Timberland Investment
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Timberland Investment
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Benchmarking Timberland Investment Performance versus Equities, Bonds and Inflation

Benchmarking Timberland Investment Performance versus Equities, Bonds and Inflation | Timberland Investment | Scoop.it

How have private timberland investments performed relative to other asset classes? While this question opens the door to a series of follow-ups and potential binge drinking, we can leverage readily available data sets – including the NCREIF Timberland Indices – to introduce timberland’s relative performance for specific questions. For example, one of the most common attributes tagged to timber relates to its ability to hedge inflation. Given that inflation in the U.S. has been below 4% for 23 of the past 27 years (1988 through 2014), what have we learned?


To answer this question, we compare timberlands with investments in the S&P 500 (equities) and 10-Year U.S. Treasuries (bonds). For private timberland investments, we will apply annual data from NCREIF). The figure below highlights the relative performance of these three asset classes in different inflationary buckets. Overall, timberland outperformed the other assets on a relative basis in higher inflationary environments based on this data set. [“Net timber” refers to estimated returns net of asset management fees.]


The concept of hedging inflation with timber deserves attention. Remember that inflation is an indicator of something else: prices, values, costs and returns are rising somewhere for someone; somebody makes money when inflation rises. So, if some seek timber to hedge rising inflation, does the corollary apply? Should we leave timber when inflation remains low? Ultimately, the relative performance confirms the academic literature, which finds that timberland performs well for hedging “unexpected” inflation.

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Timber Forecasts, Inflation and the Price of Eggs

Timber Forecasts, Inflation and the Price of Eggs | Timberland Investment | Scoop.it

At times, when developing timber forecasts or reviewing timberland valuation models, we find that inflation is misunderstood. A single rising price of a single product or commodity is not inflation. Sawmills are making more money this year because lumber prices are higher than last year, not because of inflation, which tracks the overall price level. And yet, the real, relative costs and revenues affecting timberland investments and wood-using facilities do change over time at different rates and times. While cash flow estimates used to value potential investments include projections of future prices, we find honest confusion and common mistakes continue to plague the use of real and nominal rates and prices.


In developing timber forecasts in the U.S., we recommend quantifying historic relationships using nominal (stated) prices that include inflation, and then adjusting for inflation if necessary. Why? Because the basis of market clearing transactions and real-time negotiations between wood buyers and timber sellers at any point are the prices as known and stated at that time in each and every local timber market given the known and available supplies and technology. As noted by timberland appraiser Jeff Wikle, “Yesterday’s (timber) price is based on yesterday’s technology.” Based on our understanding of forestry markets, this is exactly correct.

Sam Radcliffe's insight:

This article includes notes from Dr. Mendell’s “Accounting for Inflation in Timber Forecasts” presentation in Portland at the 2013 “Who Will Own the Forest?” conference.

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Inflation Hedges That Pay Today

Inflation Hedges That Pay Today | Timberland Investment | Scoop.it

...a great antidote to deflation is current income: so investing in real assets that also provide yield is a double-purpose move.


There aren’t so many, but there are some. Timber is a favorite of Harvard, and, when you think about it, its easy to understand why.  It’s fully renewable, generates annual income, and has solid fundamental support: as the world’s middle classes grow, its use in homebuilding does too.


But maybe the most interesting thing about trees is the way you can “store on the stump.”  Instead of selling in a bad year, when the market down, you can just defer the harvest and let them get bigger.  With commercial real estate, a year of lost income is lost forever; not so with timber.

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Now, I know what you’re thinking: these all sound great, but how do I invest in them?  Well, first, here’s how not to: ETFs.  There are all sorts of “timber” or “agriculture” ETFs but they invest in public companies that own these sorts of assets, not the assets themselves.  That is a huge difference.  Investing in companies means investing in management teams, not assets; and it also means riding the general ups and downs of the market, which is definitely not the point.


Instead, you’ll probably have to go to less liquid formats to get the benefits of these inflation busters. Direct ownership, of course, works just fine. But traditional privately placed partnerships can be very attractive, since you probably want an expert to select and manage the investments for you (certainly you do with art), and you usually want diversification that pooled investment delivers.

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Hedge Timber Exposure Against Inflation

Hedge Timber Exposure Against Inflation | Timberland Investment | Scoop.it

There's something to be said for looking outside the box in terms of considering including asset classes in your portfolio. In the past, I've espoused the potential benefits of exposure to water, as one example.


Timber, a positive in portfolio construction, has historically had low correlations with more traditional asset classes, is another outside-the-box item


As an asset class timber has outperformed the S&P 500 over a bevy of time periods, and several challenging market environments, typically with a lower level of risk than equities.

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Real Interest Rates And Future Chaos

Real Interest Rates And Future Chaos | Timberland Investment | Scoop.it

The folks at Gresham’s Law just published a nifty interactive chart of real (i.e., inflation-adjusted) interest rates since the 1960s that explains a lot about today’s world.
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Since the 2008 crisis the real rate of interest has been mostly negative, which accounts for the global boom in real assets. For someone with access to borrowed money it now makes sense to use it to buy fine art, trophy real estate, farmland, and other things that governments can’t create more of. All of these things are in raging bull markets, implying that the smart money is responding to negative interest rates exactly as you’d expect.


So what now? History as depicted here says the borrowing binge/asset bubble continues until real rates spike, either because nominal rates soar or inflation plummets. It also implies that the phase change, when it comes, will be sudden. Looking at 1975, 1980 and the volatility since 2007, it’s clear that a financial system based on fiat currencies is inherently unstable — i.e., incapable of finding a stable price for money. So the least likely scenario is a return to a nice, placid world of “normal” interest rates.

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Academic paper questions merits of property as inflation hedge; timberland an exception

Academic paper questions merits of property as inflation hedge; timberland an exception | Timberland Investment | Scoop.it

Property and energy infrastructure assets only offer weak or no inflation protection to investors, new research funded by Deutsche Asset & Wealth Management has demonstrated.


According to a paper examining the return on direct investments in real assets by KJ Martijn Cremers of the University of Notre Dame, only commercial real estate was able to prove a real link between inflation and returns.


Cremers' research examined returns on timberland, farmland, infrastructure and commercial real estate in a number of areas, including correlation with other asset classes, downside risk and real assets' ability to hedge against inflation.


The paper concluded that, with the exception of direct investment in timberland, real assets were unable to offset inflation over the entirety of the study from 1978 to 2012.

Sam Radcliffe's insight:

The paper also addresses the diversification benefits of timberland and farmland. From the final paragraph: "...the diversification benefits of direct investments in natural resources were much lower in times when equity markets went down. This could be explained by liquidity shocks being correlated across markets, or more generally that institutions are much less likely to invest in illiquid securities such as direct investments in timberland and farmland during times of sustained negative equity returns. This illustrates the significant challenge of investing in all of these real assets, namely dealing with illiquidity, generally long holding periods, and information uncertainty." 


Since the NCRIEF index was used as the proxy for timberland returns, I would also point out that at least some of the non-correlation to equity markets is due to the source of the index -- some independent timberland appraisals, a few transactions, and some internal TIMO valuations. There is considerable lagging and/or "smoothing" of timberland returns due solely to the methodology of the index.

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Assessing the Inflation Hedging Ability of Timberland Assets

Assessing the Inflation Hedging Ability of Timberland Assets | Timberland Investment | Scoop.it

Authors: Wan, Yang; Mei, Bin; Clutter, Michael L.; Siry, Jacek P.

Source: Forest Science, Volume 59, Number 1, 23 February 2013 , pp. 93-104(12)


Inflation hedging is one of the unique features of timberland assets that attract timberland investors. This study uses Fisher hypothesis and capital asset pricing model under inflation to analyze how effectively private- and public-equity timberland assets hedge actual, expected, and unexpected inflation in the United States over 1987 to 2009. Rolling regression is used to evaluate whether timberland assets can persistently hedge inflation, whereas the state space model is used to examine the time-varying inflation hedging ability. Empirical results suggest that private-equity timberland assets do hedge actual, expected, and unexpected inflation, whereas public-equity timberland assets are not consistent in hedging actual, expected, or unexpected inflation. Hedging effectiveness depends on the state of the economy. We find that private-equity timberland assets are effective in hedging inflation during the boom and less effective during the recession. Investment horizon also plays a significant role in timberland inflation hedging. The longer people invest in the private-equity timberland assets, the stronger and more consistent the hedging ability holds.

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