp and paper mills.

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The sale of timberland provided forest product companies capital to restructure and refocus their operations, invest in new or existing manufacturing facilities, pay down debt or return capital in dividends to their shareholders. Governments, most notably in Australia and New Zealand, decided that their commercial forest assets could be managed in a productive and environmentally responsible manner under private ownership, while freeing needed funds for social programs, improving physical infrastructure and closing budget deficits.

In the wake of the 2008 global financial crisis, the pace of timberland investment activity slowed considerably, particularly for large scale, commercial properties. Post-2008, deal-flow was impeded by the generally more restrictive availability of credit and the reluctance of timberland owners to bring properties to market at a cyclical low-point. In addition, timberland faced strong competition for institutional investment funds from bonds and equities which were both experiencing strong recoveries following the global economic recession. The availability of commercial timberland properties for purchase in the U.S. was also limited by the constrained supply of industry owned timberland. By 2008, nearly all of the North American forest product companies had divested their timberland properties.

More recently, interest and activity in institutional timberland investment has revived. Rising concerns about the future possibly diminished prospects for equity and fixed income investments has shifted attention to real-assets in general and timberland in particular. The potential of timberland to reduce overall portfolio risk as well as providing an inflation hedge makes a strong case for its inclusion in a portfolio at this time. A number of major transactions have been concluded in recent months, including a privatization of an Australian state’s timber plantations (79,642 HA) and the acquisition of a major U.S. timber investment management organization (TIMO) assets (544,700 HA). Based on recent transactions, timberland appears to be priced to generate real (after-inflation) returns in the range of (5.0 to 10.0 percent). As with any asset, greater risks are associated with higher returns, and there are strong regional differences in the risk/return profiles associated with individual timberland properties. Timberland located in regions with well developed infrastructure, state-of-the art processing capacity, good access to deep product markets and a supportive business climate will be priced to reflect these advantages.

Timberland: The Natural Alternative (continued)

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Looking forward, opportunities for timberland investment will continue to surface. Financially stressed governments continue to review the sale of physical assets (including timberland) to rebalance budgets and meet their financial obligations. While most U.S. forest products companies have already disposed of their timberland holdings, this trend has barely begun in other important timber producing areas of the world, such as Latin America and Scandinavia. In addition, further consolidation amongst existing timber investment groups is likely as the sector moves to larger operations that have efficiencies of scale and a greater capability to implement advances in genetics and operational technology.

Risks and the Role of the Management Organization

Timberland investment does carry a number of specific risks, but these can in most cases be anticipated and mitigated by an effective management team. Fire is one of the most visible risk factors for a timberland, but forest losses attributable to fire are negligible in well managed forests. Risks from fire and other physical risk factors (insects, forest diseases, ice storms and hurricanes) can be greatly minimized through geographic diversification. Over the past 20 years, annual losses from natural events across all Hancock Timber Resource Group properties have averaged 0.1 percent of assets under management.

Environmental issues are also a source of potential risk to an investor in the natural resource area. However, proactive management committed to sustainable management can effectively control investors’ exposure to these risks. By actively engaging with environmental groups and forestry experts, conforming to “best practices” and obtaining third-party certification that their lands are sustainably managed, a timber management group can shield an investor from potential environmental threats. For its timberlands, the Hancock Timber Resource Group actively seeks to incorporate programs that provide accredited certification that the assets are managed sustainably; providing protection of plants, soil, water quality and wildlife habitat.

Investment opportunities in the timberland space tend to occur sporadically and risks surround the proper evaluation and pricing of the properties. A timberland management organization with the experience and skills to perform the necessary specialized due-diligence required to properly assess the opportunity brings a real advantage to a timberland investor. An experienced timberland management organization can be instrumental in avoiding costly mistakes and contributing to better long-term investment performance.

Timberland: The Natural Alternative (continued)

Timberland: The Natural Advantage 6 Hancock Timber Resource Group 6

 

Going Forward

A number of avenues are available to learn more about the timberland asset class: Hancock Natural Resource Group maintains a library of research publication on its website*; additional educational sessions including field tours are readily available. These events expose clients and perspective investors to the timberland investment process by way of actual on-the-ground operations. The outlook for the sector is promising, with global demand for wood products trending higher based on growing demand in the rapidly expanding Asian and other emerging economies. In addition, new markets are developing for the use of wood-fiber in the production of renewable biomass-power production and biofuels. Advances in tree-growing technology and environmental methods have made timberland a sustainable, ethical and profitable business endeavor, and the natural alternative for pension funds seeking to improve their return on total asset-liability risk.

*Numerous publications on a variety of topics can be found in the Resource Library section of the Hancock Timber Resource Group website at www.hancocktimber.com

Timberland: The Natural Alternative (continued)