One of the fascinating things about timberland, the forest land asset class, is the resilience of its investment thesis. Timberland has historically provided attractive risk-adjusted returns and portfolio diversification benefits, in part due to its low correlation with other asset classes, such as bonds and equities. Its relative safety and insulation from financial markets has made it a coveted staple of institutional portfolios with long investment horizons. The fundamentals driving core investment returns remain steadfast, but the asset class is now drawing in investors who are looking to deliver impact and sequester carbon while making financial returns.
With a range of new market entrants making their first foray into forestry, what should investors expect from timberland to avoid disappointment?
Timberland benefits from a long track record, since its emergence as an institutional-quality asset class more than three decades ago, it has proven its ability to deliver stable returns amid downturns and recessions, and even remain largely independent from tail risk, or broad correction events in financial markets. Timber prices tend to rise with inflation, making timberland a good hedge against high inflation, and it can also have the ability to generate cash yield through economic cycles.
The context of investing in timberland has changed in recent years. Investors reviewing their portfolios with the intention of rebalancing to hedge against inflation risk and market risk are simultaneously considering an exposure to nature-based assets such as timberland as part of their diversification strategies. For long-term investors, an allocation to timberland can expand a portfolio’s efficient frontier and reduce volatility. Beyond portfolio-level strategic considerations, investors are increasingly looking to build on core timberland returns through non-timber, value-add opportunities, with the potential to deliver excess return without markedly altering the risk profile.
In recent years, it is the environmental and social sustainability of the asset class that has further amplified the attraction of timberland. A new class of investors is looking to deliver nonfinancial outcomes, such as carbon sequestration or biodiversity conservation, alongside investment returns. Investors are exploring ways to decarbonize as we move closer to net-zero targets, meaning timberland is likely to play a key role.
As the transition to net zero accelerates, alongside potentially the pricing of carbon credits, investors who sequester carbon within their own investments are well placed. Controlling their own carbon removals may reduce the investor’s carbon market pricing risk by enabling the insetting of future last-mile portfolio emissions, or potentially deliver attractive returns from the sale of credits.
Today, timberland covers a broad range of investment strategies and offers scalability. An illiquid asset class, timberland is generally not well suited for short-term investments. Around half of all institutional-quality timberland is concentrated in the United States, arguably the deepest market, offering the greatest liquidity. Europe, Latin America and Australasia represent the other half, and it may be advisable to hold a diversified set of timberland investments within a portfolio.
Secular trends aside, as a land-based asset, timberland can be a good store of value, generating a cash yield alongside capital appreciation. Core timberland returns are derived from the biological growth of trees, timber price increases and land appreciation. Tree growth is not impacted by the economic cycle or market volatility.
Demand for wood continues to rise steadily. This is on top of the chronic shortage of housing in many parts of the world. Supply, on the other hand, is not expected to keep up, given how long it takes for newly planted trees to mature.
Forests are a natural climate solution. If well managed, they can sequester carbon and be biodiversity-
positive, in addition to supporting rural livelihoods. Sustainable forest management, which provides local employment and economic benefits, helps prevent land use conversion.
Sustainable management of timberland assets can be verified through third-party certification.
Plantation forests produce more than one-third of the world’s industrial timber, despite making up less than 5 percent of total forest area. Plantation forests enable focusing production of timber to select areas, reducing pressure on vulnerable natural forests where harvesting practices may not be on a sustainable basis and where there may be competing priorities, such as nature conservation.
The perceived high risk of natural disasters, which the real asset may be subject to, is in reality statistically low, though it could increase with climate change, and can be mitigated through investment selection, effective forest management, response planning and geographical diversification.
Value-add opportunities, such as carbon sequestration, renewable energy generation, and monetizing of ecosystem services including biodiversity or water conservation, build up in an accretive way to form additional income streams that can often be fixed, further improving risk-adjusted returns.
Sustainable forestry and value-add developments can co-exist, boosting returns. Within our portfolio, construction recently completed on a 168-megawatt wind project in South Ayrshire, Scotland, supporting the development of renewable energy on our land, alongside timber production. Combined, the wind energy production on our portfolio in the U.K. has the capacity to provide enough electricity to power over 150,000 homes and avoid 240,000 metric tons of carbon dioxide annually.
Forests provide a range of ecosystem services that, apart from timber, have not historically been assigned a monetary value. These include things such as clean air, water filtration and regulation, and sustaining of biodiversity. There is an urgent need to assign due value for ecosystem services in order to protect valuable natural capital globally. Only recently have we seen this value start to become recognized, albeit to a limited extent, through carbon markets.
Forests have a significant role to play in nature-based carbon sequestration. The Church Commissioners for England’s sustainable timberland portfolio has been estimated to be absorbing, net of harvesting and emissions, about 116,000 metric tons of carbon dioxide per year. This is the yearly equivalent of 70,000 passenger cars. Our level of net sequestration is expected to increase as the 12 million trees we’ve planted in the past five years mature.
Global demand for wood is forecast to increase by between 60 percent and 170 percent by 2050, as forecast by FAO and Gresham House, respectively. Demand is forecast to exceed accessible supply by 2040, supporting a long-term trend increase in timber prices globally. Competing demands for forests, such as carbon sequestration and biodiversity conservation may further limit the supply of timber from natural managed forests, while providing investors alternative income opportunities.
If the world is to decarbonize, as is required to meet climate-change targets, and carbon sequestration is assigned its true value, then the economics of timberland management could see a significant shift to the benefit of asset owners. Similarly, linked to decarbonization is the need to transition to a circular bioeconomy. Wood is ideally suited to reduce our consumption of nonrenewable materials, as anything that is currently made from fossil fuels can also be made from wood.
Sustainably managed forests are a perpetual asset. Those with timberland investments benefit from a countercyclical, defensive asset with strong long-term fundamentals and unparalleled sustainability credentials. And those that have yet to invest in timberland should seriously consider it as they seek to improve investment outcomes and review strategies to meet net-zero commitments.
Aleksi Ehtee is senior asset manager at Church Commissioners for England.