From aiCIO Magazine's February issue: Paula Vasan reports on the lure of a New Zealand forest.
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What do a tree and an endowment fund have in common? It sounds like the start of an awfully bad joke, doesn’t it?
Answer (drumroll, please): They’re both in it for the long term.
OK, so it is a really bad “joke,” if you can even call it that, but it explains the growing (pun intended) attraction among institutional investors toward timber and agriculture to add to their diversification and return needs. And if the saying “money grows on trees” is true, forestry must be a good bet.
The National Council of Real Estate Investment Fiduciaries has asserted that in the United States, timber returns between 1987 and 2010 have averaged about 15% a year—compared to 11.5% for the S&P 500—while exposing investors to less risk. Meanwhile, in the United Kingdom, the average annualized return for the Investment Property Databank UK Forestry index for 10 years is 10.4%.
Harvard Management Company (HMC), the manager of Harvard University’s US$32 billion endowment, has been one of the most visible institutions in its recognition of the asset class. Its endowment fund lost roughly $10 billion in 2009—a -27% return that forced the fund to brainstorm ways to recoup that painful dent. The solution was found (at least partially) in timber. More recently, as of October 2011, its endowment made an 18.8% annual return on its natural resource portfolio, which included majority ownership of the cutting rights to New Zealand’s Kaingaroa forest. (HMC purchased the forest in December 2003 for about $650 million.)
“A forest in the South Pacific might seem like an odd investment for America’s oldest university, yet this timber symbolizes what the Harvard endowment has become: one of the most sophisticated and diversified portfolios in the world,” aiCIO’s Kip McDaniel wrote in the summer of 2009. “Fixed-income and equities are the traditional bastions of endowment investing, yet it is among the fissured bark and needle-covered ground of this foreign forest that the recent history of HMC can be told. It is here, among these towering pines, that we can begin to see how the shift into such alternative investments may have caused the endowment to…catch a cold in today’s turbulent economic climate.”
However, Harvard may be giving up a little of its “timber edge” as other institutions swoop in for a piece of the forest. In December, the Public Sector Pension Investment Board of Montreal and the New Zealand Superannuation Fund agreed to purchase stakes of 30% and 1.25%, respectively, in the Kaingaroa from HMC. The New Zealand fund, which initially took a stake in late 2006, increased its 20% stake over two years. Its current 40% stake in Kaingaroa—a 178,000-hectare forest estate—is the fund’s largest single investment, accounting for roughly 4.6% of its overall portfolio as of October 31, 2012. “We like the asset class because of the diversification benefits it gives us. Kaingaroa is a large contiguous forest that has its own road network, is close to ports, and is one of the world’s best plantation forests,” Matt Whineray, general manager of investments at the fund says.
On the other hand, for institutional investors with large amounts of capital to deploy—such as insurance companies, pension funds, and university endowments—the drawbacks of timber and agriculture investments stem from a lack of large-scale access to land ownership. “Foreign investment rules are more restrictive with timber and farmland, so there’s a lack of qualified investments. It’s hard to find the scale we want, particularly in farmland,” Whineray says, noting that the sector is highly illiquid, with investors advised to be prepared to hold onto timber investments for decades at a time.
Another challenge Whineray underscores is the lack of available data devoted to timber and farmland. “There’s just not as much data available as listed asset classes. So finding the data you need to sustain an investment case can be a challenge.”
So, is the hype justified?
It could be that investors are simply feeling the pressure to own a slice of the pie before others do—a forestry arms race, some say. Institutional investors, however, will tell you that timber and agriculture investing is a pristine hedge against inflation, largely due to the fact that such investments are uncorrelated to global equities. Indeed, as of September 2012, Jeremy Grantham—the co-founder of Boston-based investment firm GMO Capital Management and the man who in 2006 predicted the housing crash—noted that he predicts timber prices rising 6.5% each year for the next seven years.
There’s nothing funny about returns like that.