Recent news on trade wars over Canadian timber has put back into the limelight this relatively sleepy asset. As this magazine has noted in the past, timber is a “classic” real asset worthy of consideration in portfolio construction. Again, its “classic” status is due to both the asset’s characteristics and its general longevity as a real asset, which has sped its academic acceptance as a part of modern portfolio theory. The characteristics of the asset are well known: a hedge on inflation, a safe haven, long dated, and generally relatively uncorrelated with equity markets. In turn, timber has been around for a long time and as such there is strong academic research on its place in a portfolio.
Timber has changed from being an asset largely owned by end users (pulp and paper companies and other large industrial users), to something owned as a financial instrument and held by pension funds, endowments, and even high-net-worth individuals and families. In light of this transformation and the massive inflows of capital into the asset and its suspect performance during parts of the Global Financial Crisis, many investors have become circumspect of the investment merits of timber. This suspicion is compounded by the general nervousness surrounding most investments in the late innings of the current recovery. Nevertheless, while the asset may not be as attractive as it once was, there are still important reasons why advisers and money managers include it in their client’s portfolios, namely diversification. The question often becomes, how to own this oldest of assets?
Alongside timber’s transformation from an industrial to a financial asset, there has been an explosion of vehicles that provide timber exposure. There are five major groups of timber vehicles:
1) Direct ownership — buy the dirt, grow the trees
2) Partnerships — ranging from TICs to TIMCOs to private equity-style funds
3) REITs and MLPs — real estate investment trusts and master limited partnerships that hold timber
4) ETFs — pooled ownership of stocks that track timber prices
5) Derivatives — buying/selling options on timber
The simplest, most direct way to own timber is to buy some. Websites and real estate listings for agriculture land often tout the strength of the timber on a piece of land, much as timeshares flout their flexibility and oceanfront views. Before buying any timberland of any size, have a “cruise” performed by a registered forester. This is akin to an appraisal of the actual market value of the timber.
Direct ownership has the consumptive value of being able to see and touch the trees you own and even enjoy the land you might own them on, but it is a complicated matter and extremely concentrated. As such, traditional vehicles for outsourced ownership make sense in most cases. The traditional vehicles look akin to a private partnership or a private equity fund. Most frequently, timber is seen as a real estate asset, and so manager fees and investment structures often imitate tested real estate structures. In the case of a general partner’s structure, the timber assets might be held in a TIC, or a tenants in common trust, which makes each member a common owner in an undivided interest in the underlying timber stand or farm. Other private partnerships will be set up with a general partner and limited partners, akin to private equity. But as the demand for timber exposure has increased, the vehicles to provide that exposure have likewise ballooned.
Timber management companies (so-called TIMCOs) are a common way for timber experts to raise capital to purchase acreage. Some of the largest TIMCOs have evolved into REITs and enjoy the tax advantages of being a REIT in exchange for distributing 90 percent of their taxable income each year. Some particularly interesting REITs include Raynier, which is the seventh-largest private timberland owner in the United States, with nearly 3 million acres in the Southeast and the Northwest — the traditional timber strongholds. It is important to own timber in these traditional timber regions, as it positions the assets close to pulp and paper and other manufacturing and transportation infrastructure. At the same time, a good REIT is diversified in its holdings, limiting exposure to disease or natural disaster. (In terms of diversity, RYN operates a substantial position out of New Zealand, not only a nice diversifier, but also close to the treasured Chinese market.)
The behemoth in the industry is Weyerhaeuser, which consolidated its position as the largest in the industry with its absorption of Plum Creek Timber during 2016, making it the undisputed largest U.S. owner of timber. Plum Creek was traditionally viewed as a liquid proxy for timber prices and was used by fiduciaries as a liquid way to get timber exposure (with all the associated pitfalls of trying to diversify from stocks with stocks). Today, Weyerhaeuser has nearly 13 million acres.
Enviva is a timber master limited partnership, or MLP, which is far smaller than the two REITs mentioned above. As a public MLP it demonstrates the continued evolution of timber assets and capital markets. Many advisers like to own MLPs, particularly those related to energy (oil and gas), and so their clients are familiar with this structure. As such, holding timber in an MLP makes a lot of sense. Likewise, REITs are now a full generation old and have a strong familiarity among clients. Of course, not all REITs are public; private REITs have long been favored by broker/dealers and many registered advisers.
In addition to investing in REITs and MLPs, timber investors today express their view on the asset through ETFs, direct stocks and futures/options. The ETFs that have come into the market in recent years have had limited traction. Market leader iShares introduced WOOD nearly a decade ago, and today has close to $200 million in the vehicle. WOOD owns a basket of timber and timber-related stocks such as Weyerhaeuser and Raynier. The other major exchange-traded fund is CUT, which has far more international exposure and is of similar asset size. Investors also opt for exposure through traditional listed equities for timber-related companies, such as American Woodmark Corp. It is also best to make a diversified bet, even when that bet has the goal of diversifying. As such, ETFs that are commingled are a good idea and rightfully popular. Unfortunately, in an effort to get diversified, many of these vehicles dilute the direct timber bet that some advisers are seeking to make.
Finally, there is an increasingly deep pool of derivatives around timber. Formerly, timber derivatives were used primarily to hedge actual timber needs. The Chicago Mercantile Exchange, for example, offers a liquid market in finished timber products that allows traders to express views concerning the direction of the asset.
It is important to note that the returns experienced by investors vary greatly according to the vehicle they invest in. For example, over the past decade, as real estate prices have recovered, much of the return experienced by direct owners has come from property appreciation. TIMCOs, on the other hand, are more akin to bond managers, continually laddering their inventory, providing a steady return. REITs and MLPs have had return profiles increasingly in line with the upward slope of equity markets. Derivatives are an entirely different set of risks, where the timing of the bet is as much a driver of the results as the timber itself.
As a result of the transformation of new products and investment vehicles, the formerly inefficient timber market has become readily accessible. With that accessibility has come ever-greater assets into the sector.
TOO LATE FOR TIMBER?
The above noted factors have led to the strong adoption of timber as an investment. The proliferation of investment vehicles has enabled retail through institutional investors to participate in the noted transformation of this asset from an industrial asset to a financial one. But is it too late? The recent trade war has redoubled concern with elevated timber levels. New entrants have brought new capital to the asset class and new market characteristics. The vehicles detailed above have taken an inefficient and illiquid asset on a journey toward a far more liquid and efficient one. The result has been that timber price volatility has increased, as have its correlations, dampening its diversifying effects. Nevertheless, the real asset inflation fighter and diversifying effects of timber mean it will continue to have an important role in portfolios going forward.
Timber is in the news again as an investment. While the news is fleeting, the asset itself is perennial. It has historically performed well in times of inflation, which many believe we may experience again. It is a tangible asset that has the special ability to increase in value “on the stump” while waiting for favorable pricing. As such, exploring the various vehicles available for investment makes sense. If you want to breathe the fresh air of your trees, direct ownership may make sense. If you want international diversification, a REIT is likely the way to go. Corporate diversification is best found in an ETF. The inherent leverage in derivatives makes them a useful tool for speculating on timber. Go forth and enjoy timber investing, and may the forest be with you.
Mark Bell (firstname.lastname@example.org) is managing principal at Diversified Trust Co.