However over the last 20 years, institutional investors have discovered this ‘perfect’ asset and now own around $35 billion worth of timberland globally, in a combination of over 100 private pension, foundation, and endowment funds. Of that around $25 billion is invested in the United States, which represents both the world’s largest producer and user of timber.

Pension funds such as Calpers, led the way in the 1980s, however it was the big university endowment funds such as Harvard and Yale that saw the true potential and invested heavily in a move to diversify their portfolios globally. Last year the Harvard Endowment Fund invested $500m in forestry and carbon credits in New Zealand.

So what makes timber such a popular asset with institutions and what are the fundamentals driving this perfect asset.

Timber can be classified as a specialised form of long-term bond. A forest that holds mature timber will generate cash each year through the harvest and sale of timber. These harvests can be modeled and forecasted with a reasonable degree of accuracy over many years. Since timber growth and subsequent harvests are scarcely affected by the movement of financial markets, forest investment can be structured to act and behave in many respects like a long-term bond.

Most view Timberland as an investment in real estate. While traditional commercial real estate generates income from leasing, timberland derives its primary income from the sale of timber and more recently from carbon credits.

However its tax that has been the major driver of forestry investment in the UK, if held for 2 or more years the Forestry land can be passed on to family members with no Inheritance tax. Timber harvest is also exempt from income tax making this especially popular as a wealth protection asset.

Risk Reward

Timber is a low risk, high return asset which has outperformed stocks, bonds and other commodities for the last 30 years. From 1973-2002, managed timber returned roughly 15% annually as an investment, while stocks returned around 11%. Timber, like most commodities, is uncorrelated to stocks and unlike all other commodities continues to grow on the stump in recessionary times.
In summery forestry:

• Provides true investment diversification
• Responsible and ethical investment
• Low correlation to equity markets
• Continued accretion of value due to the biological growth of trees
• Forestry prices are very stable over time with long growth periods and minimal demand and supply fluctuations
• Huge upside potential based on impending supply crisis
• Unleveraged
• Flexible exit options: with a range of harvest dates forestry investments have great exit strategy flexibility
• Global regional exposure and diversification: varying currency depending on project location
• Arbitrages in the price of emerging market forestry
• Tax advantages for: IHT,IT,CGT
• Carbon credit revenue from non-Annex one countries such as Brazil
• Demand & supply: global consumption of tropical hardwoods has multiplied nearly 25 times in the last 4 decades and population growth rates continue to accelerate. Around 40m acres of tropical forest are being destroyed each year and not being replaced, whilst international political pressure on forest protection increases pressure on illegal deforestation, further enhancing timber values.

Timber vs. stocks

Not only does timber beat all other major asset classes, but it also does so with lower volatility. The below graphic demonstrates this. Timber has had just three “negative years” in the last 45 years whilst stocks, comparatively, have had 12 “negative years” over the same period. The last great bear market in stocks began in the late 1960s and lasted until about 1980. An investor in stocks during that period lost money due to inflation alone.

Diversification

Commercial timberland is affected by a different set of macroeconomic and market factors than other asset classes such as stocks, bonds, and real estate, the traditional mainstay of most investment portfolios. The addition of a low correlation timberland asset can expand the risk-to-return profile of any portfolio.

Why timber prices will continue to rise

Demand for timber is raising fast, especially from the emerging economies of China and India. One current forecast predicts that China’s urban population will increase from 530 million people to 875 million people by 2030. The equivalent of almost 50 cities the size of greater London will have to be constructed over the next 20 years to accommodate them, putting huge strains on global timber prices.

Global consumption of tropical hardwoods has also multiplied nearly 25 times in the last 4 decades. Populations continue to swell as more people seek to consume and live the middle class ideal. Around 40m acres of tropical forest are being destroyed each year to meet the demand for hardwood product and agriculture, of which little to none is being replaced.

International political pressure on forest protection is increasing, the invention of the Carbon Credit has created a value for living trees. This has a very positive effect on global climate change, however it will only seek to further enhance timber values through supply shortages, good news for forestry investors.

Green and ethical investment-biological growth

Aside from its carbon capturing properties, forestry is an incredibly green construction material. The table below demonstrates the amount of energy needed to create each respected construction material. Also by using sustainable timber the carbon within is locked up for the life of the project.

Aside from offering risk adjusted returns and portfolio diversification, timberland continues to add value due to the biological growth of trees at no extra cost unlike other real-estate assets, all the while sequesting carbon from the atmosphere. Trees grow in volume, size, and ultimately into increasingly higher-valued products.

For example, trees begin as lower-value pulpwood, then grow into low value saw timber trees (9 to 12 inches in trunk diameter) before maturing into high value saw timber (greater than 12 inches in trunk diameter).
As a tree grows into a larger and higher value product classes, the monetary value of the tree increases along with its carbon credit value. The effect of inflation and possible downward movement in timber prices is mitigated by volume growth; however what makes timber such an attractive investment is the effect of upward price movement is compounded by volume growth.

Timber continues to grow although at a slower rate as trees mature. This allows the investor to “warehouse” the timber “on the stump,” until such time as market conditions are optimal.

Timberland portfolio structuring to produce specific investment objectives

Timberland is an incredibly diverse asset and can be structured to meet different investment objectives. For example, higher cash flows can be achieved by including a higher proportion of more mature timber holdings such as teak.

If long-term gains are more important than regular cash flow, this goal can be achieved by acquiring young plantations and investing at the seedling stage for maximum long term uplift combined with high growth rates and intensive management techniques.
If the investors’ objective is a balance of cash flows with an emphasis on long-term appreciation, various timber age classes can be included in the portfolio to achieve this goal. In addition, investment returns can be improved with a variety of additional structuring and management options such as carbon credits, the use of leverage, selling selected properties that have real estate development potential or recreational use value such as shooting right.

In short, timberland investments have the versatility to be shaped through financial engineering to meet a variety of goals for both the institution and the sophisticated private investor. Its amazing how few investors have exposure to forestry in light of the above, a fact which won’t stay this way for long, double digit returns and tax benefits will attract a vast number of investors especially as the green revolution takes hold.

What the experts say

Tree growth averages about 8 per cent a year. “If the market goes up that is an added bonus [to the tree growth]. This is what makes timberland a safe investment,” says Liane Luke, head of timber investment at Four Winds, which manages specialist fund Phaunos Timber.

Bloomberg Wealth Management: Hardwood has quietly and consistently outperformed nearly all other commodities for the past 100 years

Another attraction of forestry investing is that when timber prices fall, there is still a “steady offset of the physical growth of the tree”, says Eva Greger, who runs GMO Renewable Resources, the large Boston-based fund manager that has been putting money into forestry since the 1990s.

For More Information on Forestry Investments Click Here

With the release of CO2 in to the atmosphere through deforestation responsible for 20% of global greenhouse pollution and recognised as practically the single largest contributor to global warming, Indonesia is recognised as the World’s largest greenhouse gas polluter through deforestation.

High levels of press exposure highlighting illegal deforestation in Indonesia for the purpose of Palm Oil plantations, which are also sideling potential food crops, Indonesia is under pressure to act fast. With over a billion tons of CO2 emissions from its forests and peatlands, Indonesia has pre-empted the UNFCC’s decision and officially issued national regulations on REDD allowing forest stakeholders, be they private organisations, local authorities or indigenous people, can all acquire REDD permits for projects that prove they prevent CO2 otherwise entering the atmosphere. More recently at the G20 summit in Pittsburgh, Pennsylvania,  President Susilo Bambang Yudhoyono pledged to voluntarily cut Indonesia’s carbon emissions by 26 percent by 2020 using the state budget, the first developing nation to do so.

Reducing emissions from deforestation and degradation, or “REDD” as it is known, is one of the most crucial topics to be addressed by the UN in Copenhagen this December. It is widely accepted by experts that limiting the rise in global temperature to 2˚C above pre-industrial levels (the level at which widespread ecosystem breakdown is forecast) will be almost impossible without REDD.

Once the International Panel on Climate Change present their findings in Copenhagen to the World governments it is hoped that necessary financial mechanisms will be implemented that correctly incentivise 3rd World governments such as Indonesia to not only protect existing rainforest but replant new forests. Only then will the Kyoto Protocol’s effective successor have taken the crucial action in attempting to mitigate climate change.

By planting 33.2 million hectares of trees and undertaking REDD programs, Indonesia could slash about 15 percent of its emissions and cut a further nine percent of its emissions by reducing forest fires in peat lands by 75 percent.

Should a large percentage of Indonesia’s current deforestation be prevented, and if REDD is accepted in to Kyoto’s existing CDM system, then the potential carbon credit trading value for Indonesia will run in to US$ bns. We only hope that in Copenhagen this winter the World’s governments can reach an agreement for this vital solution to global climate change, and financially motivate everyone to protect their forests.

Source: Communities to get paid through REDD & Indonesia first volunteer to emission cuts

“We’ve lost over half the forests on the planet, to give you an idea of the speeds they’re going, we lose about the size of 36 football pitches every minute – so that’s pretty fast.” Colin Butfield, head of Campaigns at WWF.

The biggest contributor to global greenhouse gases, the destruction of tropical forests emits more carbon dioxide every year than all the cars, planes, and boats on the planet – between 15 and 20% of global emissions. Its clear to see why conservationists turned economists are being dispatched around the world to work out a forest’s asset value and in turn create a new investment opportunity in the form of carbon credits.

“It is possible to calculate the amount of carbon in a hectare of rainforest to a reasonable amount of precision,”. Colin Butfield. Ground survey data is combined with satellite imagery to calculate the carbon stock, satellite pictures are then used to track the impact of any deforestation to create models for likely deforestation rates. That forest deemed to be under greatest threat that hold the most carbon are then worth the highest net value.

The resultant carbon credits issued for the protection of the trees can be traded on the voluntary carbon market. However most spectators myself included believe that Reduced Emissions for Deforestation and Degradation (REDD) will be accepted into the CDM in one form or another increasing both the demand and value of forestry stock.

London’s financial centre is the main home to the incipient global carbon market. Prof Heal believes that in a decade, the trade could be worth trillions of dollars and a report out already claims that the value of the market – which doubled in 2008 to £449m consists of carbon credits from offset providers and credits traded in the voluntary Chicago Climate Exchange cap-and-trade scheme.

Commodities traders are not the only ones who are seeing the potential in this new market, Sky Television wants to do its bit too. They have teamed up with the WWF to offer subscribers the chance to donate £10 to the Rainforest Rescue site which will help to protect around 500 trees iAcre Brazil – Sky will match every donation made, up to the value of £2m.

This is an exceptional piece of triple bottom line PR for Sky, they are genuinely doing good by protecting rainforest, they are creating massive PR for both themselves and a topic that is perhaps the most import threat our generation has seen and they are likely to receive a healthy income from the resultant carbon credits created.

It’s this type of model that shows companies can make a difference and a profit at the same time. Not to mention all the social implications of job creation in the area.

REDD is still in its infancy with regard being accepted as a global solution to climate change, this will change rapidly over the coming months and years. Those companies such as Sky acting now will see the benefits of this. If the dot com boom made millionaires of the geeks, it is now time for the conservationist and ecologist to plant themselves firmly on centre stage.

“Experienced timber investors will remain confident with their knowledge and understanding of the fundamentals that separate the timber market from other investment classes that have suffered so much recently.

With biological growth rates, relatively accurate forecasts can be made from historical data to predict a tree’s wood volume delivery rate. Considering the long slow and stable growth period between planting a seed to harvesting the asset, the timber market supply is therefore a relatively stable one.

Only in the past decade as a result of the construction industry boom has some instability crept in to the demand-side of the market, rallying the market and driving prices faster than previously expected. Some believe that due to the halt in construction a knock-on effect will make timber market values plummet, however a few crucial factors need considering that will prevent this occurring.

Timber growth is a long slow process and a housing construction crash now will not affect today’s timber production cycle in any way. Wood will either be harvested and sold at current slightly lower market prices, giving investors a slightly lower IRR when considering the number of years the investment is made, otherwise it will be stored rather than sold. Neither of these actions will directly drive prices down.

Timber plantations and investments also have a much lower gearing level than that of all other financial instruments during recent years, such as COO for equities and mortgages for real estate. Lower gearing within both the supply and demand-side of any market directly results in a much less volatile price market. With very little credit entering the marketing, rallying and driving prices and attracting price speculation, and subsequently deserting and in turn deflating the market, timber prices are so much more stable.

One more crucial difference between the timber markets and other investment assets is the ability to create complex financial instruments. In the equity markets all number of derivative and option markets, hedge funds and funds of funds, have skewed the perceived true value of the underlying assets and enabled the derivative market to become more “valuable” than the asset itself. In the real estate world, the off-plan investment model was devised that was dangerously exacerbated by off plan financing, further enabling re-writing of short-term contracts and falsely inflating market prices.

With global population growth at an unprecedented high, predicted to increase from over 6bn to 9.5bn in the next 40 years, there can be no question that demand on all basic human needs, including housing construction, will increase. Whilst new lower-carbon construction technologies are developed, the simple quality desired from wood products is undeniable and provides the long-term demand all wood investors understand.

Combined with the global forest protection programs being enforced by governments worldwide in an effort to reduce climate change, the long-term demand and price increase on reforestation and plantations that produce woods is an absolute certainty.”

Source: Forest funds outstrip equities and property