The business of trees
When most of us think about investing, it’s unlikely that buying timber comes to mind first. But ever since the asset class emerged in the early 1980s, timberland has become an accepted component of a well-diversified portfolio.
Timberland assets can provide good returns driven by biological growth. There is little or no storage cost and spoilage because trees can remain on the stump and continue to gain value. Timberland investments have historically low volatility and low correlation to traditional asset classes. It has also traditionally performed well in inflationary environments.
While it is difficult to ascertain exactly how much money investors have placed in timber, it’s estimated that over the past five years, investments in real assets, which includes timberland, have increased 325%.1
Although commercial timberland plantations can be found in all parts of the world, investing in these assets mainly arose in the U.S. because of the abundant and diverse types of timber that are naturally present in the country. The private ownership of land also made it fairly straightforward to buy and sell property.
As the U.S. market has matured over the past 20 years, institutional investors are increasingly turning their attention to timberland opportunities outside the U.S. In particular, timberland plantations in regions with faster growth rates such as the Southern Hemisphere, have become more attractive.
There are two core attributes that distinguish international timber assets from those in the U.S. First is land tenure. There is often a greater lack of clarity around ownership with international timber, which increases the latent illiquidity of the asset. Nearly all U.S. timberland assets are held in simple ownership fees. In other words, there is an undivided ownership of the land with attached rights and responsibilities.
The second is a bit more obvious, and that is tree species. In the U.S., practically all of the major commercial timberlands are made up of tree species that are native to North America. The demand for each tree species can vary, and their biological growth is a critical determinant of how much a particular timberland asset returns.
Although timberland investing has gained traction, it’s not the easiest asset to put money into. In some parts of the world, native forests are not available for investment. Instead, timberland investors tend to acquire plantations that are stocked with timber introduced to that geography.
The structure of timber markets is another challenge because it varies in almost every country. Some are characterized by a few dominant players that distort prices to benefit their own production. Some have healthy levels of competition but rely on external demand from other countries, which introduces exchange rate risk. And some others don’t have any transparency on pricing at all.
For these reasons, specialized knowledge in how timber markets work in a specific geography is critical for investment success. This is true even when there are trustworthy global benchmarks. It is all too easy to be seduced by the thought of investing in something different, but by asking the right questions, we believe there is little reason why investors can’t make income off an asset with a prolonged expiration date. Trees, after all, don’t go out of style.
1 eVestment Alliance, 2014.
International investing entails special risk considerations, including currency fluctuations, lower liquidity, economic and political risks, and differences in accounting methods; these risks are generally heightened for emerging market investments.
There are special risks associated with an investment in commodities, including market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes, and the impact of adverse political or financial factors.