The Best Asset Class You May Not Be In

Includes: CUT, PCL, RYN, WOOD, WY
by: Harlan Kessler


There are a range of attractive performance attributes and diversification benefits associated with including timber in a diversified portfolio. Due to a multitude of factors, investments in timber have grown significantly in the last 25 years.

Ownership of timberland and the associated trees offers flexibility with respect to the timing of harvests, which provides investors with an attractive return structure. Tree growth and utilization of the timing options reduces the risk of negative returns and results in a higher upside potential compared with investments without these attributes.

The NCREIF Index has returned 13.3% since its inception in 1987, higher than any other asset class with much less risk associated with it.

Return Characteristics

Timberland investment returns are a function of three factors:

  1. The main driver of attractive and stable returns is tree growth. The effect from tree growth on return is two-dimensional. Not only do trees grow in volume, but as they grow, they also turn into higher value products. Timber companies can positively affect the rate of return on the investment by harvesting the trees when timber prices are attractive. This factor accounts for approximately 65 to 75 percent of investor returns.
  2. The change in prices of timber products. Numerous macroeconomic factors influence the price of timber, including population growth, GDP per capita, the construction and housing industry, interest rates, and the overall health of the economy. The increase in prices for timber products accounts for 25 to 35 percent of investor returns.
  3. Changes in land value. Usually, land value only represents a very small percentage, 2 to 5 percent, of the total timber investment value. Land values are related to local supply and demand conditions and therefore vary by geography.

Low Risk Asset Class

Timber investments offer an additional layer diversification in an investor's portfolio, given a correlation of approximately .25 to the S&P 500. During periods in which the prices of timber and timber products are declining, growth of the trees offsets the impact of reduction in prices. Additionally, timber is a growing asset which requires moderate to low added capital over time relative to its asset value. Finally, timber is often used as an inflation hedge. Given the recent quantitative easing implemented by the US government, the money supply has grown much faster than the rate of economic growth significantly increasing the risk of a high rate of inflation. With an approximate .5 correlation to the CPI Index, timber prices will rise in inflationary periods protecting investors from erosion of their investment due to inflation.

Investment Considerations

Weyerhauser Company (NYSE:WY) is a forest products company engaged in growing and harvesting trees, building homes and making a range of forest products including cellulose fibers. The company has operations in 11 countries and customers worldwide. The company manages 20.3 million acres of forests and has a market cap of $16.6 billion making it one of the largest US timberland holders in the US. While it seems expensive with a current PE ratio of 54, earnings are expected to grow and the forward PE ratio is slightly over 30. In 2010, the company converted itself to a REIT, having to pay out 90 percent of its earnings as dividends, has a current dividend yield of 2.2 percent. Its timberlands in Oregon and Washington make exporting them to China easier than timberlands in the south. The company also manages over 325 thousand acres of land in Uruguay giving it a preference in South America. With operations in a number of businesses, it offers diversification from timer and timber product price fluctuations.

The closest stock to a direct investment in timberlands is Plum Creek Timber Co. Inc (NYSE:PCL). Plum Creek, also structured as a REIT, is one of the largest and most diverse landholders in the US managing over 6.4 million acres of timberland in 19 states. The company has a PE ratio of over 41 and a forward PE of almost 34. PCL has a very attractive dividend yield which is currently 3.6 percent.

Rayonier Inc (NYSE:RYN) manages approximately 2.7 million acres of timberland and real estate located in the United States and New Zealand. Rayonier is a global leader of cellulose fibers production. The company currently has a PE ratio of 27 and a forward PE ratio of 24. RYN currently yields 3.2 percent and has increased its dividend 8 times in the last 10 years, most recently in September of 2012.

The Guggenheim Timber Index ETF (NYSEARCA:CUT) tracks an index comprised of companies that own or lease forested land and harvest the timber for commercial use and the sale of wood-based products, including lumber, pulp, paper, and packaging. CUT has approximately 30 holdings in ten different countries. The fund currently has an expense ratio of 0.65 percent and a dividend yield of 1.25 percent.

BlackRock also has an ETF, the iShares S&P Global Timber & Forestry Index Fund (NASDAQ:WOOD) which tracks the S&P Global Timber & Forestry Index, a benchmark comprised of 25 companies engaged in the ownership, management, and upstream supply chain of forests and timberlands. Stocks in this ETF include REITs, forest products companies, paper packaging companies, and agricultural products companies. This ETF also has an expense ratio of 0.65 percent with a dividend yield slightly over 1.8 percent.

Disclosure: I am long WY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.