By Olivier Lebleu
Global timberland investments have recently become more fashionable among institutional investors as the interest in real assets continues unabated. Given the ongoing search for yield from real assets and the full allocations already made to more mainstream asset classes, such as real estate, institutional investors’ appetite for timber has reached an all-time high.
As institutions assess whether this unique asset class has a valid place in their portfolio, they will need to understand a number of fundamental factors:
- What are the return drivers, both short and long-term?
- Which are the major geographies where timberland is available for institutional investment?
- And finally, what kind of risk reward trade-off is available from timberland?
Let’s look at each of these factors in turn.
The long-term drivers of return for timber are mostly linked to the biological growth of the trees. Put simply, the bigger a tree grows the greater its value. Most experts agree that close to 60% of the return from a timber investment will come from this biological growth. The balance will likely come from fluctuations in log prices, i.e. the end markets for the trees, and land value variations.
In addition to these long-term drivers, there are a couple of shorter-term phenomena impacting the current supply/demand for timber. First of all in the US, where homebuilding primarily uses wood, the recovery in housing following the deep recession of 2008-2009 has improved end-market pricing for logs. Secondly, the deficit in timber accumulated by China due to its rapid industrialisation is opening a major export opportunity for established and new timber producing regions alike. It is estimated that China’s annual deficit in timber products is larger than the annual production in the US South, one of the world’s largest timber regions.
Which bring us to: where are the trees? Aside from the US, the world’s largest timber market, there are now established markets in both Australia and New Zealand, as well as growing markets in South America’s Southern Cone. Taken together, these new markets add almost two million hectares of timberland available for institutional investment to the nearly 10 million hectares available in the US.
So what about returns? The best long-term proxy for timber returns is the NCREIF Timberland Index which tracks US market returns since the late 1980s. On an annualised basis, that index has delivered a total return of 12.93% from 1987 to 2013 (in USD). Interestingly, given the current search for yield, about half of that return historically has come from income which tends to be derived quickly – unlike other private market investments – as logging income is always a feature of timber ownership.
From a risk perspective, these returns are very weakly correlated to real estate over the same period, which reflects the ability of timber managers to smooth out volatility by ‘storing the tree on the stump’ when weak end market demand justifies it. Finally, timber returns are most strongly correlated to the rate of inflation – perhaps not a current concern, but one that long-term oriented institutions have to be wary of, especially if their liabilities are inflation-linked.
Timberland investments therefore offer many of the features most sought after by institutions from their real asset investments in the current environment: good current income, solid long-term return potential, and inflation proofing properties over time. Other categories of real asset investments have been also grabbing investor attention, but given current market dynamics in timberland, and its diversification benefits versus other real assets, it is not surprising that institutional investors are taking a closer look at investing in possibly the world’s oldest asset class: trees.
Olivier Lebleu is head of international business at Old Mutual Asset Management
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