But for those with a long-range perspective, timber is an alternative asset class that can provide diversification and sustainability, in addition to solid performance. In fact, during the past 20 years the NCREIF Timberland Property Index – the key American indicator for measuring timberland performance – yielded returns averaging 15%, significantly exceeding stocks and bonds. And with demand on the rise, the outlook for continued performance is good.

Sybille Borner-Schweizer, a senior equity analyst for the Swiss-based SAM (Sustainable Asset Management) AG, has a positive assessment regarding timberland investment yields. She reasons demand for industrial timber and wood fuel is on the rise, and its popularity as a material for home furnishings and residential construction is growing. Additionally, she believes that over the long term this renewable raw material could potentially compete with dwindling oil resources as a fuel source.

Projections aside, an advantage is that timber correlates only slightly with other investments, making it superb for diversification. The NCREIF Timberland Property Index had a correlation of just 0.22 to the S&P 500 Index from 1987 to 2007. “For me,” says Borner-Schweizer, “it’s more important to reduce risk while maintaining the expected yield by diversifying the portfolio through the addition of unlisted securities.”

Claus Jørgensen, head of equities of Danish PKA, the collective pension scheme for employees in the public social and health sectors, also finds timber investments interesting from a portfolio point of view: “It’s a good diversifier – and we also get good returns.” PKA started investing in timber in 2005, by now investments have reached a market value of $375 million, about 2 % of the total portfolio.

Good returns are a factor of scarcity. Despite reforestation projects, trees need at least 20 years – often up to 100 – before they can be harvested. Yet, the scarcity is a factor that guarantees the escalation of prices, with very little risk. Gerda Smits, spokeswoman of PME, the Dutch industry-wide pension fund for the Metalektro industry, explains: “When the market environment is unattractive, the manager will decide to cut less than projected. Subsequently, more timber can be harvested when timber prices have improved again. Also, when trees grow they increase in value as they move from the ‘pulp & paper’ to the ‘lumber’ category.” In 2006 PME entered into timber with two investments in the US, which are now worth close to €500 million ($6.2 million), representing 2.6% of PME’s portfolio.

“Two things are important when it comes to investing in timber: time frame and liquidity, or the ability to sell shares as needed,” explains Borner-Schweizer. Investing in timberland ties up a great deal of capital and requires expert knowledge. Alternatively, publicly traded timber companies can be too risky for some. The growing popularity of timber has led to more opportunities such as open-ended certificates for the entire investment chain. Danish pension funds PKA uses the services of a gatekeeper, the International Woodland Company, to invest in timber, while Dutch PME also uses limited partnerships to make timber investments in funds. But overall, due to the long time frame need for timber, the asset class is dominated by closed-end funds.

Timber’s promise of sustainability is also part of its growing importance as an investment product, particularly for fund managers who must adhere to ESG investing principles. However, timber investments are only sustainable if logging practices are subject to strict environmental criteria. Contrastingly, illegal or uncontrolled clear-cutting in developing countries such as Indonesia and Brazil has a horrendous environmental impact. “It is possible to sustainably utilize natural forests, including tropical rainforests, and operate timber plantations sustainably as well,” asserts Borner-Schweizer. “Of course, production methods must be assessed on a case-by-case basis, but certification systems can provide important information.”

For many, the Forest Stewardship Council (FSC) seal is the only certificate with any relevance. Frankfurt-based Caudex Capital has certified its plantations in accordance with the standards of the FSC. PME is also making sure investments are sustainable: “ESG criteria from PME are incorporated in the contracts, plus we have a contractual obligation to pursue FSC,” says Smits.

Choosing countries that regulate logging in accordance with strict criteria, as well as companies that are required to engage in reforestation, should be the goal of those seeking to invest sustainably. Canada is one such country. In spite of most of Canada’s forests being government property subject to stringent conditions, profits can be made. In 2005 Canada, the largest exporter of timber products, had 16% of the global market. Even so, the North American boreal forest, one of Canada’s key economic engines, remains one of the largest contiguous, healthy ecosystems left in the world.

Accordingly, Tembec, one of the top 10 Canadian timber companies, has sought FSC certification for all its timberlands. “This certification demands far more than simple adherence to the law,” the company states, “but we believe these efforts will certainly pay off due to increasing market demand.”

Borner-Schweizer agrees. “The pressure on companies that engage in non-sustainable practices can be expected to grow, easily leading to higher costs, including capital costs,” she says. “It isn’t clear how much these assumptions are reflected in their financial performance, but I suspect there is more leeway for higher yield expectations regarding investments in sustainable companies.”

But there are risks. Despite the fact that timber company stocks should be classed in the defensive segment, they are subject to economic movements, as evidenced by recent timber indices. “Even timber can’t avoid the crisis,” states Markus Jakubowski of France’s Société Générale Bank, which offers the Timbex Open-End Certificate (Timbex) consisting of up to 15 large companies. “Almost every asset class has lost value as a result of the financial crisis.”

Many companies in the indices are based in the United States, so investors also incur exchange rate risk. Further, US and Canadian timber companies produce products mainly for residential construction, which makes them dependent on the real estate market which is in crisis.

Despite all this, Dutch pension fund PME still has high expectations for timber investments: “In the coming years, we expect a return of just under 10% in the US given the maturity of the market. Outside the US, returns above 10% are foreseen, given the fact that the non-US timber industry has not reached the same maturity and efficiency, providing upside potential,” says Smits.

Jørgensen of PKA is also convinced. PKA’s returns on timber investments look to reach about 1% to 2 % above investments in government bonds. For the future Jørgensen expects returns for some of the investments in emerging markets of up to 5 % above government bonds. Jørgensen comments, “It is simply not an asset class where you should look at a single year – it’s a long-term investment and even now we are still getting reasonable returns.”

Published by PROJECT M in June 2009