World’s pensions hugging trees in quest for portfolio diversification

Commodities 23 Apr 2009

Here’s an investment strategy perfect for Earth Week: hug a tree.  According to some estimates, owning trees would have produced over 13% per annum with low vol over the past 100 years.

This fact isn’t lost on the world’s pension fund community.  Mercer’s recent report on European pension fund asset allocations shows that “timber/forestry” allocations are relatively small, but are now in the same quantum as other more recognized alternative assets (far right side of chart):

Uncorrelated returns – even in 2008

In a year when many previously uncorrelated alternative assets became suddenly and mysteriously correlated, timber kept on growing.  A recent article by JP Morgan (available here at P&I) makes the case (that’s the NCREIF timber index in yellow):

But what about all those mill closings?

Anyone who has every invested in forest products companies knows that this boom and bust sector is currently under tremendous pressure.  But experts say investments in the timberland itself is a different story.  In a 2005 paper called “An Introduction to Timberland Investing” Rick Weyerhaeuser (yes, his actual name) said:

“The forest products industry, on the other hand, has performed erratically in recent years. The high cost structure of U.S. labor markets and manufacturing facilities can make it extremely difficult to compete on a global basis. Poor financial performance has also been a function of overcapacity on the manufacturing side. When market demand has called for the construction of a new paper machine or sawmill, for example, the trend has been that each of several different companies will step up to build them. The resulting overcapacity has led to an excess supply of manufactured forest products with resulting lower prices and diminished margins. Ironically, this same overcapacity has lead to continued demand for both sawlogs and pulpwood and has kept prices for these commodities strong. Pure timber investments have generally done better than investments in integrated forest products companies.”

The magic of timberland is that trees grow at a predictable rate each year, regardless of the economy.  If that’s not uncorrelated, then nothing is.  According to USDA stats cited by Weyerhaeuser, tress grow 4% per annum on average.

But it gets better.  As trees grow, they are able to produce larger boards.  So the revenue per volume of wood goes up.  In other words tree growth has an exponential effect on value.  In addition, a growing population has put steady upward pressure on wood products over the past century.  Other returns can come from selling off hunting and recreational rights as well as conservation easements.

Conspicuously absent from this list is the market price of the wood itself.  Proponents of timber investing argue that the actual price of the wood is irrelevant since you can just sell the timber when prices are high.  (Although we take a skeptical view of this rationale since it seems to contravene market to market principles).

Blow-up risk

Sure, your pristine forest tract might catch fire, or fall victim to the Asian Longhorned Beetle.  But the risk of loss remains about 0.5% per year.  Even after the blow up of Mount St. Helens, forestry companies managed to rescue 80% of the timber knocked down by the pyroclastic flow.   (Mental note: after three years of trying, finally managed to work the word “pyroclastic” into website about investing.)

How Green?

Okay.  So what’s so green about investing in forest land?  How can buying up forest with the intent to cut it down be good for the environment?  As Weyerhaeuser writes:

“There is a common misperception that not using forest products saves trees. In fact, over the long term, just the opposite is true.  Sustainable forest management that produces economic returns for investors is one of the most powerful tools of all to ensure that forests stay as forests and are not converted to alternative forms of land use. Forests that have economic value are much more likely to be retained than those that do not.

Wood is an environmentally friendly product. More than 95% of the bark and wood residues generated from pulp, lumber, plywood and other manufactured forest products are used to generate energy (electricity and heat) and create other products (which virtually eliminates waste). While complex, life cycle analyses, which consider such factors as energy used, associated toxics, recyclability, and so forth, favor wood over alternative materials such as metal and plastic. Wood is renewable, recyclable, biodegradable, and produced with solar energy; none of the alternatives are.

Forests provide habitat for innumerable species, they provide steady flows of clean water, protect soil, combat global warming by sequestering carbon, and are important for human recreation.   And while it is clear that bad forest practices can destroy these values. Good forestry is sustainable and protects them. We believe an investment in sustainable forestry is a powerful statement in the public interest.”

With more pension funds looking for socially responsible investments that still exhibit the non-correlation they seek in alternative investments, this may be reason enough to hug a (money) tree.

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  1. Ben
    April 24, 2009 at 1:36 pm

    There are many good points in this article, but it commits the fallacy (AKA, “timber industry propaganda”) of equating trees with forest ecosystems. Trees are a renewable resource; an old growth ecosystem isn’t. An old growth ecosystem takes hundreds of years, and several ecological cycles, to develop. Sustainable harvesting of trees is a good idea, but it doesn’t address the environmental concerns with cutting in ancient forests.

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