by Aaron Levitt | October 26, 2012 7:30 am
No wonder investors have been clamoring for all things commodities: Inflation is expected to rise over the next few years as central bank easing programs come to a head and emerging markets continue their blistering growth. Commodities have become a more widely accepted part of every investor’s portfolio, and the benefits of commodity investing have been well-documented in recent years.
From gold to corn, portfolios are now stuffed with various natural resources, and funds tracking the sector have exploded in popularity.
Yet, when most investors think of these assets, big-name commodities come to mind. However, a number of other options present equally compelling investment potential. One can be found simply by taking a walk in the woods.
With the U.S. housing market still in the earliest stage of a rebound, lumber seems like an unlikely commodity portfolio candidate. However, this often-ignored asset class could be the key to long-term, inflation-beating returns.
As an investment, timber is as boring as it gets. But that sleepy demeanor is how the asset class rouses a portfolio. When lumber prices are low, companies can withhold harvesting logs. When prices rise, they not only profit on the higher log price, but they make more money per tree since the tree has grown. On average, a forest grows by 7% each year.
This steady nature has been benefiting the sector for decades. The National Council of Real Estate Investment Fiduciaries Timberland Index has generated an average annual return of 14%, compared to 9.4% for the S&P 500, from 1987 to 2009.
Timber’s stable returns are even more impressive during periods of high inflation and market panics. Between 1973 and 1981 — America’s last major inflationary period — timberland values increased by an average of 22% per year. Inflation averaged roughly 9.2% during that time. As for market panics, timberland soared roughly 200% during the Great Depression and more than 9.5% during the recent 2008-09 recession.
Stability aside, there could be some real growth opportunities as well.
Global demand for timber continues to rise and is expected to double over the next three decades. Asia remains the catalyst for this growth with China and Japan leading the way. According to a research paper by RISI, Chinese demand for timber in 2011 reached record levels. Analysts predict that China will need to import about 182 million cubic meters of wood by 2015, an increase of 70% from its current level.
At the same time, as Japan continues rebuilding after the tsunami and Fukushima nuclear disaster, its timber imports are rising as well.
Another boost for timber lies in the shrinking supply of forests around the world. Though lumber is a renewable resource, global forestland acreage is dropping on an annual basis — via farmland cultivation and pests like the Asian longhorn beetle and pine beetle. That’s making wood more scarce, which could lead to global price jump.
Let’s also not forget a nascent recovery in the U.S. housing market. Lumber has risen about 27% this year as homebuilding picks up again.
While institutional investors will often invest in timber management organizations (TMOs), which own and manage forestland and profit when they sell logs, most retail investors can’t participate in these transactions. The average initial investment for a TMO is in the $1 million to $5 million range, with a 10- to 15-year lockup period.
However, there are some ways to gain timber exposure, although those methods aren’t a perfect 100% correlation to the asset class. However, they come pretty darn close and can yield big portfolio results.
The first is through exchange traded funds. While no timber futures-focused ETF is on the market, there are two broad timber equity funds to choose from: the iShares S&P Global Timber & Forestry Fund (NASDAQ:WOOD) and Guggenheim Timber (NYSE:CUT). Cute tickers aside, both funds track the entire timber spectrum, including forestland owners as well as companies that sell finished goods such as paper and packaging.
Investors looking for more “oomph” may want to consider the Guggenheim ETF. CUT features a more concentrated portfolio — at 25 holdings — as well as a higher percentage of emerging market and international stocks. WOOD features a bigger weighting to REITs and domestic firms, and pays a much larger dividend at 2.3%.
The tax-advantaged structure of REITs is growing in popularity for timber assets. Giant Weyerhaeuser (NYSE:WY) was the latest firm to make the transition. However, the trio of Plum Creek (NYSE:PCL), Rayonier (NYSE:RYN) and Potlatch (NYSE:PCH) all offer large land holdings, steady cash flows and high dividends. While they have other operations outside of straight growing and sawing logs (Rayonier has a high-tech performance fiber division), timber REITs are as close as it comes to woodland investing for regular Joes.
Overall, this group makes a great starting point when thinking about adding timber to a portfolio — something long-term investors should seriously consider doing.
As of this writing, Aaron Levitt is long PCL, RYN & PCH.
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