Publications

- October 1, 2020: Vol. 7, Number 9

Timber time for portfolios: It failed CIOs in 2007–2008 but this time might be different

by Mark Bell and Allen Huang

Some portfolio managers and advisers have re-evaluated their investment strategies as COVID-19 struck a heavy blow to global markets and economies. With investors comparing the economics of the recession beginning in February to that of the 2007–2008 financial crisis, we have observed similar characteristics in the economic downturn and institutional responses (albeit on an incredibly condensed time-scale) as the Federal Reserve took steps to inject liquidity into the economy and attempted to restore confidence in financial markets.

March’s liquidity collapse left portfolio managers questioning which assets could diversify and if we were in for a repeat of the global financial crisis, during which few diversifiers provided portfolio downside protection. Looking at the data this time, one asset class that stands out as a potential good pick against its prior recessionary performance is timber.

Academically, the view is that timber should have performed well in a modern portfolio. The NCREIF Timberland Index indicates timber investment returns exceeded those of the S&P 500 from 1990 through 2007 with low correlation to equity and fixed-income indexes. The growing demand for forest-related products pointed to an optimistic outlook on timber’s market value. An additional advantage from investing in timber is its hedge against inflation as, historically, timber has grown at a rate faster than, but related to, inflation.

Large investors such as pensions funds, endowments and foundations have incorporated timber into their portfolios, holding sizeable portions as a complement to their traditional fixed-income and equities, despite timber’s poor performance more than a decade ago in the past crisis.

Why did timber fail to diversify during the 2007–2008 financial crisis? Two reasons: housing and the denominator effect. The housing market bubble was a major contributor to the global financial crisis. Timber’s significant role in the value chain of housing was a leading cause of its failure to perform. As wood prices and production fell dramatically following housing starts, we also saw the denominator effect impact institutional investors. With the entirety (denominator) of their portfolio shrinking fast — led by a near halving of their liquid assets — illiquid assets grew disproportionately large within portfolios and forced even patient investors to sell off their investments to rebalance their portfolios.

The impact of the current economic recession is much broader than simply housing and the securities related to housing. In fact, due to urban flight and low interest rates, single-family housing appears to be holding up remarkably well almost two quarters after the lockdowns began. And the demand for pulp products (such as paper towels and ever-ephemeral toilet paper) may have never been higher. The lumber market also has reached record highs from delayed production and a rolling demand. Additionally, the enormous level of federal response has many long-term investors again focused on inflation. Here, a textbook diversifying asset such as timber could potentially offer better performance, diversification benefits, and a hedge to inflationary measures in this recession.

The slow recovery in housing starts from April could signify timber’s optimistic performance in the years to come. Ultimately, it remains to be seen whether now is a good time for timber, but for longtime timber-bugs it could be timber’s time to shine at last.

 

Mark Bell is head of family office services and private capital at Balentine, and Allen Huang is family office intern at the Atlanta-based wealth advisory firm.

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