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From Special Report: Timber Investing - March 2012

Preparing for timber falls

While investing in timber has much potential, the risks involved also need careful consideration beforehand

By Nyree Stewart | Published Mar 26, 2012 | comments

Timber investments are becoming more popular as investors look for alternative sources of returns following extreme volatility in traditional markets.

Timber appears not only to be uncorrelated to other asset classes, but it also acts as a hedge against rising inflation due to the close correlation between timber prices and overall prices in the economy.

However, when investing in timber, through whatever type of vehicle, investors should consider the returns they are aiming for, the risks they will tolerate and what end market suits their needs. Timber, according to FIM Services, has essentially seven main markets: construction, packaging, pallets, fencing, panel board, paper and biomass for energy and heat.

Not only do you need to consider the eventual use of the wood, you also need to decide what region you want to invest in, as data from the Earth Policy Institute suggests that in 2010 forest covered 4.03bn hectares of the world – approximately 30 per cent of the total land area.

Commercial woods

Hugh Humfrey, partner at Timberland Investment Resources (TIR) Europe, says: “As an investor, we focus on commercial woods, those that have a genuine commercial market and that can be both softwoods and hardwoods. [These] can come from anywhere in the world, from plantations or from natural forests, so there is a huge opportunity.

“It depends on what the investor’s risk/return goals are, because if they’re lower – single figure returns – they can get those from the developed markets such as the US. If they’re looking for higher returns, then they’ve got to move into some of the more opportunistic regions, such as central Europe, some parts of South America and south-east Asia. The higher up the return spectrum you move, the less likelihood there is of having developed infrastructure, on-the-ground skills, the abilities to access markets and the abilities to move wood.”

Liane Luke, chief timber officer of the Phaunos Timber fund, says: “Probably the most readily available investment woods are pine, fir, and eucalyptus. Teak is becoming more available in plantations in the past 10 years, and poplar as well. It’s all about delivering to the market what it wants, and these woods are popular investments because they have many commercial applications and can be grown readily in plantations.

“Other popular investment hardwoods, such as mahogany, maple, and oak, are typically grown in natural forests, and although they may have more narrowly defined target markets, can be very valuable.”

Ms Luke also points out another issue to consider is the rotation length of the species. Some trees can take 200 years to grow to maturity, others are harvestable in seven years, or even less.

“It depends on the species, the location and the intended product application. The amount of time it takes to bring the tree to harvest is factored into the sales price by your manager.”

In the UK, one of the main drivers of the market is the tax advantages of the asset class, including 100 per cent relief from inheritance tax (IHT) after two years, with the most popular wood being softwood conifers.

Anthony Crosbie Dawson, portfolio manager at FIM Services, an investment firm specialising in sustainable forestry and renewable energy, explains: “Major advantages are tax incentives – no IHT and no CGT on increase in value of timber and no income tax when selling trees – and the physical growth of real assets. Softwood conifers are the most productive in the UK as they have the shortest rotation – 35-45 years for Sitka spruce, the quickest growing, versus 120 years plus for hardwood broadleaves such as oak and beech.”

The risks for timber can be divided into systemic risks, or risks to the market as a whole, and non-systemic risks, arising from the management of individual assets. The former include regulatory and policy risks, biological risks such as fire and disease, and prices that do not behave as expected.

Mr Humfrey explains: “The way one tries to mitigate it is by not having all your eggs in one basket. You diversify your holdings by region, by geography, by tree species, by maturity of trees and by end use markets, so that with a bit of luck and a bit of skill, if something is depressed in the market then your entire portfolio is not depressed.

“The classic example [of price risk] at the moment is the disastrous US housing market, and that has a significant impact on pine prices in the US, which are definitely down by quite a long way. But there are other parts of the US which are very buoyant, such as the Pacific North West region, which exports significantly to China and south-east Asia.”

In terms of non-systemic risks, Mr Humfrey points out there is the risk of a timber manager not doing a good job, and also inventory risks.

“If you imagine a modest timberland property might be 10 times the size of Hyde Park, you’ve got a lot of trees there. If you think you’ve either got more or less than you’ve actually got, whatever you do for the next 10 years, you’re never going to be able to catch up. So the amount of due diligence you do before you buy something is very important.”

However, one of the obvious advantages of investing in timber is that the trees continue to grow regardless of exogenous events.

Ms Luke adds: “No matter how volatile or bearish the overall markets are, trees continue to add volume, and since the primary driver of value is “price times volume,” this is important.

“Because you can ‘store’ timber on the stump – delay harvest until you choose to sell the wood at favourable pricing levels – timber can provide capital preservation. The investor doesn’t have to take the spot price at the end of a growing season, or rent storage. The investor can let the trees grow for another season if he chooses.”

Nyree Stewart is deputy features editor at Investment Adviser

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