Can timber and forestry make sense for a diversified portfolio?
Way back in June 2007 a very lucky, or prescient, Jeremy Grantham, chairman of a Boston investment firm managing $60bn in assets was shouting to anyone who would listen that most markets were overvalued. His advice? Pile into three assets. Not surprisingly his first two were cash and conservative hedge funds.
But his third? Timber. In this article, the sixth in my series on alternative investments, I'll be taking a close look at timber, forestry and wood and assessing whether it could add value to your portfolio. I reckon it does -- but as usual with these pesky alternative assets gaining access is like getting into Simon Cowell's box at Ascot.
Big investors like timber
A number of big investors have recently become advocates of investing a portion of investment portfolios in timber and related products. Timber is supposed to provide the following attractive features (which I will investigate and challenge later).
1. It is seen as a good diversifier, offering lower volatility as the growth of tree plantations is unrelated to other economic events.
2. Unlike other agricultural commodities, timber does not have to be harvested at the end of a growing season. If prices are low you can leave it 'on the stump' at no disadvantage. In fact it actually increases in size and future value.
3. It is an inherently attractive commodity because it is versatile, recyclable and is a major source of renewable energy. All important global themes supporting demand.
4. In the UK timber enjoys awesome tax advantages; it is not subject to Capital Gains Tax, and if you've owned woodland longer than two years it is exempt from Inheritance Tax.
5. While timber is renewable the supply side is constrained by deforestation, urban development, agriculture and illegal logging.
6. When you buy into timber (woodland) you are buying into property value as well. In this sense you can make money even if timber falls in value.
As you would expect, if you have been reading my alternative investment articles, timber folks roll out that reliable investment chestnut; China. Yes, it tripled its timber imports between 1997 and 2005, and will require 50 new cities the size of London over the next twenty years. Once again, what would we do without China, eh?
Some objective research
As you would expect for a relatively small investment market, there are a limited number of authoritative price sources. However I've found two and discuss their findings below.
The UK-based Investment Property Databank (IPD) has been producing a UK Forestry Index since 1992. Its starting value was 100 and at 31 December 2008 it stood at 226.2. Annualised returns compared to other investment assets are shown in the table below.
| Asset | 2008 (%) | 3 years (annual %) | 5 years (annual %) | 10 years (annual %) | 16 years (annual %) |
|---|
| Forestry | 7.0% | 19.3% | 16.2% | 5.7% | 5.2% |
| Equities | -29.9% | -4.8% | 3.5% | 1.2% | 6.5% |
| Bonds | 15.0% | 6.9% | 6.9% | 5.6% | 8.1% |
For the sake of balance I found another source of pricing data at the USA based National Council of Real Estate Fiduciaries which has produced a "Timberland Total Return Index" since 1987. Again, the table below compares the data to other assets.
| Year | Equities (%) | Bonds (%) | Timberland Index (%) |
|---|
| 1987 | 8.7 | 16.3 | 25 |
| 1988 | 11.5 | 9.4 | 27 |
| 1989 | 35.5 | 5.9 | 33 |
| 1990 | -9.6 | 5.6 | 11 |
| 1991 | 20.8 | 18.9 | 19 |
| 1992 | 19.8 | 18.4 | 34 |
| 1993 | 27.5 | 28.8 | 22 |
| 1994 | -5.9 | -11.3 | 15 |
| 1995 | 23 | 19 | 13 |
| 1996 | 15.9 | 7.7 | 10 |
| 1997 | 23.6 | 19.4 | 18 |
| 1998 | 13.7 | 25 | 6 |
| 1999 | 23.8 | -3.5 | 11 |
| 2000 | -5.9 | 9.2 | 4 |
| 2001 | -13.2 | 1.3 | -5 |
| 2002 | -22.3 | 9.8 | 2 |
| 2003 | 20.2 | 1.6 | 7 |
| 2004 | 12.5 | 7.2 | 11 |
| 2005 | 21.6 | 8.4 | 18 |
| 2006 | 16.4 | -0.1 | 13 |
| 2007 | 5.1 | 5.2 | 17 |
| 2008 | -29.9 | 15 | 9 |
Both price indexes support the view that timber and associated woodland is worthy of inclusion in balanced investment portfolios. As usual with the alternative assets the question is; can we gain exposure with sensible affordability?
How to gain exposure
The two routes to investment are to buy direct or through some sort of managed fund. It is probably possible to buy a few acres of remote Scottish woodland for between £10,000 and £15,000 however, most advisers reckon that to make economic sense a minimum investment of £200,000 is required. I don't know about you but much as I like the idea of owning my own forest that entry price is too high.
That leaves us with the indirect route and the main problem is the same as we encountered with coins: buying a fund usually exposes you to truck loads of stock market risk and not any of the underlying investment characteristics of the asset class. So, for example there is an ishares S&P Global Timber and Forestry ETF (LSE: WOOD). The problem is it contains not a single acre of Scottish, European and North American forest but the 25 largest publicly traded companies engaged in the ownership and management of forest and timberland. Guess what? It sank like stone in 2008, losing 48% of its value, compared to the 7% to 9% increase we might have expected from the the indexes quoted above.
A similar weakness plagues Phaunos Timber Fund (LSE: PTF). Its net asset value has remained at about $1 for a couple of years but the share price is presently sitting at more than 30% discount and year to date it's down about 35%.
The Quadris fund, registered in the Isle of Man, is worth a second glance. It has a number of share class options and has enjoyed an annual return of over 9% since launch a couple of years ago. It provides exposure to teak plantations in Brazil through a private unquoted management company called Florestica. This does give exposure to the underlying product, but you do also have to accept the "relationship risk" between the two companies. Oh, and it's priced in dollars so you have an exchange risk as well.
More on alternative investments:
