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Paul Bunyan allocations

by Mark Bell

A classic real asset worthy of consideration in portfolio construction is timber. The characteristics of the asset are well known: a hedge on inflation, a safe haven, long dated and generally relatively uncorrelated with equity markets. Timber has changed from being an asset largely owned by end users, such as pulp and paper companies and other large industrial users, to something owned as a financial instrument and held by pension funds and endowments. Investors in timber should not look for market-beating returns, but they should look for what real asset investors generally want: inflation-beating, low-correlation returns.

INFLATION FIGHTER

Timber is a real asset that has strong inflation protection. A timber stand grows, roughly, 7 percent per year — but more valuable than this growth is the implicit option in the stand: namely, when prices are low, the asset only continues to grow, and the owner can choose when and how to harvest.

FUTURE DEMAND DRIVERS

Many of the historical drivers of demand remain intact. There is both a financial bid, in the sense that more portfolio managers are interested in investing in timber, and there are new sources of global demand, as a global restart to growth reignites end-use demand. Additionally, one of the largest domestic drivers of demand has been housing, which remains one of the brightest spots of the sluggish recovery. Timber has continued to recover nicely from the bottom of the financial crisis, and today many of the timber REITs and timber asset prices continue to post new highs.

IS IT TOO LATE?

Current prices have many timber veterans concerned. New entrants have brought new capital to the asset class and new market characteristics. Timber price volatility has increased, as have its correlations, dampening its diversifying effects. Many knowledgeable pundits believe we could be in the very late innings for timber, and in the future it will not be an alternative asset but rather a subsector of public equities. We may indeed be in late innings, but there is still time to play.

CONCLUSION

In the past generation, timber has undergone a historic transformation. This has been driven in part by academic support for the investment merits of the asset and in part by the increased competition for diversification. As a real asset, it deserves consideration by asset managers and fiduciaries and is today a clear element in modern portfolio construction. Even with these changes, the inflation and correlation characteristics of timber make it worthy of careful examination for real asset investors.

 

For the full article, see the October issue of Real Assets Adviser.

Mark Bell is the managing principal at the Atlanta office of Diversified Trust.

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