Active Management of Timberland Investment Portfolios

Background

The unique nature of timberland investment properties permits investors holding such properties to meet a very wide range of investment objectives. Some seek the preservation of capital through the ownership of real assets, while others are willing to sacrifice financial returns to preserve wildlife habitats or ecosystems. Most institutional and private investors in timberland assets, however, hope to obtain a competitive financial return as might be obtained from actively managed portfolios of real estate or security assets. Unfortunately, active management of timberland investment portfolios has been the exception rather than the rule in the sector, with some managers having a “unit investment trust” mentality by constructing a portfolio of assets and holding them in place throughout a 10-15-year fund investment period. The lack of turn-over of assets can be attributed to many factors including the extended period of time it generally takes to transact timberland properties, and fund structures that discourage the reinvestment of capital. Although timber and timberland markets change at a snail’s pace relative to equities, they do change, and passive management of timberland investment properties has likely hurt financial returns in this sector.     

Timing Matters

It is very difficult to time timberland investments as transactions can take months to complete, and liquidity can be a constraint in emerging markets. Nevertheless, timing matters. An internal study by ForestEdge LLC used historical delivered timber prices in several countries between 1995 and 2016 to model the potential financial performance of U.S., and U.S./International timberland investment portfolios during this period. Although the analysis was based on delivered timber prices and only captured changes in timber prices, biological growth and shifts in product classes, the results showed that a U.S. South portfolio purchased for a sum of the parts value in 1995 and held until final harvest in 2006 increased in value at an annual rate of 9.52% in real terms over that period. If the same portfolio was purchased in 2000 and held until 2011, it’s rate of increase in value fell to 8.42%/year over that period(1). Conversely, a portfolio consisting of timber assets in the U.S. South (50%), Brazil (20%), New Zealand (20%), and South Africa (10%) increased in value at a rate of 12.09%/year if acquired in 1995 and sold in 2006, but 15.60%/year if acquired in 2000 and divested in 20111. Although some of the change in value reflects changes in currencies, the result also reflects non-correlated changes in regional market conditions and timber prices. These figures do not reflect actual portfolio performance, but theoretical performance based on delivered timber prices, biological growth and shifts in product classes. Nevertheless, the analysis clearly shows that timing matters.     

Structuring for Active Management

Recognizing this problem, the timber investment sector has slowly moved in the direction of greater liquidity through timber REIT’s, open-ended fund structures and an increasing proportion of separate accounts. Further movement is needed in the development of secondary markets for shares in co-mingled funds, and in more uniform platforms for timberland asset transactions.

However, there is still a reluctance to turn assets within a timberland portfolio by some managers, but there are steps that an investor can take to encourage and perhaps facilitate more active management; They include:

  • Careful selection of timberland investment properties and detailed due diligence of not only timber markets (a poor understanding of regional timber markets is the primary cause of timberland investment underperformance), but also the market for timberland transactions. Geographies with established investment platforms (legal, operational, and regulatory structures known and in place) will enable a faster turn of investment assets,
  • Holding assets within separate accounts, rather than co-mingled funds, and insuring that account documents encourage active management (selling and buying) if maximization of financial return is the objective of the investor, and
  • Regular and aggressive hold/sell analysis using objective price and cost projections to ensure that capital gains are realized, and assets liquidated from the portfolio that are not expected to meet return requirements of the investor.

While it is not likely that timberland markets will ever achieve the liquidity of equities or even real estate markets, more active management of timberland portfolios should improve the efficiency of the timberland investment market. This, in turn should broaden the appeal of the asset class, and reward those able to discern market trends and valuations.

R. Hagler
May 2017

(1) Based on historical market/index performance and is not indicative of future performance or expected investor returns.

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