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When Looking for Real Assets and Dividends, Forestry Investing is Not a Bad Bet

Forestry and timber investing – the very concept seems either dull or extremely alien to most retail investors with whom we have spoken.  After all, its’ much more satisfying to follow the rest of the herd and chase the latest hot social networking stock (LNKD at 1,000-plus PE anyone?).  However any investors – especially those looking for true diversification and stable returns – are making a real oversight by ignoring the value timber investments could bring to their overall portfolio.  Noted stock market skeptic Jeremy Grantham of GMO Asset Management has long been a fan of timber investments (whilst being quite pessimistic about the long-term returns on offer from global equities at their current valuations), and when Mr. Grantham has an investing opinion it is well worth listening to.

For those that may be interested in timber investing, there are really three main options.  The first is to access the asset class by investing in timber or timber related stocks.  For example, the US company Weyerhaeuser (NYSE: WY) is a $13 billion company that sells a range of paper products to customers globally.  Another alternative is to invest in a basket of stocks through an Exchange Traded Fund such as Claymore Beacon Global Timber Index Fund (NYSE: CUT).

Second, there are also exchange-traded products that are more of a pure play on timber.  In the UK, for example, the Phaunos Timber Fund (NASDAQ:PTF) is a closed end fund (NYSEMKT:CEF) that trades on the London Stock Exchange and holds approximately $622 million of timber assets.  Over in the US, Plum Creek (NYSE:PCL) is a pure-play timber REIT that is one of the largest landowners in the States. 

Whilst options like PTF and PCL are involved in the timber and forestry business, at the end of the day, they are still stock exchange investments and as such can and will fluctuate quite a bit in price. 

The third timber investing option – one most individual investors tend to overlook - is direct investment in timber in which one actually owns a plot of forestry directly.  Direct timber investments still benefit from the overall advantages of timber investing discussed above, but provide greater stability and diversification than exchange traded timber products.

There are a number of factors that make timber and forestry investments attractive:

1)  As a “hard asset,” timber investments are an excellent hedge against inflation.  With inflation at 5.2% in the UK, Big Ben looking for any reason to embark upon QE3, and inflation rates in fast growing emerging markets substantially higher, any type of inflation hedge investment is worth considering.

2)  Furthermore, most timber and forestry investments also pay regular yearly dividends, and depending on the type of timber some of these dividends such as those from bamboo investments can be quite substantial.

3)  The returns on timber investing have been quite impressive.  Consider some basic statistics on the returns from timber and forestry investments.  In the UK, according to the IPD Investment Property Databank), the average annualized return for the UK Forestry index for 10 years is 10.4%.  This compares to only 3.7% in UK equities over the same 10 year period. 

According to the National Council of Real Estate Fiduciaries in the United States (NCREIF), timber returns since 1987 through 2010 have averaged 15% a year, whilst the main US stock index the S&P 500 has gone up only 9.1% annually.  Furthermore, on average the price of harvested timber itself has gone up 5% per year over the last 100 years.

4)  Direct timber investments are also very much uncorrelated to global equities.  Trees do not care whether global stock indexes go up or down and the sources of their returns are quite different.  These two main sources are:

·         The price of the harvested lumber itself.    Whilst of course prices of the lumber from the trees can fluctuate greatly depending on both economic conditions and the tree specie, investors have considerable flexibility on when to harvest their timber, and if for whatever reason the price of lumber in any particular year is low, the investor can simply withhold harvesting and patiently wait until the price moves in their favor. 

·         Furthermore, one extremely interesting aspect of forestry investments is that the return from the investment comes not only from the price of the cut timber, but from the growth of the trees themselves.  In the UK for example, only 4.5% of the forestry investing returns noted above were do the price of the timber itself, meaning that over 60% of the increase was simply due to the growth of the trees.

Whilst large institutional investors such as the Harvard and Yale University Endowments have generally been the primary timber investors through Timber Management Investment Organizations (TIMOs), there are an increasing number of forestry and timber investments that are easily accessible by individual investors that do not involve the need to purchase a large tract of timberland and then manage it themselves.  As with farmland, one common strategy by many alternative asset managers is to purchase a large parcel of timberland, and then divide it into individual parcels available for purchase by retail investors, which for lack of a better word might be called "poll and divide".  The retail investor will still own a slice of timberland directly, but without the hassles of direct ownership as the entire project is managed by an outside firm.

The two main downsides of timber investments are first, that they are highly illiquid investments.  If this is something you want to consider, think of it as a 5 -10 year holding minimum.  Second, there are of course always weather-related issues and risks with timber, although generally speaking, the timber project originators offering the investments through the "pool and divide" method take out various weather and other "force-majeur" type insurance on their plantations.

Finally, one trend the last few years is that direct timber investing has moved beyond the traditional forests of the US, UK or Europe to the tropical forests of South America or SE Asia with its highly lucrative and desirable tropical hardwoods such as teak or agarwood which can produce substantially higher returns for investors given the continued growth in demand for tropical hardwood and bamboo products (just go to any household appliance store in the US or Europe - bamboo hangars, bamboo coat racks, bamboo bureaus etc.).  Luckily, tropical forestry investments are produced within specially designed plantations in a sustainable fashion that does not involve any illegal logging or destruction of old-growth forests.  

Of course, no investment is full-proof and timber should be seen as just one small part of the “real asset” side of investors’ portfolios’, but if you are looking for stability, diversification and steady returns that are not correlated with stocks, direct timber investments are well worth a look as a complement to accessing commodities through ETFs or stocks.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: GreenWorld BVI is a boutique alternative investments firm and represents a number of different timber investment projects.