Nature of Forestry Assets
Forestry, or 'timberland' as it is known in the USA [1], is unusual in several ways as an asset class:
- Forestry is a physical asset which, unlike other property, has not traditionally generated a leasing income, except perhaps for sporting purposes. Its value has been derived from the timber growing on it and underlying land value.
- Investment in forestry in the case of ‘pure commercial’ plantations is therefore primarily a commodity play, driven by the international price of timber [2].
- Unlike other property assets, a forestry asset enjoys inherent organic growth. To a large extent this growth can be managed to maximise value.
- Further features of forestry investment are that it is long term, uncorrelated with equity and commercial property markets, and can be structured to produce regular income.
- Forests are finding new roles in developing environmental markets, such as carbon credits, wind energy and biomass which are adding to their value (renewable energy).
- One might also add amenity to that list as well as biodiversity, landscape and other environmental benefits which are seldom individually valued [3] but rather built into the overall market value upon sale.
These are unusual characteristics compared with other asset classes, hence offering benefits to many institutional and private investors and which are further explained below.
Special Qualities of Forestry Investment
Portfolio Diversification
One major feature of forestry investments is that they have been shown to non correlated or to have a very low correlation with stocks and bonds [4]. As a result, Forestry is considered to have strong diversification potential and to be capable of reducing an investment portfolio's overall risk [5].
Although we are not investment advisers, we observe that forestry generally forms a minor element of an overall investment portfolio, perhaps no more than 5-10% as a maximum.
Liquidity
Directly purchased forestry assets are less liquid than many other investments. However, the liquidity of forest land can vary tremendously, and is strongly influenced by the age and merchantability of the timber growing on it. Young forests are generally less liquid than mature forests. However, this creates a potential opportunity for investors willing to purchase young forests at discount prices, hold until the crop approaches maturity, and then sell at a premium.
Certain forestry investments such as COEIC or ‘closed end’ funds and Exchange Traded Funds (see section 4 below) are traded daily on markets such as the London Stock Exchange and Alternative Investment Market (AIM).
Some investors such as pension funds take a longer term approach and they may take less liquid holdings in forestry such as direct land purchases or through large TIMO-managed assets [6].
Similarly, investment trusts such as ‘Close Trading Companies’ [7] can take a longer term view as they are seeking long term growth, sheltered from UK Inheritance Tax, for their investors.
Inflation Protection
Forestry is considered a hedge against inflation for two reasons: firstly, because of its finite supply and, secondly, through its inherent organic growth. Recent studies have shown forestry to be very potent as an inflation hedge [8].
UK Tax Treatment
The tax treatment of forestry investment in the UK recognises the long term nature of the investment. All income from timber sales and other income generated from ownership of commercial woodlands is free of income tax. Growing timber is exempt from Capital Gains Tax (CGT); moreover, CGT liabilities arising from sale of business assets can be ‘rolled over’ into commercial woodland purchases.
For individuals investing with the ultimate benefit of their children in mind, forestry is particularly attractive as, after two years of ownership, it qualifies for 100% Business Property Relief from UK Inheritance Tax.
Sustainability
As one of the most plentiful and relatively easily renewed natural resources in the world, reliance on wood is likely to increase with developing technology, as replacement of wood with other materials will become more environmentally costly. In spite of many examples of unsustainable logging activity around the world, forestry can be managed on a sustainable basis i.e .without risk of long term degradation to the environment. Certification standards such as FSC have been developed to provide an internationally understood framework against which sustainability can be measured.
Overall, the forestry industry in the USA and Europe has successfully balanced sustainability with timber production since the mid 20th century and, indeed, the US standing timber inventory more than doubled between 1953 and 2003.
The widespread use of Conservation Easements in the north-east USA in particular has led to large tracts of forestry being productively managed to sustainability principles, further assisting the environmental sustainability of timber production.
Summary
In summary, forestry investments provide steady organically based growth and low volatility. These characteristics, along with the low correlation with equities, bonds and commercial property, give the asset class an important diversifying and risk hedging quality that can be exploited in multi-asset portfolios.
Forest and forest-related investments also offer environmental sustainability, a feature much in demand today.
- These terms are taken to include both forestry plantations and managed semi-natural forest.
- We are not including here the purchase of many lowland, broadleaved woods in the UK, where market value is heavily influenced by its amenity and recreational qualities
- A significant exception is Conservation Easements in the USA. See section 7 herein.
- RG Ibbotson and C L Fall, “The United States Market Wealth Portfolio: Components of Capital Market Values and Returns 1947-1978”, Journal of Portfolio Management 6, No. 1 (1979):82-92.
- F.C. Zinkhan, W.R. Sizemore, G.H. Mason and T.J. Ebner, Timberland Investments, Portland, Oregon: Timber Press, 1992.
- Timber Investment Management Organisations (‘TIMOs’): Pension Funds and other institutional investors are able to invest in the approximately 20 TIMOs based and traded in the USA and Australia. These companies purchase and manage global portfolios of forestry assets on behalf of their institutional investors.
- Managed by Close Aset Management
- Forest Research Notes, Vol 4, No. 3s rd Qtr 2008, Forest Research Group, Rowley, MA, USA.
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