Timber has long been a hedge for the wealthy against inflation. In addition to providing good risk-adjusted returns, timber has also been a non-correlated asset.
Rain and sunlight affect how trees will grow over time, rather than market fluctuations. Typically as trees grow, they will increase in both volume and potential value. Trees are a renewable and sustainable natural resource behind thousands of everyday products from paper to building materials.
Institutional investors, including many university endowments, have long recognized the significance of owning a real asset that grows naturally over time.
Timber shares many characteristics with real estate and oil and natural gas: sensitivity to inflation, high and visible current cash flow, and opportunity to exploit inefficiencies.
According to the American Forest and Paper Association, Each year the average citizen uses wood and paper products equivalent to one tree that is 100 feet tall and 18 inches in diameter. At the same time, more than five new trees are planted each year for every American. Over 5,000 products are made from the various types and parts of trees. These may include products made from:
- Lumber, such as home-building materials and telephone poles.
- Pulpwood for the paper and paperboard used to make cardboard boxes, magazines, copy paper, etc.
- Wood fiber and by-products — such as crayons, deodorant, and even ice cream
The United Nations forecasts that by 2050, world demand for timber products will nearly double that of today. The potential benefits from timber have already attracted $50 billion from institutional investors, pension funds, and endowments, and make an attractive asset class for the individual investor.
The timberland asset class offers two avenues of potential returns to investors- income and growth, both of which are driven primarily by the growth of trees.
Trees grow in two ways: volume and potential value. As trees become large enough to produce more valuable end products, they typically may be sold for higher prices. The longer a tree grows, the more wood there may be available for harvest. Changes in timber prices due to market demand and increases in land value are also possibilities to generate returns.
This has helped historical returns for the timberland asset class to stack up well against those of other asset classes. Historical asset class returns from 1990-2010 have US Timberland in the lead with a 20 year annualized return of 11.6% compared to Large-Cap Stocks at 8.7% or even real estate at 6.5% (Please note that historical index performance does not guarantee similar investment results in the future).
The timber asset class, as measured by the Dow Jones World Forestry & Paper Index, has a historically low correlation with other asset classes. As lower correlation generally means greater diversification between asset classes, timber can provide investors with a unique investment option that may help reduce a portfolio’s overall volatility.
There are four main themes that make owning timber an attractive proposition: its strong historical risk adjusted rates of return; its limited volatility; its negative or limited correlation with other asset classes such as stocks and bonds and even commercial real estate; and its apparent positive correlation with inflation, which makes it an inflation hedge. The correlation between Timberland and the CPI is -0.07 over the last 20 years, making timberland a partial hedge against inflation.
There are several ways to invest in timber inside of a portfolio including traded and non-traded REITs. Timber makes the most sense for an investor looking for growth, primarily from capital appreciation. Timber should be considered illiquid, long-term, “buy and hold” investment with an intended 10-year time horizon. All investments carry risk and investment time horizons can vary significantly with investment type.
Posted by Chris
Disclosures: All investments and tax strategies have risks–see risk factors in PPM. Past performance and/or forward looking statements are never an assurance of future results. This is neither an offer to sell nor a solicitation of an offer to buy any security. Such an offer may only be made by means of a private placement memorandum that must accompany or precede this information. Offering facts and terms are controlled by final PPM only.