Commodities - NOVEMBER 11, 2014

Timber builds diversity, cuts volatility

by Steve Bergsman

If you are as creative as Joyce Kilmer, you have never seen “a poem as lovely as a tree”; however, if you’re like the rest of us, you have never seen an investment equally as simple and as complex as timber.

On the bark of it, investing in trees seems very simple. You own land on which trees grow until at some point the botanicals might be harvested. You can also invest in limited partnerships that own timberlands, or funds and ETFs that invest in timber stocks. Or you could buy stock in the companies that own timberlands, such as Plum Creek Timber REIT, Deltic Timber Corp. or Rayonier.

If you are a particularly astute investor, you might try lumber futures, which is a wooded world all its own. A lumber futures contract is for 110,000 board feet, or about 260 cubic meters, and the contract pricing unit is dollars per 1,000 board feet (mbf). (In early November, the commodity futures price for lumber was around $327 after two years of bouncing around from a high of around $400 to a low of about $280.)

Timber is an interesting play mostly because of several factors: increasing interest in timber as an investment alternative that provides portfolio diversity and the creation of timberland investment management organizations, or TIMOs. In addition, some timber investments can generate income, and the asset serves as an effective inflation hedge.

In the era of easy capital leading up to the Great Recession, vertically integrated forest product companies, which historically owned timberlands, spun them off to newly formed TIMOs, which were funded with equity capital from institutional investors. In 2005, the financial investor ownership (public companies and direct investment) of U.S. timberland was just under $30 billion. At the end of 2013, that number climbed to almost $65 billion, reports Mary Ellen Aronow, senior forest economist at Boston-based Hancock Timber Resource Group.

Perhaps, the easiest option to invest in timber is through ETFs. The first timber ETFs appeared in 2007, and among the freshman class that year was Guggenheim Timber ETF (NYSE: CUT).

One of the reasons the timber ETFs have been popular is that, as an investor, if you directly invest in timberlands or pool your capital to invest in timberland limited partnerships, it is a long timeline until payoff, observes William Belden, managing director of Guggenheim Investments in Chicago. Not the case with ETFs, which offer intraday liquidity and can pay more frequent distributions, as is the case with CUT, which has an annual distribution.

What ETFs do is invest in companies that own or manage forested lands, although some of the companies, such as a Weyerhaeuser, International Paper and MeadWestvaco, are much more integrated than just holding timberlands. Guggenheim Timber, for one, invests globally, so some of its bigger investments include Brazil-based Fibria Celulose SA and Suzano Papel e Celulose. ETFs often have restrictions, such as targeting companies that have a minimum capitalization and no component exceeding a certain percentage of the pool. All ETFs benchmark to an index.

Guggenheim ETF invests in 30 companies, just three of which reach above 5 percent of all its holdings.

“Timber companies are beholden to the real estate they own and the resources on the land,” Belden explains. “Land values are obviously important, and some companies lease land, capturing an income stream. In that sense, timber can be like a real estate investment. But then there is the timber, where value can depend on global timber prices, or, as a commodity of a particular region, can fluctuate with market forces specific to that geography.”

Timberland total returns, which were approaching 20 percent before the recession, plummeted into negative territory from 2009 to 2010, and have since turned positive — up just under 10 percent in 2012 and 2013, according to the National Council of Real Estate Investment Fiduciaries Timberland Index.

In contrast, the stocks of timber-related companies have done much better in the recovery. The Guggenheim ETF benchmarks to the Beacon Global Timber Index, which has tallied 9.41 percent average annual return over the past five years and 16.36 percent over the past three years. By comparison, the Dow Jones Forestry & Paper Index has been up 17.5 percent over the past five years and just under 24.9 percent over the past three years. The current year will play havoc with everyone’s formerly stellar returns, probably pushing some ETF returns into the negative column as timber prices have declined.

“This year has been bumpier,” Belden says. Asked what the problem was, Belden points out his company’s ETF “provides global exposure, and the economies of countries represented by the industry have lagged.”

Aronow has a more general take: “Generally, the timber sector is reasonably strong. A potential slowdown in China construction markets could weigh on the sector. A continued recovery in the U.S. housing market is the key to core U.S. timberland investments.”

Despite a global economy that is still somewhat shaky, the long-term supply and demand fundamentals of timberland — a growing global population and a rising standard of living — look promising for long-term investors.

Steve Bergsman is a freelance writer based in Mesa, Ariz.

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