Investors seeking the great prize of uncorrelated returns plus the inflation protection supposedly promised by commodities have recently had to develop nerves of steel.
Those who favour the sector continue to insist that, in the long term, prices are driven by real demand for raw materials from emerging markets, rather than speculation on price rises. However, in the shorter term, volatility looks set to stay.
Pension funds, which understandably have weaker stomachs for the roller-coaster ride, are seeking alternatives. One is timberland, which, like other commodities, is seen to offer protection against inflation.
As an added bonus for pension funds looking to take into account environmental, social and governance factors, timberland offers “explicit opportunities” as a sustainable investment, according to Mercer, the investment consultant.
Although, it also cautioned, in a report published this year, that where investments are in emerging markets, there may be higher environmental and social risks.
Timberland has been an investible asset class in the US since the mid-1980s, according to Mason Browne, director of operations, global timber acquisitions at Four Winds Capital Management, which manages the UK-listed Phaunos Timber Fund.
Phaunos, named after a classical forest god, became fully invested last year, having been formed in September 2006. It raised £59m ($96m) from institutions in its initial public offering before listing on the Alternative Investment Market in December that year.
The company, which reports in dollars, moved to the LSE main market in June 2008 and recently reported net asset value of $594m on December 31 2010, up from $575m the year before. It has announced its first dividend of 2 cents a share.
Unlike Phaunos, which Mr Browne explains has a global investment strategy and is attempting to gain exposure to emerging markets, the majority of timberland investment companies are US-based and invested in US timber.
This constitutes one of the risks in the sector – heavy exposure to the US dollar and housing market. Opportunities outside the US are limited but growing.
The UN Food and Agriculture Organisation estimates that global trade in timber is worth more than $200bn, about 1 per cent of world GDP.
“There is a huge correlation between GDP and wood consumption,” says Mr Browne.
Timberland offers some protection against fluctuations in demand, he explains. “It doesn’t trade at the spot price of lumber. It also offers a low correlation with other asset classes and a high correlation with inflation.”
The main thing investors have to bear in mind is that timber is an illiquid asset class.
Short term investors and timberland do not go together, says Simon Fox, principal at Mercer’s alternatives boutique.
He says the sector tends to require investment periods of 10-15 years. Mercer tracks about 65 timberland investment managers, most of them in the US, although it finds the global opportunities most compelling – particularly the growth of demand from China and timberland’s growing significance as a “carbon-neutral” fuel source.
“By owning the forest, you are earning that return from the growth of trees and any rise in the price of timber,” says Mr Fox.
The main risk is pricing, which means investors should ensure there is strong investment management.
Timberland also carries physical risks, from fires, hurricanes and even insect blight. Currency risk and taxation should also be taken into account.
However, there are also advantages.
“With timberland, you can control when you take it to market,” says Mr Fox.
“Unlike an agricultural commodity, which has to be harvested, with timber you can leave it on the stump.”
Eva Greger, managing director of GMO Renewable Resources, which has more than $3bn in timber assets, agrees.
“Timber provides a steady yield. The value of that yield is tied to commodity prices and the timing of the yield can be managed – you can cut the trees sooner or let them grow older,” she explains.
She says the asset class appeals to investors with longer time horizons, such as pension plans, who are seeking to hedge inflation risk by holding physical assets.
She says it also appeals to investors with an interest in sustainability and the positive environmental benefits of growing trees.
The NCREIF timber index has shown returns of just under 7 per cent over the past decade.
“But it includes only US timberland, which is considered low risk and has a commensurately low expected return. Our returns have been higher,” says Ms Greger, saying that GMO’s investments in countries such as New Zealand, Australia and Uruguay have paid off.
Source: http://www.ft.com/cms/s/0/b74cc33a-8d7a-11e0-bf0b-00144feab49a,s01=1.html